Written by: TaxDAO, Wu Shuo Blockchain

Introduction

The development of crypto assets has brought not only innovation and opportunities, but also challenges and risks. In the field of taxation, the complexity and diversity of crypto assets have brought new challenges and requirements to tax management. As one of the global leaders in financial technology, the United Kingdom plays an important exemplary role in the tax policies of crypto assets for other countries. At the same time, the reform of crypto asset taxation in the UK is also at the forefront of the world, which is worth investors' attention. This article will analyze the development trends and challenges of crypto asset taxation in the UK from three aspects: basics, current situation, and future.

Basics: Overview of the UK General Tax System

Taxation in the UK is mainly managed and collected by Her Majesty's Revenue and Customs (HMRC), and includes income tax, property tax, capital gains tax, inheritance tax, and value-added tax. Among them, income tax, capital gains tax, and inheritance tax are progressive taxes based on the taxpayer's income level, while property tax and value-added tax are proportional taxes based on fixed rates.

Direct Taxes: Income Tax and Capital Gains Tax

Income tax is a direct tax levied on various incomes of taxpayers. Taxpayers' incomes include wages, interest, dividends, rent, pensions, benefits, etc., but not all income is subject to income tax. For example, interest from Individual Savings Accounts (ISAs) and National Savings Certificates (NSCs), winnings from lotteries and premium bond prizes, and rental income (if less than £7,500 per year) are exempt from income tax.

In the UK, there is a basic tax-free allowance for individuals, called Personal Allowance. This is the tax-free income that each taxpayer can enjoy before paying income tax. For the 2022-23 tax year, the personal allowance is £12,570, and income exceeding this amount is subject to different rates of income tax. In England, Wales, and Northern Ireland, there are four income tax bands: Starter Rate, Basic Rate, Higher Rate, and Additional Rate, while in Scotland, there are five income tax bands.

Capital Gains Tax (CGT) is a tax levied on the profits obtained by individual UK residents when selling or transferring assets. The tax rate for capital gains tax depends on the applicable income tax rate and the type of asset sold, with a certain exemption amount. If the individual income tax applies at a higher or additional rate, the capital gains tax on residential property is 28%, and on other assets is 20%; if the individual income tax applies at the basic rate, the capital gains tax on residential property is 18%, and on other assets is 10%. For the 2021/2022 tax year, the individual tax-free capital gains amount is £12,300.

Corporation Tax is a direct tax on the income and capital profits of companies or other legal entities in their business activities, including the taxation of capital gains obtained by companies, i.e., when companies sell or transfer assets within the scope of corporation tax, their profits are included in the scope of corporation tax. In terms of tax rates, there has been only one unified tax rate for corporation tax, which is 19%. However, starting from April 1, 2023, to increase tax revenue and encourage the development of small and micro-enterprises, the UK government has stipulated a new corporation tax plan: companies with profits exceeding £250,000 are subject to a 25% corporation tax; companies with profits below £50,000 still pay 19% corporation tax; companies with profits between £50,000 and £250,000 pay corporation tax at a marginal increasing rate.

Indirect Taxes: Property Tax and Value-Added Tax

There is no tax type called "property tax" in the UK, but correspondingly, there are indirect taxes levied on residential and commercial properties, mainly in the form of Council Tax and Business Rates. These are local charges for residential or commercial properties, used to pay for public services provided by local governments, such as education, health, waste disposal, road maintenance, and traffic management.

Value-added tax (VAT) is an indirect tax levied on the value added to goods and services in the production and sales process. In the UK, there are three different VAT rates: standard rate (20%), reduced rate (5%), and zero rate (0%). Different types of goods and services are subject to different tax rates, for example, food, children's items, newspapers, etc., are subject to the zero rate, while the vast majority of goods and services are subject to the standard rate.

Current Situation: Analysis of Crypto Asset Taxation in the UK

Historical Review of Crypto Taxes in the UK

The UK is one of the largest financial centers in Europe and an important participant in the global crypto asset market. However, the UK's tax policies on crypto assets were not initially clear and uniform, but were revised multiple times in response to the rapid development of the crypto asset field.

