UK DeFi tax reform historic breakthrough! No gains, no losses, Capital Gains Tax deferred.

The UK has launched a new tax framework to ease the burden on DeFi users, implementing a deferral of Capital Gains Tax for crypto assets lending and liquidity pool users until the underlying tokens are sold. Her Majesty's Revenue and Customs (HMRC) has proposed a “no gain, no loss” approach for DeFi, which will cover lending tokens and receiving the same type of tokens back, borrowing arrangements, and transferring tokens to liquidity pools.

UK DeFi No Yield No Loss Tax Framework

(Source: UK Government Official Website)

On November 26, the UK HMRC proposed a “no gain, no loss” approach to DeFi, eliminating the Capital Gains Tax on deposits made on cryptocurrency lending platforms. This approach will cover lending tokens and retrieving like-kind tokens, lending arrangements, and transferring tokens to liquidity pools. This tax treatment will treat DeFi transactions as temporary asset form conversions rather than taxable disposal actions.

According to the proposal, taxable gains or losses upon the redemption of liquidity tokens will be calculated by comparing the number of tokens received by the user with the number of tokens originally invested. This method of calculation ensures that taxes only occur when actual profits or losses are realized, rather than triggering a tax event each time a deposit or withdrawal is made. This is similar to the tax treatment of securities lending in traditional finance, reflecting regulators' understanding of the economic nature of Decentralized Finance.

Currently, when users deposit funds into the protocol account, they may need to pay Capital Gains Tax for various reasons. In the UK, the Capital Gains Tax rate fluctuates between 18% and 32% depending on the specific circumstances. This tax treatment greatly limits the use of DeFi, as each deposit of Token into lending protocols such as Aave and Compound, or providing Liquidity to decentralized exchanges like Uniswap and Curve, may be considered a taxable event. This complex tax treatment not only increases the burden on users but also makes compliance extremely difficult.

Comparison of UK DeFi Tax Reform Before and After

Before Reform: Depositing into the agreement immediately triggers Capital Gains Tax, with a tax rate of 18%-32%, and each operation is subject to taxation.

After the reform: Adopt the “no gain no loss” method, only tax at the time of final sale of the Token.

Scope: All DeFi operations including lending tokens, borrowing arrangements, liquidity pool deposits, etc.

Calculation Method: Compare the number of Tokens received at redemption with the initial investment, the difference is the taxable income.

The significance of this reform is extremely far-reaching. It not only alleviates the tax burden on DeFi users, but more importantly, it simplifies the compliance process. Users no longer need to track the time and price of every deposit and withdrawal, but only need to calculate the overall gains or losses at the time of the final sale of the Token. This simplification will greatly lower the entry threshold for DeFi and encourage more users in the UK to participate.

Industry leaders praise the UK's Decentralized Finance tax reform

Sian Morton, the marketing director of the cross-chain payment system Relay protocol, stated that the “no gain no loss” policy of HM Revenue and Customs is a meaningful advancement for UK DeFi users who use crypto assets as collateral to borrow stablecoins, and makes tax treatment closer to the actual economic conditions of these transactions. She added, “This is a positive signal for the UK's evolving stance on cryptocurrency regulation.”

Maria Riivari, the lawyer for the DeFi platform Aave, stated that this change “will clearly indicate that DeFi transactions will only trigger taxes when you actually sell the tokens.” She added, “Other countries facing similar issues should perhaps take note of the practices of the UK’s HM Revenue and Customs, as well as the in-depth research and considerations behind it.” This evaluation suggests that the UK’s tax reform model could serve as a reference template for other countries around the world.

Aave CEO Stani Kulechov stated that the proposal “is a significant victory for UK DeFi users who wish to borrow stablecoins using crypto as collateral.” As one of the largest DeFi lending protocols in the world, the positive assessment from its CEO carries important industry significance. This tax-friendly policy could attract more DeFi protocols and users to choose the UK as their preferred jurisdiction for operations or usage.

The unanimous praise from industry leaders shows that this tax reform truly addresses the core pain points of DeFi users and protocols. In the past, complex and frequent tax events made many users hesitant to actively use DeFi features, fearing they would fall into tax dilemmas. The introduction of the new framework will unleash the suppressed demand for DeFi, potentially triggering rapid growth in the UK DeFi market.

The proposal is still in the consultation stage, final rules are pending

However, the proposal has not yet been finalized. The UK HM Revenue and Customs stated that they are continuing to communicate with relevant stakeholders “to assess the pros and cons of this potential scheme, as well as the necessity for legislative changes to the tax rules regarding Crypto Assets loans and liquidity pools.” The agency added: “It is especially important to ensure that it covers the various transactions that can be carried out under these arrangements, and that individuals are able to comply in practice.”

This continuous consultation approach shows that HMRC wants to fully listen to industry opinions before launching the final rules to avoid policy loopholes or unrealistic requirements. The DeFi ecosystem is extremely complex, covering various scenarios such as lending, liquidity provision, derivatives trading, and cross-chain bridging, each of which may have special considerations for tax treatment. HMRC needs to ensure that the new framework simplifies the compliance process while not creating tax loopholes or unfair treatment.

In the initial consultation, individuals, businesses, tax professionals, and representative organizations submitted 32 formal written responses, including venture capital firm a16z Capital Management and the self-regulatory industry association Crypto UK. This broad participation demonstrates that the UK crypto industry is highly concerned about tax reform and is actively providing professional opinions to shape the final policy.

The participation of a16z and Crypto UK is particularly important. As a leading crypto venture capital institution, a16z's opinions reflect the considerations of investors and project parties. Crypto UK, as an industry association, consolidates the demands of numerous local companies in the UK. The joint participation of these three parties ensures the balance and comprehensiveness of the policy-making process.

The UK Leads Global DeFi Regulatory Innovation

These rules solidify the UK's reputation as one of the most friendly major economies for DeFi innovation globally. Compared to the regulatory uncertainty of the US regarding DeFi and the complexity of the EU's MiCA framework, the UK is attempting a more pragmatic and flexible approach. The core of the “no gain, no loss” principle lies in recognizing that the essence of DeFi transactions is a temporary conversion of asset forms rather than a final disposition.

Other countries facing similar issues may want to pay attention to the approach taken by HM Revenue and Customs in the UK, along with the in-depth research and considerations behind it. Many tax authorities still treat every cryptocurrency transaction as a taxable event, an outdated handling that overlooks the technical characteristics and economic nature of Decentralized Finance. The UK's innovation may prompt a rethinking of global DeFi tax policies.

If the UK successfully implements this tax reform and proves that it can both protect tax revenue and promote innovation, it may attract global DeFi projects and users to concentrate in the UK. This will enhance the UK's position in the competition for global Crypto Assets financial centers, competing with traditional crypto-friendly jurisdictions such as Singapore and Switzerland. In the long run, this kind of regulatory innovation may be more effective in driving industry development than direct financial incentives.