Why Ethereum (ETH) Merge Spell Tax Trouble for UK Crypto Stakers

In Brief

• Staking is likely to become mainstream, which could prove rather costly for U.K. taxpayers.
• Cryptocurrency staked on exchanges could be subject to capital gains tax, while earnings from staking would be taxed as income.
• As Britons typically do not have to file taxes annually, this additional administrative burden could prove overwhelming to the system.

Ethereum (ETH) holders in the United Kingdom looking to stake their crypto following the Merge earlier this month could face paying much more in tax.

Following the upgrade, Ethereum converted from a proof-of-work system to proof-of-stake one, in which holders are encouraged to “stake their crypto in order to secure the blockchain.

With yields hitting 5.2% by one estimate, this news is expected to bring staking to the masses. Already some $25.2 billion in Ethereum, roughly 12% of all eligible ETH in circulation, was locked up in staking wallets as of earlier this week, according to Staking Rewards.

U.K. tax office issues DeFi guidelines
However, the UK’s HM Revenue and Customs issued guidelines earlier this year on how staking should be treated for tax purposes, updating its framework for cryptoassets to include decentralized finance (DeFi).

The new proposals have put an increased responsibility on investors to establish what they might have to pay, as the terms and conditions of particular platforms could dictate whether a levy must be paid.

For instance, a capital gains tax could be incurred if a platform has use of a person’s coins while holding them, as this would indicate that the beneficial ownership of those assets has passed, and thus be treated as disposal, HMRC, the U.K. tax department, said.

According to experts, this would likely be the that could happen to those staking ETH on exchanges, because staked tokens are grouped together from multiple users.

Additionally, many users are likely to use exchanges as well because of the technical expertise and necessary capital required to be a validator on the Ethereum blockchain.

Accordingly, validators who run their own nodes on the blockchain are “not covered within the DeFi guidelines,” HMRC clarified.

The guidelines added that the earnings from staking would not be treated as interest, since crypto assets are not considered currency or legal tender in the U.K. This puts rewards from staking under income tax, which can rise to rates as high as 45% (although the government recently announced it would cut the top rate).

Taxpayers in for a shock
Yet, this tax burden could come as a surprise to many in Britain, as workers in the U.K. do not have to file tax returns, unlike the United States, unless they collect earnings from investments.

Consequently, there are likely many who are unaware of the requirement to file returns in such cases. “One of the challenges for any tax authority is, are you causing a lot of people to suddenly file a tax return that weren’t previously?,” said David Wren, a tax partner at EY.

Since the vast majority of employed Britons are not required to file annual returns, the new requirements could also potentially be a massive administrative undertaking for authorities.

Tax officials “are going to give themselves quite a big headache if they suddenly require a lot of people to file tax returns just for their crypto,” Wren said. “So it’s not just that the tax position isn’t great, it’s also that the administration is not great on either side.”

Tax guidelines could damage country’s crypto ambitions
Meanwhile, industry advocates in the UK have expressed discontent with the guidelines. In addition to being “full of problems, overburdensome, and very difficult to value and enforce,” according to Ian Taylor, head of industry lobby group CryptoUK, the HMRC’s initial guidelines could also threaten the country’s recent efforts to attract crypto talent.

However, the sector has expressed some optimism about a consultation the authority has since held with industry participants regarding ways of improving the tax system.

“HMRC is currently analyzing the responses to the DeFi call for evidence,” the department said in a response. “A summary of responses will be published in due course together with details of the next steps.”

According to recent data, over a third of those in the U.K. currently own cryptocurrency.

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