Navigating DeFi Taxes in the UK: A Comprehensive Guide for 2024

by
Pratibha Tiwari
Reviewed by
Deepak Pareek
min read
Last updated:

DeFi enthusiasts and crypto investors in the UK, have you ever pondered the impact of your decentralized finance activities on your tax obligations? 

Well, of course you have!

You wouldn’t be here if that wasn’t the case.

As the DeFi space continues to expand, it's vital to grasp the tax consequences of your transactions. The HMRC has recently issued guidance regarding DeFi taxation in the UK, clarifying whether your crypto endeavours are subject to Capital Gains Tax or Income Tax.

In this guide, we'll unravel the complexities of DeFi taxation, demystify the 'nature of the transaction,' and examine the key factors influencing the tax treatment of your DeFi returns. Whether you're a seasoned DeFi user or just entering the world of decentralized finance, this blog post equips you with the knowledge to navigate the UK's tax landscape in the ever-evolving crypto sphere.

Understanding DeFi

Decentralized Finance (DeFi) harnesses the power of cryptocurrencies, blockchain technology, and smart contracts to provide borderless access to financial services such as trading, lending, borrowing, and yield farming. Dapps (Decentralised Apps) and DEXs (Decentralised Exchanges) are the spine of DeFi as they offer inclusive financial services to everyone thanks to smart contracts that offer a trustless environment.

What are Smart Contracts?

Smart contracts are essentially a special piece of code that executes a certain set of actions when certain conditions are met. The special thing about smart contracts is that they are autonomous and do not require intermediaries. This creates a trustless environment which acts as a basis for various DeFi services with no middlemen.

How DeFi Transactions are Taxed?

HMRC has released specific guidance on crypto taxation, including DeFi assets. It's crucial to differentiate between various DeFi activities as they are subject to different tax treatments. 

Here's a breakdown of how DeFi activities are taxed in the UK:

1. Crypto Capital Gains Tax

In the UK, Capital Gains Tax (CGT) on crypto is levied on profits arising from the sale of digital assets, including those obtained through DeFi ventures. The applicable CGT rate depends on your income bracket, with a tax-free allowance for capital gains set at £6,000 for the 2023/2024 tax year.

The following tax rates apply on Crypto Gains:

2. Crypto Income Tax

Income tax applies when you earn income from DeFi activities like staking, mining, and yield farming in the UK. Accurate reporting of these earnings to HMRC is essential to ensure compliance with tax regulations.

3. Taxation of DeFi Lending and Borrowing

The tax implications in the UK hinge on beneficial ownership transfers, especially when it comes to DeFi assets. If beneficial ownership changes hands, it's considered a taxable event and falls under Capital Gains Tax (CGT). Moreover, any interest earned from DeFi activities is subject to Income Tax.

4. Airdrop Taxes

Airdrops that are provided in return for, or in expectation of, a service are subject to Income Tax, reflecting the importance of accurately reporting them to HMRC. Furthermore, Capital Gains Tax (CGT) may apply when you decide to sell or exchange the airdropped assets, so it's essential to consider the potential tax implications when dealing with airdrops.

5. Yield Farming Taxes

Yield farming refers to depositing tokens into a liquidity pool on a DeFi protocol to earn rewards, typically paid out in the protocol's governance token.Income from yield farming in the UK is viewed as taxable income and falls under the purview of Income Tax. This includes any newly acquired tokens resulting from assets that you've deposited in yield farming activities.

Taxation of DeFi Protocols and Related Transactions

1. DEX Trades

Trading on decentralized exchanges attracts tax obligations in the UK. Notably, crypto-to-crypto trades are considered taxable events, making them subject to Capital Gains Tax. 

2. Staking

Staking income is subject to Income Tax, and swapping or selling earned tokens is subject to CGT.

3. Liquidity Mining

Adding or removing liquidity pool (LP) tokens is subject to CGT if received in exchange for providing assets. LP tokens received while holding a position are subject to Income Tax.

4. Flashloans, Play-to-Earn, and Gas Fees

Gains from flashloans, play-to-earn activities, and gas fees are subject to CGT or Income Tax, depending on the nature of the transaction.

Special Cases in DeFi Taxation:

1. Synthetic Assets, Options, Margin Trading, Perpetuals, Futures, and Derivatives:

All profits from such avenues are subject to CGT. Although we suggest seeking guidance from an experienced tax professional to gain more clarity on the subject.

2. Wrapped Tokens and Crypto Bridges:

Wrapping tokens falls under crypto-to-crypto trade and is therefore subject to CGT. Taxation related to crypto bridges varies and requires consultation with experts.

