Dear Alex,

The Taxation of Decentralised Finance involving the lending and staking of cryptoassets – call for evidence

We welcome the opportunity to respond to the call for evidence and welcome the UK taking the initiative to consider the current statutory approach to DeFi lending and staking.

Andersen LLP is a tax advisory and accounting practice with global presence with a dedicated and experienced specialist crypto team.

Question 1:

HMRC would like more information about the UK DeFi lending and staking sector. Please provide any information you hold that is relevant to the following questions. Where appropriate, please summarise data using appropriate ranges or categories, rather than providing only totals or minima and maxima.

• How many DeFi lending and staking platforms are you aware of that are based in the UK? What is the approximate value of their assets?
• Approximately how many UK-based individuals engage in DeFi lending and staking, and how much do they lend/stake?
• How many non-UK-based individuals are served by UK platforms and what amounts do they invest?
• How frequently do individuals transact, and what is the duration of each lending or staking transaction?
• Approximately what percentage of UK-based individuals engaging in DeFi are serviced wholly or mainly by UK platforms? Where else are the platforms UK individuals use commonly based?

We cannot answer this question. This information is available from firms that monitor blockchain analytics and from actors that participate and engage with users. We note that CryptoUK, where we have also contributed to the response, has provided further information on this question.

Question 2:

Bearing in mind that UK individuals are subject to the same tax treatment for DeFi lending and staking wherever the platforms they use are located, does the current tax treatment make the UK less attractive to platforms as a place to do business? If so, which jurisdictions are favoured and why?

Our view, based on conversations with clients, is that businesses and platforms want to be based and do business in the UK. However, it is not the tax treatment that is primarily causing businesses to relocate, but the inability to obtain the appropriate regulatory licences (i.e. in compliance with the 5th Money Laundering Directive) within a commercially viable timeframe, if at all.

From a personal taxation perspective, we are aware of differing approaches being taken by other jurisdictions for example by France, Switzerland and Portugal. However, by and large, the approach being taken internationally has been fairly consistent with jurisdictions continuing to apply existing legislation. Whilst some jurisdictions may provide, seemingly, beneficial treatment there may not be certainty that that treatment will continue.

Question 3:

Approximately what proportion of DeFi lending and staking transactions give rise to disposals for tax purposes under the current rules?

Please see our response to question 1.

Question 4:

Of the transactions giving rise to the disposals, what proportion would fall within the (i) Repo rules and (ii) Stock Lending rules, if cryptoassets were treated as securities?

Generally, we consider that the repo rules and/or stock lending rules at s.263A and s263B TCGA 1992 will not apply to cover the majority of transactions due to their nature and the terms and conditions. It is difficult to provide a view as to what proportion this would be with any confidence. However, anecdotally, we expect this to be a significant proportion.

We note that the call for evidence is seeking to simplify DeFi lending and for the tax position to follow economic reality. However, this option will still require those engaging in DeFi transactions to review the terms and conditions of the contracts. Given the number of transactions and interactions with different protocols this does not appear to ease the compliance burden on taxpayers, advisers or HMRC.

Question 5:

Do you favour changes to the current rules?

As a first point we recognise that it is not in all cases that a DeFi lending transaction will result in a disposal as there may not be a transfer of beneficial ownership. The challenge for taxpayers is that they will usually engage a number of differing platforms, with the terms and conditions for each not always being clear (e.g. we have reviewed T&Cs that have stated beneficial ownership of the assets remains with the user, when after a review of the transactions is not the case). Whilst we are cautious on the use of analogies, there are similarities to the lending of stocks where, under the existing repos rules the lending of securities does not result in a disposal. Suffice to say that the current legislation did not envisage these types of transactions and pursuing this option carries additional risk of unintended consequences.

We understand from HMRC’s market research¹ that only a third of cryptoasset owners considered that they had a good understanding of Capital Gains Tax (CGT). However, around a quarter of participants were already using De-Fi products. The brief circumstances laid out above have created confusion that does not benefit HMRC or taxpayers. This is a complex area and there is clearly active use of the products.

Therefore we, wholeheartedly, support changes to the existing rules to provide both clarity and a more equitable outcome.

Question 6:

• Do you consider Option 1 to be a suitable model for DeFi lending and staking transactions? What are the pros and cons?
• If appropriate, should the Repo, the Stock Lending or both regimes be expanded to apply to DeFi transactions?

This option considers the extension of existing legislation to bring cryptoasset lending into scope of the repos rules. A positive for this option is that it may be the easiest route to provide more beneficial treatment of lending and staking at least from a perspective of implementing legislative change. However, this could lead to unintended consequences on three, interdependent, grounds. Firstly, the repos legislation was intended for a very different purpose for which it would then be turned to bring with it the increased risk of unintended consequences. Secondly, following the preceding point, we do not consider that this would bring all DeFi lending activities into scope and this gap may increase in the future. Finally, there will remain the need for due diligence on the relationships that the taxpayer has engaged in therefore this will not reduce the compliance burden.

Question 7:

• Do you consider Option 2 to be a suitable option? What are its pros and cons?
• Should the new rules be modelled on the Repo rules or the Stock Lending rules, or would both sets of rules be needed to cater for different contractual arrangements?

We consider the creation of specific legislation for DeFi lending and stalking activities to be a step in the right direction. However, if the opportunity is available we consider that a recreation of the existing repos rules for lending and staking to be a missed opportunity as option 3 provides a more comprehensive forward thinking approach.

