UK review of cryptoasset regulation: tax aspects

Update: For details of HMRC’s consultation on expanding the IME, see our article “Expanding the IME to include cryptoassets”. For details of the call for evidence on the tax treatment of DeFi transactions, see “Taxation of decentralised finance: call for evidence”.

The government has published its response to its 2021 consultation on the regulation of cryptoassets and stablecoin and the use of distributed ledger technology in financial markets. The response confirms that the UK will now bring forward legislation to regulate the use of stablecoin and will also consult later in 2022 on regulating a wider set of cryptoasset activities.

As part of these announcements, including a keynote speech by John Glen, Economic Secretary to the Treasury, the government has announced that it will also look to explore ways of enhancing the competitiveness of the UK tax system to encourage further development of the cryptoasset market in the UK, including consulting on extending the scope of the Investment Manager Exemption (IME) to include cryptoassets.

The speech, and the government’s website, mention two specific issues that the government will be looking at in this context.

Firstly, the government will review how decentralised finance (DeFi) loans – where holders of cryptoassets lend them out for a return – are treated for tax purposes.

HMRC recently included guidance in its Cryptoasset Manual setting out, for the first time, HMRC’s view on the taxation of cryptoassets used in or DeFi transactions. The new guidance covers a number of important tax questions concerned with DeFI transactions, including HMRC’s view on the nature of returns from these activities and when taxable events occur where cryptoassets are lent or staked. In particular, HMRC’s guidance indicates that the lending or staking of cryptoassets to a DeFi platform in return for other tokens received from the DeFi platform will generally give rise to a disposal for tax purposes where the lender/transferor if the lender/transferor has transferred beneficial interest in their tokens. The same analysis would apply to a borrower who provides tokens as collateral for a loan. This analysis is, of course, fact specific and will depend on particular terms of any arrangement as well as factors including the nature of smart contracts deployed and the underlying technology of the tokens lent/staked. However, this analysis has attracted some criticism as it potentially leads to a tax charge in circumstances where the lender/transferor does not receive any return at the time of the disposal (a so-called dry tax charge). (For further information, see our recent Insights article discussing HMRC’s DeFi Guidance)

It is to be hoped that the government will address this issue as part of the review, either ensuring that disposals do not occur in in appropriate situations or ensuring that where disposals do occur that there should be an ability to roll-over any potential gains.

Secondly, the government has confirmed that it will amend the IME to remove disincentives to UK fund managers including disincentives to UK fund managers including cryptoassets in their portfolios.

Strictly speaking, the IME regime itself doesn’t disincentivise UK fund managers from trading in cryptoassets but rather the IME regime does not explicitly cover transactions in cryptoassets as things stand. Where the IME regime doesn’t apply, profits from relevant UK trading activities would be subject to UK corporation tax.

The lack of certainty over the treatment of transactions in cryptoassets is undesirable and has led to challenges for managers that wish to deploy particular investment strategies. Therefore, the government’s announcement of a consultation into the IME regime with a view to bringing cryptoassets in scope will be welcomed by the Industry.