Conclusion

Navigating the complexities of UK DeFi crypto taxes in 2023 demands careful consideration of various activities and their corresponding tax implications. Staying informed, maintaining accurate records, and seeking guidance from cryptocurrency tax experts are vital steps to ensure compliance with HMRC regulations. As the DeFi space continues to innovate, staying ahead of the taxation curve will empower UK residents to engage confidenly with DeFi transactions.

Disclaimer: This article provides general information and should not be considered as professional tax advice. Tax regulations and guidelines may change, so it is recommended to consult with a qualified tax advisor for the most up-to-date and personalized information.

FAQ 

1. What is DeFi, and how is it different from traditional finance?

 DeFi, short for Decentralized Finance, utilizes cryptocurrencies, blockchain technology, and smart contracts to provide financial services without the need for traditional intermediaries like banks. Unlike traditional finance, DeFi operates on decentralized networks, offering borderless access to services such as lending, borrowing, trading, and yield farming.

2. How are DeFi activities taxed in the UK?

 DeFi activities are subject to various taxes in the UK, including Capital Gains Tax (CGT) for profits from selling digital assets, and Income Tax for earnings from activities like staking, mining, and yield farming. Taxation depends on the specific DeFi activity and the nature of the transaction, whether it's a crypto-to-crypto trade, income, or a taxable event.

3. What is Capital Gains Tax (CGT) and how does it apply to DeFi?

CGT is a tax applied to the profit made from selling assets, including cryptocurrencies acquired through DeFi activities. For DeFi, CGT is applicable when selling or swapping digital assets. The tax rate depends on your income level, and there's a tax-free allowance for capital gains, which was £6,000 for the 2023/2024 tax year.

4. How are airdrops and yield farming taxed in the UK?

Airdrops are considered income and are subject to Income Tax. If you sell or swap airdropped tokens, Capital Gains Tax may also apply. Yield farming returns are treated as income and are subject to Income Tax, including new tokens earned from deposited assets.

5. Are gas fees, flashloans, and play-to-earn activities taxable?

Yes, gas fees paid in Ethereum are considered part of the cost basis of the acquired asset or as an advertising cost related to the disposal transaction. Gains from flashloans, play-to-earn activities, and other similar activities are subject to Capital Gains Tax or Income Tax, depending on the specific nature of the transaction.

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!

How we reviewed this article

Written by
Pratibha Tiwari

Content Creator - Kryptos, An engineer who transitioned to become a Web3 Content Writer and Creator, has contributed to core marketing teams of renowned Web3 projects.

Reviewed by
Deepak Pareek

Head of Tax & Accounting - Kryptos, Crypto Tax and Accounting Expert, having experience in working with Big 4 accounting firms as well as top tier law firms of India.

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Navigating DeFi Taxes in the UK: A Comprehensive Guide for 2024

By
Pratibha Tiwari
On

DeFi enthusiasts and crypto investors in the UK, have you ever pondered the impact of your decentralized finance activities on your tax obligations? 

Well, of course you have!

You wouldn’t be here if that wasn’t the case.

As the DeFi space continues to expand, it's vital to grasp the tax consequences of your transactions. The HMRC has recently issued guidance regarding DeFi taxation in the UK, clarifying whether your crypto endeavours are subject to Capital Gains Tax or Income Tax.

In this guide, we'll unravel the complexities of DeFi taxation, demystify the 'nature of the transaction,' and examine the key factors influencing the tax treatment of your DeFi returns. Whether you're a seasoned DeFi user or just entering the world of decentralized finance, this blog post equips you with the knowledge to navigate the UK's tax landscape in the ever-evolving crypto sphere.

Understanding DeFi

Decentralized Finance (DeFi) harnesses the power of cryptocurrencies, blockchain technology, and smart contracts to provide borderless access to financial services such as trading, lending, borrowing, and yield farming. Dapps (Decentralised Apps) and DEXs (Decentralised Exchanges) are the spine of DeFi as they offer inclusive financial services to everyone thanks to smart contracts that offer a trustless environment.

What are Smart Contracts?

Smart contracts are essentially a special piece of code that executes a certain set of actions when certain conditions are met. The special thing about smart contracts is that they are autonomous and do not require intermediaries. This creates a trustless environment which acts as a basis for various DeFi services with no middlemen.

How DeFi Transactions are Taxed?

HMRC has released specific guidance on crypto taxation, including DeFi assets. It's crucial to differentiate between various DeFi activities as they are subject to different tax treatments. 

Here's a breakdown of how DeFi activities are taxed in the UK:

1. Crypto Capital Gains Tax

In the UK, Capital Gains Tax (CGT) on crypto is levied on profits arising from the sale of digital assets, including those obtained through DeFi ventures. The applicable CGT rate depends on your income bracket, with a tax-free allowance for capital gains set at £6,000 for the 2023/2024 tax year.

