Tax position for lender/staker where CAPITAL REWARDS received and there is NO transfer of beneficial ownership
HMRC explain at CRYPTO61640 that the DeFi lending platform/protocol is treated as a nominee for the borrower, so any capital gain or loss on a disposal of the tokens held as collateral by the DeFi lending platform/protocol is deemed to be the capital gain or loss of the borrower.
HMRC state that any tokens taken from the borrower as a penalty is not an allowable cost for CGT purposes.
HMRC are clear in CRYPTO61640 and their example in CRYPTO61675 that the tokens disposed of to settle the borrower’s position are treated as disposed of at their market value in sterling. However, this seems to result in an unfair tax position, since nothing is received upon liquidation in return for giving up the collateral, yet the CGT is based on the market value of the collateral which has been lost (which is often significantly more than Nil).
The collateralised loan which has been retained upon liquidation is not consideration for the collateral given up; because this is treated as acquired for and sold for market value for tax purposes, with the effect you are only subject to CGT on the appreciation or depreciation in value whilst in your possession.
When following the HMRC guidance, the gain of £100,000 in Example 2B and Example 2D, where there is no transfer of beneficial ownership upon adding the collateral, is £200,000 more than in Example 2A and Example 2C. However nothing was received in exchange for the collateral in either example, and the £100,000 spent on the original purchase of the collateral is now lost in both cases. So it would seem logical that the overall tax position should be the same, regardless of whether or not beneficial ownership is transferred when the collateral is added.
If the HMRC guidance is not followed and alternatively the disposal proceeds upon liquidation in this situation are recorded as Nil (not market value as per the HMRC guidance), it realises a capital loss of £100,000, which is a true reflection of the loss by the taxpayer and seems to more fairly reflect the position.
It is recommended you seek professional tax advice regarding this matter, especially if you are considering taking a position that is not in agreement with HMRC's guidance.
Upon liquidation it could be the case that no capital reward tokens are received and will ever be received; or capital reward tokens may be received, which may or may not have a lower value than expected.
Upon entry, the estimated capital reward was subjected to capital gains tax and a 'Marren v Ingles right' was acquired at the same time. The acquisition cost of the 'Marren v Ingles right' is the estimated present value of the future capital rewards that was subjected to capital gains tax upon entry.
Upon liquidation, a capital gains tax calculation is required for the disposal of the 'Marren v Ingles right' acquired upon entry.
Where no capital rewards are received, the disposal proceeds will be Nil and there will be a capital loss equal to the acquisition cost of the 'Marren v Ingles right'.
Where capital rewards are received, the disposal proceeds will be the sterling market value of the capital reward tokens at the date of receipt. The acquisition cost of the 'Marren v Ingles right' is deducted from the disposal proceeds.
Where the disposal of the ‘Marren v Ingles right’ gives rise to a capital loss, it may be possible to elect to set that loss against any capital gain that arose upon entry. For more information about this election HMRC point you to CG15080 onwards