UK Crypto Yield Farming: HMRC Tax Guide [2024]

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Cryptocurrency has taken the financial world by storm, especially in the United Kingdom, where 4.97 million enthusiasts, a remarkable 10% of the population, are actively engaged in decentralized finance (DeFi) strategies. Each month, crypto investors in the UK embark on a path to achieve financial freedom, staking their digital assets and reaping extraordinary rewards. 

However, amidst the excitement, a crucial question demands attention: Are they or you aligning with the latest crypto tax regulations imposed by HMRC? If not, Be aware the Tax man is about to knock on your door.

In this extensive guide, we'll delve into the nuances of UK Crypto Yield Farming, exploring its various facets and shedding light on how HMRC views these dynamic activities and how crypto tax tools like Kryptos can help you stay compliant.

We're only covering UK Yield farming taxes in this guide, if you want to learn more about crypto tax in the UK generally, check out our Ultimate UK Crypto Tax Guide.

The Landscape of UK Crypto Yield Farming

Layers of Yield Farming

Yield farming, a strategic play within the DeFi ecosystem, empowers crypto investors to optimize their passive earnings by leveraging various protocols. These protocols, ranging from decentralized exchanges to lending platforms, staking, and liquidity mining, create a complex yet potentially lucrative landscape.

Understanding Composability

One of the key features that sets DeFi apart is composability. This term refers to the interoperability of different protocols, allowing users to stack them together for amplified returns. The synergy of these protocols is the engine behind the yield farming strategy, where investors strategically utilize multiple platforms to maximize their profits.

Key Platforms and Tokens

For those venturing into yield farming in the UK, key platforms include Uniswap, Compound, and Curve. Tokens such as UNI, COMP, and CRV are highly favoured among enthusiasts, signifying the popularity of these platforms in the DeFi space.

Essential Components of Yield Farming

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1. Decentralized Exchanges (Dexes): Platforms like Uniswap serve as hubs for trading various cryptocurrencies. The liquidity providers on these exchanges are generously rewarded for their contributions.

2. Lending Platforms: Protocols like Aave and Compound offer a seamless way for investors to earn passive income by depositing their capital and earning interest and potentially governance tokens.

3. Staking: Staking protocols, a popular method for earning interest on Proof-of-Stake cryptocurrencies, provide an avenue for investors to keep more of their rewards, thanks to non-custodial models.

4. Liquidity Mining: The process of adding and removing liquidity from pools, earning rewards in the form of tokens or interest. The complexities arise when these rewards are treated differently based on their nature.

HMRC's DeFi Tax Framework

HMRC has acknowledged its presence and has offered initial guidance on how it plans to tax various transactions. The challenge lies in interpreting and applying existing crypto tax rules to yield farming.

The Nature of Transactions: Income vs. Capital

HMRC classifies crypto transactions into two main categories: income and capital. The classification dictates the tax treatment, with disposals subject to Capital Gains Tax and revenue-oriented activities subject to Income Tax.

Potential Tax Liabilities for UK Crypto Investors

To better understand the tax landscape, let's break down some common DeFi transactions and their potential tax implications:

1. Swapping Crypto on Dexes: This activity is subject to Capital Gains Tax, reflecting the disposal of assets.

2. Adding/Removing Crypto from Liquidity Pools: Typically subject to Capital Gains Tax*, with the liquidity pool token inheriting the cost basis of the added capital.

3. Earning New Tokens through Liquidity Mining: Subject to Income Tax* if received in return for deposited capital.

4. Staking Rewards: Tax treatment is dependent on the specific protocol*.

5. Yield Farming: Tax implications vary based on the protocol*.

6. Lending Platforms: Tax treatment is dependent on the specific protocol*.

7. Crypto Margin Trading: Subject to Capital Gains Tax.

8. Crypto Derivatives: Subject to Capital Gains Tax.

9. Selling NFTs: Potential Income Tax for created NFTs, Capital Gains Tax for purchased NFTs.

10. Play-to-Earn Rewards: Subject to Income Tax.

*HMRC is currently reviewing the tax implications of these transactions.*

An In-Depth View of Specific DeFi Activities

Crypto Loans: Navigating the Tax Terrain

Lender's Perspective:

When lending out crypto, the lender triggers a disposal, making them subject to Capital Gains Tax. Calculating the capital gains involves determining the amount of crypto received in return for the loan.

