If you’re venturing into the realm of crypto yield farming, understanding how the HMRC views your earnings and what’s expected of you at tax time becomes paramount. This guide aims to clarify those very intricacies for the 2023 crypto tax year.
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Basics of Crypto Yield Farming
Yield Farming is often equated with Liquidity Mining within the realm of Decentralised Finance (DeFi).
However, they have distinct differences.
Liquidity Mining involves depositing your crypto assets into a liquidity pool of a decentralised exchange (DEX) to facilitate trading and ensure price stability. In return, you receive platform tokens or other types of tokens as rewards.
Yield Farming is a broader strategy to maximise returns. While it encompasses Liquidity Mining, it doesn’t stop there. Users aim to combine various DeFi processes like borrowing, lending, and earning governance token rewards across different protocols to gain maximum returns.
The rise of DeFi governance tokens incentivizes users to utilise platforms by rewarding them. With everyone able to participate in DeFi, why not let an algorithm automatically join various platforms to amplify yield?
Considering the intricate operations across platforms, this brings added complexity, especially for tax considerations.
Popular platforms and tokens in the UK for yield farming include Uniswap, Compound, and Curve with tokens such as UNI, COMP, and CRV being highly favoured among enthusiasts.
The Basics of Cryptocurrency and Taxation in the UK
The UK’s stance on cryptocurrency is clear: it’s not considered ‘money’ or ‘currency’, but rather ‘property’. This classification by the HMRC (Her Majesty’s Revenue & Customs) has significant implications for how crypto is taxed. Essentially, every time you dispose of or use cryptocurrency – be it through selling, exchanging, or even making purchases – there might be a tax event.
Taxation of crypto revolves around two primary facets: capital gains and income.
If you sell your cryptocurrency for a profit compared to what you paid, you’re likely facing Capital Gains Tax (CGT).
However, if you earn cryptocurrency – whether through mining, airdrops, or in our main focus, yield farming – it’s typically treated as income.
This income should be reported on your tax return, and depending on the amount and your other income, you might owe Income Tax on it.
Learn more about the way crypto is taxed here: UK Crypto Tax Rates
How Crypto Yield Farming is Taxed in the UK
The process of Crypto Yield Farming consists of various operations. Each of these operations must be evaluated individually from a tax perspective. Therefore, how Yield Farming will be taxed by HMRC cannot be answered generally but depends entirely on your strategy and which operations it includes – be it lending, swapping, or liquidity mining.
Click on the links to learn more about the respective taxation.
The profits you obtain from Yield Farming probably largely come from Liquidity Mining. So far, there is no binding statement from HMRC regarding the tax treatment of income obtained through Liquidity Mining. There are scenarios where liquidity mining rewards might be classified as income rather than capital gains. This is especially true when:
- The return is predetermined, rather than being speculative.
- It’s paid by the borrower or the DeFi platform.
- It’s consistently distributed throughout the lending or staking period.
If you find yourself receiving tokens or coins regularly due to your DeFi engagements, HMRC is more likely to view this as earned income, making it subject to Income Tax. To remain compliant, calculate the value of these rewards in pounds sterling upon receipt, as this amount will be treated as income.
Here’s how Blockpit represents the process of adding liquidity to a Uniswap V3 Liquidity Pool:
Here’s how Blockpit represents the process of receiving liquidity mining rewards:
When selling tokens obtained from liquidity mining rewards, you may be liable for Capital Gains Tax on any profit relative to their initial value at the time of acquisition.
Detailed logs of all transactions provide clarity on profits, losses, and potential tax liabilities. Accurate records ensure compliance with regulatory requirements and streamline tax filings. Without meticulous documentation, you risk financial miscalculations and potential legal complications, undermining the benefits of your yield farming endeavours.
Specific Taxation Scenarios
Yield Farming with Stablecoins
Yield farming using stablecoins might seem straightforward due to the coin’s pegged value. However, even though these coins are designed to maintain price stability, occasional fluctuations can occur. If you profit from these minor shifts when farming, those gains are subject to taxation. It’s crucial to track and record even the smallest of these differences to ensure accurate tax reporting and compliance.
Re-investing Yield Farming Rewards
Reinvestment of yield farming rewards presents a layered tax scenario. Each reinvestment action could be treated as a disposal of the original asset, thereby potentially incurring a taxable event.
The determination hinges on the concept of beneficial ownership, as elaborated in our blog article: Liquidity Pool Taxation in the UK
Continuous record-keeping is essential, particularly when rewards are frequently churned back into the farming ecosystem.
Yield Farming as Part of a Business vs Personal Activity
In the UK, the taxation of cryptocurrency activities, including yield farming, hinges on the nature of the activity: business or personal.
Business Activity
If someone is operating as a business, frequently trading, mining, or actively yield farming, the profits or losses from these activities are typically treated as income and are subject to Income Tax. The intention, scale, frequency, and organisation of these activities play a role in determining this classification.
Unsure if your crypto activity constitutes a trade? Learn more about: Crypto Investor vs. Trader
Personal Activity
For those engaging in cryptocurrency activities on a more occasional or passive basis, such as sporadic trading or infrequent yield farming, any gains realised upon the disposal or sale of their cryptocurrency are likely subject to Capital Gains Tax (CGT). This encompasses individuals who might sell tokens acquired from yield farming as a one-off or on a non-regular basis.
However, receiving the rewards is typically considered as income.
Deductions & Losses
Claiming Expenses
Investors and yield farmers can claim certain expenses to reduce their tax liability. Notable expenses include transaction fees associated with trades and the initial cost of acquiring the crypto assets. By deducting these expenses, one can lower the overall taxable gain or profit.
Handling Crypto Losses
Crypto losses can sometimes serve as a silver lining. If you’ve incurred a loss during a tax year, this can be offset against any gains, effectively reducing the amount on which you might owe Capital Gains Tax. It’s essential to maintain detailed records of all transactions, both profitable and loss-making, to maximise this benefit.
Streamline your crypto tax return with Blockpit
Blockpit creates the most comprehensive crypto tax reports in PDF format. The report provides information about all your balances and transactions and can be used as proof of origin with banks or tax advisors. It contains all relevant transactions of your account in the selected tax year and shows details such as timestamp, amount, asset, costs and fees of the individual transactions.
Using Blockpit couldn’t be easier:
1. Import your transactions
Blockpit offers direct integrations for crypto exchanges, wallets and DeFi protocols. Automatically import your transactions via API integration, wallet address synchronisation, or by manually uploading an Excel file.
Discover all crypto integrations
2. Validate & Optimise
Blockpit offers smart insights and suggestions to optimise your tax report, fix issues, add missing values and to validate your transactions.
3. Generate your tax report
Generate your compliant tax report with the click of a button. Our tax engine calculates your tax report on the basis of the UK tax framework.
