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Koinly crypto tax calculator - UK DeFi tax

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UK DeFi Crypto taxes - the Ultimate Guide

Last updated: Thursday, 11 November 2021

Decentralized finance, or DeFi, has sparked the interest of UK crypto investors. But many don’t realise the tax implications of their DeFi investments. Learn how DeFi is taxed by HMRC.

Decentralized finance, or DeFi for short, is looking to tackle the issues faced by traditional financial systems and instead provide global, decentralized finance for all. 

While we’re still in the very early stages of DeFi, the potential is huge and it’s got crypto investors around the world and in the UK excited for new investment opportunities. 

We’ll be looking at what DeFi is, how HMRC views DeFi and how various DeFi transactions are taxed in this guide. 

What is DeFi?

You can learn more about exactly what DeFi is in our DeFi guide. But, in brief, DeFi is an umbrella term for a variety of financial applications and services built using blockchain technology.

DeFi platforms have attracted more than $90 billion in collateral since the term was coined in 2018. 

DeFi hopes to eventually provide all of the services that centralised financial institutions do, but without any of the limitations created by borders, regulations and policies. Instead, DeFi hopes to empower investors through borderless, decentralized and transparent financial services.

Most DeFi applications currently are built on the Ethereum blockchain. This is due to Ethereum's smart contract capabilities.

Smart contracts work just like real contracts, but  they're completely digital. The contract is a computer program stored inside a blockchain. These programs will have a variety of specific conditions that need to be met to execute the contract, otherwise the funds will be liquidated and the contract will be cancelled. 

Smart contracts can be used for practically anything - from crowd funding to loans. The important thing to note is that technology automates the process - so it can't be slowed down or halted by human error - and that the technology removes the need for a third party - like a bank.

Koinly crypto tax calculator - what is defi

What can DeFi do?

DeFi apps are constantly evolving and adding new functionalities. What this means is there is an ever-growing list of transactions that UK investors can make with DeFi apps. Currently this includes:

  • Send money to anyone, anywhere.
  • Buy, sell and trade cryptocurrencies.
  • Invest in stable currencies.
  • Loan or borrow crypto.
  • Earn interest and rewards through staking, yield farming and liquidity mining.
  • Advanced trading like derivatives, margin and leveraged trading.
  • Crowdfund and invest in new DeFi projects.
  • Insure your crypto investments.
  • Manage and grow your crypto investments automatically.
  • Gamble and bet crypto.

With all these different transactions comes different taxation.

How does HMRC tax DeFi?

At the time of writing, HMRC has issued no specific guidance on the taxation of DeFi. But before you breathe a sigh of relief - this doesn’t mean you don’t pay tax on your DeFi investments in the UK.

While there is no specific guidance for DeFi, HMRC has plenty of detailed guidance on the taxation of crypto in the UK in general. Much of the current guidance covers DeFi investments, and sets a precedent for how a DeFi investment is likely to be viewed from a tax perspective. 

All this comes down to whether your crypto will be viewed as income or a capital asset.

Koinly crypto tax 101 - how is defi taxed

Income or capital asset

HMRC views crypto in one of two ways and subjects them to two different types of tax. In the UK DeFi trades are either seen as income and subjected to Income Tax or seen as a capital asset and subjected to Capital Gains Tax.

The lines on what is considered income can get quite blurry. However, some crypto transactions are clear cut. For example, the following investments are seen as income and subject to Income Tax:

  • Getting paid in crypto - known as ‘money’s worth’ and subject to Income Tax and National Insurance contributions.
  • Mining crypto - depending on the degree of activity.
  • Staking crypto - depending on the degree of activity.
  • Airdrops - in most instances.

Koinly crypto tax calculator - income tax UK

Capital Gains Tax, on the other hand, only applies when you sell, swap, spend or gift your crypto (excluding to your spouse). This is known as a ‘disposal’ of an asset’. It’s important to note that even when you pay Income Tax on a crypto asset, you’ll also pay Capital Gains Tax when you later dispose of your crypto asset. Similarly even if you didn’t pay Income Tax on your crypto asset, you’ll still pay Capital Gains Tax when you dispose of it.

Crypto transactions which are subject to Capital Gains Tax in the UK include:

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

Koinly crypto tax calculator - capital gains tax

While these transactions are covered in detail by HMRC, many newer DeFi concepts like yield farming and liquidity mining are not. However, there are many transactions similar to these in the current guidance and investors can infer that similar transactions may be taxed in a similar manner. 

We’ll look at the common types of DeFi transactions and how HMRC is likely to view them under the current guidance. It’s important to note Koinly takes a conservative approach to taxation to decrease the chance of investigation by HMRC. There is no wrong or right approach to crypto taxation - investors can take a more aggressive approach if they so wish, but they should be aware that the risk of being investigated by the HMRC is increasing as the tax office puts more and more pressure on crypto investors.

Loaning and borrowing crypto tax UK

When it comes to borrowing crypto on a DeFi platform - you won’t pay Income Tax or Capital Gains Tax. You’re not earning or disposing of an asset.

When it comes to loaning crypto, it’s a little more complicated and it will depend on the DeFi platform you’re using. In some instances, when you loan your crypto this could be seen as a disposal, but it very much depends on the platform you’re using. With platforms where you get tokens of an equivalent value in exchange for the crypto you loan, this could arguably be seen as a swap - which is viewed as a disposal by HMRC.