Borrower's Perspective:

For borrowers, the loan is treated as an acquisition, and any interest payments are considered allowable expenses. When repaying the loan, it becomes a disposition, subject to Capital Gains Tax.

Staking

Staking rewards are viewed as miscellaneous income, subject to Income Tax. Additionally, new HMRC guidance suggests that the crypto assets being staked may also be subject to Capital Gains Tax.

Yield Farming

Yield farming has become a buzzworthy term in DeFi circles. Broadly speaking, it involves strategically investing in crypto assets to yield the highest returns, be it in the form of tokens, interest, or transaction fees. The complexity arises from the need to strategically stack different crypto investments to unlock the largest rewards.

Liquidity Mining

New HMRC guidance indicates that adding and removing liquidity from pools is subject to Capital Gains Tax. The liquidity pool token received in return inherits the cost basis of the added capital. Rewards earned through liquidity mining are also taxable, with the nature of the reward determining the tax treatment.

Crypto CFDs

While HMRC has not provided specific guidance on Crypto CFD trading in the DeFi market, it is likely subject to Capital Gains Tax. Investors engaging in derivatives, margin trading, and leveraged trading should seek advice from tax professionals, considering existing guidance on traditional financial markets.

Gas Fees: Allowable Expenses in the Tax Equation

HMRC has provided clear guidance on allowable expenses, including transaction and transfer fees. These fees can be added to the cost basis, reducing the overall taxable amount.

Wrapped Crypto: Swapping and the Disposal Dilemma

In instances where wrapping coins is necessary before depositing them into a smart contract, HMRC has not yet offered clear guidance. However, as this involves swapping one coin for another, it is likely to be viewed as a disposal, subject to Capital Gains Tax.

HMRC's Update in 2023

In 2023, HMRC announced a second consultation on DeFi and staking, indicating a potential shift in its stance. The tax office is considering disregarding Capital Gains Tax implications from certain activities related to lending or staking. If this outcome materializes, it could position the UK as an attractive destination for crypto investors, given the unique tax perspective.

Is Yield Farming Subject to Capital Gains Tax?

Some yield farming transactions introduce the possibility of being subject to income tax and capital gains tax. Let's delve into the specifics of these tax implications based on various transactions.

Capital Gains Tax and Yield Farming Transactions

Certain yield farming transactions, such as depositing and withdrawing cryptocurrency from a liquidity pool, may be deemed disposals, making them susceptible to capital gains tax. Taking Uniswap V2 as an example, users can contribute cryptocurrency to liquidity pools and earn rewards. However, to receive these rewards, a trade or exchange of cryptocurrency for an underlying LP token is required.

Key Events Considered as Disposals:

1. Trading Cryptocurrency for LP Tokens:

      Resulting in a capital gain or loss based on the price fluctuation of the deposited crypto since its acquisition.

2. Redeeming LP Tokens for Cryptocurrency:

      Recognizing a capital gain linked to the fluctuation in value of LP tokens and including the value of the received crypto as a reward.

Other Disposals Subject to Capital Gains Tax:

• Selling cryptocurrency
• Trading cryptocurrency for another crypto
• Using cryptocurrency for a purchase

Do I have to pay Income Tax for Yield Farming Rewards?

Earning cryptocurrency without trading existing holdings may lead to income tax implications for yield farming rewards. Protocols like Maker, offering DAI in exchange for liquidity provision, exemplify scenarios where rewards are subject to income tax based on the fair market value of the received crypto at the time of receipt.

Instances of Cryptocurrency Income:

• Staking rewards
• Interest rewards
• Referral rewards

It's imperative to remember that disposing of the received cryptocurrency incurs capital gains tax, determined by the price fluctuation of the rewards since their reception.

For Example: 

Todd receives: 1000$ ETH as Income. 

Later he sells his ETH for 1500$. 

Todd Recognizes 1000$ of income and 500$ of capital gain. 

Income or Capital Asset: Decoding HMRC's View

HMRC views crypto assets in one of two ways: as income or as a capital asset. 