The following tax rates apply on Crypto Gains:

2. Crypto Income Tax

Income tax applies when you earn income from DeFi activities like staking, mining, and yield farming in the UK. Accurate reporting of these earnings to HMRC is essential to ensure compliance with tax regulations.

3. Taxation of DeFi Lending and Borrowing

The tax implications in the UK hinge on beneficial ownership transfers, especially when it comes to DeFi assets. If beneficial ownership changes hands, it's considered a taxable event and falls under Capital Gains Tax (CGT). Moreover, any interest earned from DeFi activities is subject to Income Tax.

4. Airdrop Taxes

Airdrops that are provided in return for, or in expectation of, a service are subject to Income Tax, reflecting the importance of accurately reporting them to HMRC. Furthermore, Capital Gains Tax (CGT) may apply when you decide to sell or exchange the airdropped assets, so it's essential to consider the potential tax implications when dealing with airdrops.

5. Yield Farming Taxes

Yield farming refers to depositing tokens into a liquidity pool on a DeFi protocol to earn rewards, typically paid out in the protocol's governance token.Income from yield farming in the UK is viewed as taxable income and falls under the purview of Income Tax. This includes any newly acquired tokens resulting from assets that you've deposited in yield farming activities.

Taxation of DeFi Protocols and Related Transactions

1. DEX Trades

Trading on decentralized exchanges attracts tax obligations in the UK. Notably, crypto-to-crypto trades are considered taxable events, making them subject to Capital Gains Tax. 

2. Staking

Staking income is subject to Income Tax, and swapping or selling earned tokens is subject to CGT.

3. Liquidity Mining

Adding or removing liquidity pool (LP) tokens is subject to CGT if received in exchange for providing assets. LP tokens received while holding a position are subject to Income Tax.

4. Flashloans, Play-to-Earn, and Gas Fees

Gains from flashloans, play-to-earn activities, and gas fees are subject to CGT or Income Tax, depending on the nature of the transaction.

Special Cases in DeFi Taxation:

1. Synthetic Assets, Options, Margin Trading, Perpetuals, Futures, and Derivatives:

All profits from such avenues are subject to CGT. Although we suggest seeking guidance from an experienced tax professional to gain more clarity on the subject.

2. Wrapped Tokens and Crypto Bridges:

Wrapping tokens falls under crypto-to-crypto trade and is therefore subject to CGT. Taxation related to crypto bridges varies and requires consultation with experts.

Conclusion

Navigating the complexities of UK DeFi crypto taxes in 2023 demands careful consideration of various activities and their corresponding tax implications. Staying informed, maintaining accurate records, and seeking guidance from cryptocurrency tax experts are vital steps to ensure compliance with HMRC regulations. As the DeFi space continues to innovate, staying ahead of the taxation curve will empower UK residents to engage confidenly with DeFi transactions.

Disclaimer: This article provides general information and should not be considered as professional tax advice. Tax regulations and guidelines may change, so it is recommended to consult with a qualified tax advisor for the most up-to-date and personalized information.

FAQ 

1. What is DeFi, and how is it different from traditional finance?

 DeFi, short for Decentralized Finance, utilizes cryptocurrencies, blockchain technology, and smart contracts to provide financial services without the need for traditional intermediaries like banks. Unlike traditional finance, DeFi operates on decentralized networks, offering borderless access to services such as lending, borrowing, trading, and yield farming.

2. How are DeFi activities taxed in the UK?

 DeFi activities are subject to various taxes in the UK, including Capital Gains Tax (CGT) for profits from selling digital assets, and Income Tax for earnings from activities like staking, mining, and yield farming. Taxation depends on the specific DeFi activity and the nature of the transaction, whether it's a crypto-to-crypto trade, income, or a taxable event.

3. What is Capital Gains Tax (CGT) and how does it apply to DeFi?

CGT is a tax applied to the profit made from selling assets, including cryptocurrencies acquired through DeFi activities. For DeFi, CGT is applicable when selling or swapping digital assets. The tax rate depends on your income level, and there's a tax-free allowance for capital gains, which was £6,000 for the 2023/2024 tax year.

4. How are airdrops and yield farming taxed in the UK?

Airdrops are considered income and are subject to Income Tax. If you sell or swap airdropped tokens, Capital Gains Tax may also apply. Yield farming returns are treated as income and are subject to Income Tax, including new tokens earned from deposited assets.

5. Are gas fees, flashloans, and play-to-earn activities taxable?

Yes, gas fees paid in Ethereum are considered part of the cost basis of the acquired asset or as an advertising cost related to the disposal transaction. Gains from flashloans, play-to-earn activities, and other similar activities are subject to Capital Gains Tax or Income Tax, depending on the specific nature of the transaction.

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!

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