Initial Exploration: 2014-2018

In 2014, HMRC issued the first guidance on crypto asset taxation, covering three types of crypto assets: exchange tokens, utility tokens, and security tokens, which put the UK at the forefront of EU countries at that time. The guidance stated that crypto assets are not currency or currency equivalents, but assets, and therefore fall under the existing tax framework. The guidance also outlined the basic principles and methods for levying income tax and capital gains tax on crypto assets.

• Mining income is not subject to VAT;
• Gains and losses from holding and selling virtual currency are treated as gains or losses from other commodities or currencies;
• Digital currency purchased and held for personal reasons, not for speculation, is not taxed;
• When selling crypto assets as services and goods in the UK, VAT should be paid.

In 2018, the UK government established a dedicated group for crypto assets to study and evaluate the impact and potential of crypto assets, and proposed a series of action intentions.

Refinement of Rules: 2019-2021

During this period, HMRC issued the second, third, and fourth guidance on crypto asset taxation, adopting the classification of crypto assets from the dedicated group report, and providing more detailed and specific tax rules for utility tokens, security tokens, crypto asset businesses, mining, and staking. For businesses engaged in crypto asset activities, they are required to record all relevant information and determine their value and profits according to the relevant accounting standards.

Addressing DeFi: 2022 to Present

During this period, HMRC issued the fifth guidance on crypto asset taxation, mainly focusing on decentralized finance (DeFi). The UK Treasury also issued two consultation papers in 2022 and 2023, seeking opinions on changes to the tax treatment of DeFi lending and staking, and proposed corresponding legislative measures, aiming to standardize and regulate DeFi management.

Tax Collection Methods for Crypto Assets in the UK

Due to the common law tradition and the flexibility of crypto assets, the UK government has not chosen to establish a complete set of crypto asset tax laws, but has incorporated them into the existing tax framework based on the nature and use of crypto assets, mainly levying income tax and capital gains tax on them. The methods of levying these two taxes are the same as for other types of income and assets. Taxpayers need to calculate their income and profits from crypto assets for each fiscal year based on their own circumstances and declare them on the corresponding tax return. The UK also provides some tax-free allowances or relief measures, such as personal allowances, Individual Savings Account (ISA) relief, and Annual Exempt Amount.

In addition, the UK may also levy other types of taxes on crypto assets, such as value-added tax, stamp duty, stamp duty reserve tax, and stamp duty land tax. These taxes mainly depend on whether crypto assets are involved in goods, services, securities, or land. If crypto assets are used as consideration for the purchase or transfer of land or buildings, then stamp duty land tax should be calculated based on the definition of "money or money's worth." However, the situation is different for the other three types of taxes: utility tokens and security tokens need to be assessed for the need to pay value-added tax, stamp duty, or stamp duty reserve tax based on their specific characteristics and uses, while exchange tokens are not considered by the UK to be goods, services, stocks, marketable securities, or chargeable securities, and therefore do not involve the above three types of taxes.

Due to the UK's decoupling from the EU, taxpayers need to convert crypto assets into pounds for tax calculation. HMRC stipulates that the exchange rate used for conversion should be the fair market value at the time of the transaction or the closest to the time of the transaction. Taxpayers can use exchange rates from any reliable source, such as crypto asset trading platforms or brokers.

Future: Further Improvement of DeFi Taxation

Overview of the Second Consultation on DeFi

The current focus of the UK government's policy is mainly on the taxation regulation of DeFi. In the second consultation paper, the UK government defines DeFi as "decentralized platforms or protocols that provide financial services using crypto assets, smart contracts, and distributed ledger technology. DeFi includes a range of activities such as lending, staking, trading, insurance, etc., aiming to provide alternatives or supplements to traditional financial services. The characteristic of DeFi is that it does not rely on any intermediary or trusted party, but achieves automation and security through algorithms and code."

In the current crypto tax system, the tax treatment of DeFi lending and staking activities is overly complex. Taxpayers need to record the details of each DeFi staking/lending transaction, including the type, quantity, value, time, source, and purpose of the crypto assets, and calculate and declare them according to different tax types and rules. Moreover, the tax treatment of DeFi lending and staking activities may lead to double taxation issues due to their nature. Therefore, the UK government is attempting to simplify and standardize the tax treatment of DeFi staking/lending activities through a reform plan, making it more consistent with its economic substance and reducing the administrative burden on taxpayers. Specifically, the reform plan includes the following:

1. Crypto assets used in DeFi transactions will no longer be considered as having incurred a tax disposal, but will only incur a tax disposal when they are economically disposed of in non-DeFi transactions. This can avoid multiple taxation of the same crypto assets and simplify the recording and reporting obligations of taxpayers.