If option 3 is not possible, option 2 would be the preferred fall back position to arrive at a similar position, albeit not as easily.

Question 8:

Do you consider Option 3 to be a suitable option? What are its pros and cons?

From the proposed options we consider that option three has the best potential to succeed in the aims as set out in the CfE. We recommend that this would be a new provision rather than amending the existing no gain/no loss as applies to spousal transfers.

A concern for this, as for all the options, is that there will still be a requirement for record retention. Any communication needs to temper expectations as to the level of burden that will be reduced on taxpayers and their agents. There appears to be an expectation that any legislation will be retrospective and whilst we accept that retrospective legislation is problematic there may be merit considering if this could be applied. Setting aside the clear benefit of providing certainty for historic transactions, in the absence of making the provision retrospective there will need to be a transition period whilst arrangements that follow the current approach ‘unwind’. A transition period has challenges of its own particularly around taxpayer education. We do not need to highlight the results from the market research that demonstrates there does remain a significant proportion of cryptoasset users that have not seen any tax education.

Question 9:

Are there alternative approaches to the taxation of DeFi lending and staking that have been adopted by other jurisdictions that the government could consider? If so, please provide more details and reasons.

As this is a complex topic many other tax administrations have yet to provide any guidance.

To date we are unaware of any other jurisdiction creating or seeking to create legislation to bring DeFi lending and staking into legislation. Furthermore we are only aware of one other tax administration that has published guidance on DeFi lending which is Skatteetaten, the Norwegian Tax Administration². The NTA position is very similar to that of the UK. Whilst the Australian Tax Office (ATO) has not published formal guidance, an early indication from their community discussions appears to indicate a similar outcome as with the UK³.

We are unable to provide any further insight as to differing approaches.

Question 10:

Besides the options outlined above, are there any further options for change that the government could consider?

An aspect not addressed in the CfE is how the view on lex situs applies to the source of the income. This is particularly relevant with DeFi lending where the location of the platform is unclear. If we assume that the individual has acquired a right from the platform then, where the individual is a non-dom using the remittance basis, what is the location of the source income. Should it be UK arising following similar principles as applied to situs or where the platform is located? This can be further complicated where the platform may be organised as a ‘true’ DAO (Decentralised Autonomous Organisation) without a corresponding recognised legal wrapper. Whilst the upcoming review by the Law Commission on DAOs may provide some insight it may not provide any clarity where they are considered to be “non-UK”.

More broadly, one of the main concerns from cryptoasset users is the level of burden that record keeping imposes. Whilst we appreciate that s.104 TCGA92 is primarily a simplification for the acquisition of securities. For many cryptoasset customers they can, and do, engage in thousands of transactions. However unlike for securities low transaction costs

mean that these transactions can be small, less than £100. The HMRC market research supports that, for the majority of cryptoasset owners, they only make small gains, i.e. below the AEA. Only 8% of the respondents stated that they made a ‘profit’⁴ over £12,500. However the compliance costs for those making gains less than the AEA could be more than their overall gain with no resulting benefit to the exchequer.

The approach taken by other jurisdictions, such as France, to remove crypto-to-crypto from being within the scope of taxation has not necessarily reduced customer compliance burden. Indeed we note that full records are still required to be retained to calculate any gain (or loss) if they are exchanged for fiat. Furthermore, as the tax ‘pain’ is felt upon realisation it seems to be acting as a psychological barrier for taxpayers to convert their cryptoassets into fiat5, which potentially has an adverse economic impact.

To reduce compliance burden, a tax-free vehicle would have significant benefits to both cryptoasset owners, business and tax administration. In a manner similar to an ISA, although a completely different product, there would be no tax implications on the buying and selling of cryptoassets or when being converted into fiat to provide “real world” economic benefit. The amount able to be contributed could be set at the same level of the AEA therefore there should be limited exchequer impact.

The benefit for this product for businesses would be the ability to offer a product that encourages initial investment. To participate in the scheme there would need to be oversight and with the coming introduction of CARF (the Crypto Asset Reporting Framework) Relevant Crypto Asset Service Providers (RCASPs) will, potentially, need to register with HMRC in any case. Rather than only putting further burden on already stretched business this product will provide a benefit for UK firms to be able to market to their UK customers.

This will provide a tax neutral approach to cryptoassets and provide similar benefits that are currently available to other asset classes, such as shares. We welcome the opportunity to discuss this novel suggestion further.

Question 11:

How could the government be confident that any proposed rules would not discriminate in favour of users of DeFi services?

We consider that the creation of rules that follow the economic reality from the lending of assets will provide an equal treatment of cryptoassets to other assets. These proposals do not appear to provide any additional benefits over and above those that are available to assets such as shares. The current market for cryptoassets is smaller than for shares however with 10% of the UK adult population owning, or have owned, cryptoassets we consider that this will put the UK in a good place to encourage innovation and investment.

1 https://www.gov.uk/government/publications/individuals-holding-cryptoassets-uptake-and-understanding

2 https://www.skatteetaten.no/en/person/taxes/get-the-taxes-right/shares-and-securities/about-shares-and-sec urities/digital-currency/defi/

3 https://community.ato.gov.au/s/question/a0J9s0000001IFOEA2/p00046444

4 Recognising that “profit” was used as a colloquialism in the place of gains.

5 https://www.euronews.com/next/2021/10/14/france-is-grappling-with-how-to-tax-cryptocurrencies-such-as-bi tcoin