All this said, there is no clear guidance on this so you should speak to a UK-based tax advisor for bespoke advice about your investments and taxation when loaning crypto. 

Crypto interest tax UK

There are many ways to earn interest from DeFi platforms. You’ll also pay interest on some crypto transactions. In the United Kingdom, the two have very different tax treatments.

Much like borrowing, when it comes to paying interest - you’re not earning income or disposing of an asset. However, if you’re paying your interest in crypto - this could be seen as a kind of disposal as you’re spending your crypto. There is an argument this could be subject to Capital Gains Tax.

When it comes to earning interest - the HMRC guidance gets a little more vague. Earning interest could be seen as an additional income - depending on the scale of which you’re trading at. HMRC does state that “only in exceptional circumstances” would individual trades be conducted at such frequency, sophistication and organisation that it could be considered a financial trade and as such subject to Income Tax.

However, when it comes to something as simple as airdrops - these are subject to Income Tax if you've done anything in exchange for them. Receiving coins or tokens from interest is arguably providing a service, as such it could be subject to Income Tax.

We recommend a conservative approach to this where you treat any other gains as income. But as ever, your best bet is to speak to a UK tax advisor for specific advice on your crypto investments and taxation.

Staking tax UK

This one is pretty clear cut because although staking exists within DeFi, it also existed long before, so HMRC has specific guidance.

Rewards from staking are viewed as miscellaneous income and they’re subject to Income Tax. You’ll also have to pay Capital Gains Tax when you later dispose of the asset. 

Yield farming tax UK

Yield farming is big news in DeFi right now. Speaking broadly, it refers to any crypto assets strategically invested to yield the greatest returns - hence the name. You can earn different kinds of yields - for example, tokens, interest or by being paid the transaction fee. The whole purpose of yield farming is to strategically stack different crypto investments on top of each other to yield the largest rewards.

You can refer to the different sections within this guide to identify how each would be treated from a tax perspective.

Liquidity mining tax UK

Liquidity mining is closely related to yield farming. You won’t pay tax when you add liquidity or remove liquidity as you’re not making a disposal or earning new income - you’re just moving your original capital around.

However, you will pay tax on the rewards earned and HMRC is yet to give any clear guidance as to whether this would be considered income or a capital gain. Their stance on airdrops being viewed as income, as well as their stance on staking possibly being viewed as income suggests that rewards earned through liquidity mining could also be seen as income. 

Crypto CFD trading tax UK

HMRC has no specific guidance on CFD trading options in the crypto market like derivatives, margin trading and leveraged trading. However, they have a lot of guidance available on how these are taxed in traditional financial markets.

The advice on traditional finance markets is pretty straightforward - these will normally be seen as individual investments, except in extraordinary circumstances where they may be viewed as a trading. For individual investments, you’re only liable to pay Capital Gains Tax on any profits when your position closes.

Of course, there are some instances where your contract liquidates, in these instances this would be viewed as a disposal and you’d similarly be liable to pay Capital Gains Tax on any profits.

It’s important to note that because there is no specific advice on crypto CFD trading, you should still speak to a UK tax advisor for specific guidance on your crypto tax for these transactions.

Gas fees tax UK

HMRC has clear guidance on allowable expenses when calculating transaction or gas fees. Transaction fees are an allowable expense, so you can add them to your cost basis. Transfer fees are also an allowable expense in most instances.

Wrapping tax UK

In some instances, you’ll need to ‘wrap’ coins before you can deposit them into a smart contract. A good example of this is when you want to use BTC on an Ethereum based platform, you can ‘wrap’ BTC and exchange it for an ERC-20 token of an equivalent value that does work within the platform. 

HMRC does not have clear guidance on this just yet. However, as you’re swapping one coin for another, it is very possible that they would view this as a kind of disposal and subject to Capital Gains Tax. So even if you make no gain or loss (because you’re swapping something for equivalent value), you may still need to declare this on your tax return.

How to calculate UK crypto taxes with Koinly

Koinly helps UK crypto investors calculate their crypto income, capital gains and losses and expenses. All you need to do is import your crypto transactions from your wallets to Koinly through CSV or API. Once your transactions are imported, Koinly will calculate your crypto taxes for you. All you need to do is head over to the tax reports page, where you’ll see a simple summary of your crypto taxes. Below this, you’ll find a variety of tax reports you can download and submit to HMRC when filing your annual Self Assessment Tax Return.

Koinly crypto tax calculator

You can find more great information about filing your UK tax reports in our UK crypto tax guide and you can find the UK Capital Gains Tax and Income Tax rates in our UK Tax Rates guide.

Summary

  • DeFi is an umbrella term for a variety of different financial apps for crypto investors.
  • HMRC is yet to issue specific guidance on DeFi taxes for UK taxpayers.
  • But there is guidance on crypto tax that already broadly applies to many DeFi transactions.
  • Your crypto will be taxed in one of two ways - as income or as a capital asset.
  • Income will be subject to Income Tax (and sometimes National Insurance contributions).
  • Capital assets will be subject to Capital Gains Tax.
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