This classification determines whether they are subjected to Income Tax, Capital Gains Tax, or both. While some transactions are clear-cut, such as getting paid in crypto or mining, others, especially in the DeFi space, can blur the lines.

Transactions Subject to Capital Gains Tax:

• Selling crypto for fiat currency.
• Swapping crypto for another cryptocurrency.
• Spending crypto on goods or services.
• Gifting crypto (excluding gifting to a spouse or civil partner).

Transactions Subject to Income Tax:

• Getting paid in crypto.
• Mining crypto.
• Staking crypto.
• Airdrops in most instances.

It's crucial to note that even when Income Tax is paid on a crypto asset, Capital Gains Tax is still applicable when the asset is later disposed of. Similarly, if no Income Tax is paid initially, Capital Gains Tax applies upon disposal.

How to Navigate UK Crypto Taxes with Kryptos

For UK crypto investors who are seeking a streamlined approach to calculating their taxes, Kryptos - UK's Best Crypto Tax Calculator offers a comprehensive solution. Importing crypto transactions into Kryptos, whether through CSV or API, facilitates accurate calculations of income, capital gains, and expenses. The platform provides a range of tax reports, simplifying the process of submitting annual Self Assessment Tax Returns to HMRC.

You can find more detailed information about "when to report your crypto transactions" in our UK crypto tax guide 

FAQs

1. What is yield farming, and how does it work in the UK crypto landscape?

Yield farming is a strategy within the decentralized finance (DeFi) space where crypto investors maximize passive earnings by leveraging different protocols. In the UK, investors use various platforms like decentralized exchanges, lending protocols, and staking to optimize returns. By strategically stacking these protocols, known as composability, investors can amplify their profits through a process commonly referred to as yield farming.

2. How does HMRC tax crypto transactions, particularly in the context of yield farming?

HMRC classifies crypto transactions into income and capital categories. The nature of the transaction determines the tax. For example, swapping crypto on decentralized exchanges is subject to Capital Gains Tax, while earning new tokens through liquidity mining may be considered income and subjected to Income Tax. The tax implications vary across different yield farming activities, and specific guidance is provided in the comprehensive HMRC DeFi tax framework.

3. What are the potential tax liabilities for UK crypto investors engaged in yield farming?

UK crypto investors involved in yield farming may have various tax liabilities depending on the specific activities. Adding/removing crypto from liquidity pools, earning new tokens, staking rewards, and yield farming itself are subject to tax, and the nature of these taxes is dependent on the protocol used. The HMRC guidance provides a breakdown of tax implications for each transaction, with ongoing reviews for certain activities.

4.How does HMRC view crypto loans and staking in the context of DeFi taxation?

HMRC treats crypto loans from both the lender's and borrower's perspectives. For lenders, the act of lending triggers a disposal, subject to Capital Gains Tax. Borrowers, on the other hand, treat the loan as an acquisition, with interest payments considered allowable expenses. Staking rewards fall under miscellaneous income, subject to Income Tax, and the assets being staked may also be subject to Capital Gains Tax, as outlined in new HMRC guidance.

5. What role does Kryptos play in navigating UK crypto taxes, especially in the context of DeFi activities?

Kryptos is a comprehensive platform that assists UK crypto investors in calculating their crypto income, capital gains, and losses. By importing transactions through CSV or API, Kryptos simplifies the tax calculation process. The platform provides various tax reports that users can download and submit to HMRC during their annual Self Assessment Tax Return. Kryptos's user-friendly interface ensures a streamlined approach for crypto enthusiasts navigating the dynamic landscape of DeFi taxation.

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All content on Kryptos serves general informational purposes only. It's not intended to replace any professional advice from licensed accountants, attorneys, or certified financial and tax professionals. The information is completed to the best of our knowledge and we at Kryptos do not claim either correctness or accuracy of the same. Before taking any tax position / stance, you should always consider seeking independent legal, financial, taxation or other advice from the professionals. Kryptos is not liable for any loss caused from the use of, or by placing reliance on, the information on this website. Kryptos disclaims any responsibility for the accuracy or adequacy of any positions taken by you in your tax returns. Thank you for being part of our community, and we're excited to continue guiding you on your crypto journey!