Example - Liquidity pool

Where there is no transfer of beneficial ownership when the tokens are added to the pool

Liquidity pool scenario - no beneficial ownership transfer

Example

A taxpayer puts in 5 ETH and 10 LNK into a liquidity pool. The 5 ETH and 10 LNK are exchanged for a ‘liquidity pool’ token that is redeemable when they withdraw from the liquidity pool. One month later, they withdraw from the liquidity pool and receive 3 ETH and 15 LNK in exchange for the ‘liquidity pool’ token. They also receive 15 USDC in rewards which they have decided is an income reward.

There is no HMRC guidance on liquidity pools where there is no transfer of beneficial ownership at the time the tokens are added to the pool, so you would need to examine the details of the transactions you are undertaking to determine the tax treatment.

Reward income

As the reward has the nature of income, the 15 USDC rewards will be taxable as miscellaneous income, subject to income tax. The sterling value of the 15 USDC at the date of receipt will be the value of the miscellaneous income.

This same value is the CGT acquisition cost of the tokens; to be deducted from the proceeds of a later disposal of the tokens (which will be subject to CGT).

Liquidity pool token

In the example above, the receipt and redemption of the ‘liquidity pool’ token appears to be simply a claim/redemption mechanism, rather than the acquisition and disposal of a cryptoasset for tax purposes.

Therefore the receipt and repayment of the redemption token has been ignored for tax purposes.

Change in principal tokens held

Where the beneficial ownership of the 5 ETH and 10 LNK put into the liquidity pool is retained by the taxpayer, it seems clear that there is no disposal of these tokens for tax purposes.

In the example above, the taxpayer withdraws 3 ETH and 15 LNK from the liquidity pool, after putting 5 ETH and 10 LNK in the pool one month earlier. They now hold 2 less ETH and 5 additional LNK, compared with when they entered the liquidity pool.

The most logical tax treatment is that upon the exit from the pool, there is a taxable disposal of 2 ETH and an acquisition of 5 LNK. The disposal proceeds being equal to the sterling value of 2 ETH and the acquisition cost being the sterling value of 5 LNK; both at the date of withdrawal of the tokens from the pool.