2. All DeFi income will be treated as miscellaneous income and included in the new miscellaneous income allowance for crypto asset transactions. This can standardize the tax treatment of different types of tokens and eliminate the distinction between trading and non-trading activities.

3. The new miscellaneous income allowance will apply to individuals and businesses, and will be levied at the corresponding income tax or corporation tax rates. This will maintain fair competition between individuals and businesses, and also align with the existing tax framework.

4. The new miscellaneous income allowance will allow taxpayers to deduct costs and losses related to DeFi transactions, but will not allow offsetting or transferring against other types of income or profits. This will reflect the actual situation of DeFi transactions and prevent potential abuse or avoidance behaviors.

The UK government considers the economic substance of DeFi lending and staking to be similar to repurchase agreements, as users in DeFi transactions do not relinquish economic interest in crypto assets, but only temporarily transfer ownership or control. Therefore, the UK government hopes to treat DeFi lending and staking as repurchase agreements, thereby excluding them from tax disposals, which means that users will not incur gains or losses in DeFi transactions. Instead, gains or losses will only occur when users economically dispose of crypto assets in non-DeFi transactions (such as selling, exchanging, or gifting), and will be calculated based on market value.

Responses to the DeFi Reform Plan

Bitcoin Policy UK (BPUK), a representative organization of the UK cryptocurrency asset community, stated in its response on June 22nd that BPUK supports the government's goal of establishing a tax framework for DeFi, believing that this will help the UK become a leader in the global financial technology market and provide more certainty for taxpayers. BPUK supports the government's view of treating staking/lending DeFi transactions as repurchase agreements and suggests allowing taxpayers to choose whether the new rules apply to their past DeFi transactions to avoid double taxation or unfair outcomes.

However, there are differing opinions regarding the treatment of staking/lending DeFi transactions as repurchase agreements. The Institute of Chartered Accountants in England and Wales (ICAEW) stated in its response on June 23rd that it supports the government's goal of establishing a tax framework for DeFi and hopes the government will further study the broader tax issues in the crypto asset market. ICAEW further believes that the "no gain/no loss" (NG/NL) rule is easier to apply for most situations in the DeFi market compared to treating DeFi transactions as repurchase agreements, not only making it more convenient for taxpayers to operate, but also covering a wider range of DeFi transactions. The DeFi Education Fund also expressed on the same day that treating DeFi transactions as repurchase agreements would lead to unfair and unreasonable taxation, as well as administrative complexity and difficulties. They suggested that HMRC should develop a simpler, clearer, consistent, and fair tax framework to accommodate the complexity and diversity of DeFi transactions.

Possible Improvements to DeFi Taxation

Overall, the UK government's regulatory attitude towards DeFi is positive and cautious, recognizing the innovation and potential of DeFi while also valuing the risks and challenges. The UK government will determine whether regulation is necessary based on the specific circumstances of DeFi and take appropriate regulatory measures, following principles such as consumer and investor protection, market competition promotion, market stability maintenance, and prevention of market abuse. The UK government will continue to monitor new technologies and models in the DeFi field and make corresponding regulatory adjustments and updates.

Regarding the treatment of DeFi lending/staking transactions as repurchase agreements, considering the opinions of various institutions, it is believed that the UK government may reconsider the plan to treat DeFi lending and staking as repurchase agreements and make adjustments and modifications based on market feedback and actual circumstances. The UK government may try to find a balance, giving DeFi more flexibility and space while adhering to principles such as consumer and investor protection, market competition promotion, market stability maintenance, and prevention of market abuse. In this consideration, the UK government may consider the application of the NG/NL rule.

In conclusion, the development trend of crypto assets in the UK is: regulation, innovation, and collaboration. This is both an opportunity and a challenge for participants in the crypto asset field, serving as both motivation and constraint.

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