Decentralised Finance (DeFi) offers users the opportunity to “lend” their crypto assets to third parties in exchange for rewards, typically in the form of other crypto assets.
On 9 November 2023, the Australian Taxation Office (ATO) updated its non-binding web guidance on the tax treatment of DeFi interest and rewards. Make sure you are not caught out if you are engaging in similar activities.
Taxation of DeFi Interest and Rewards
According to the ATO’s view, the rewards that users receive from DeFi arrangements represent a type of “yield” or “return” for the crypto assets held, loaned, or offered as part of that arrangement. As a result, the ATO has aligned the taxation of these crypto asset rewards with that of traditional interest income.
This means that the market value of crypto asset interest and rewards (calculated at the time you receive the interest or reward) must be reported as your assessable income. Should you subsequently dispose of that crypto asset, the cost base of the crypto asset will be its market value at the time you acquired it.
Example of DeFi Interest Taxation
Let’s examine the following scenario.
You agree to lend 100 stablecoin tokens through a DeFi platform.
Each token is valued at $1, and the DeFi platform offers you a return rate of 1% in the form of newly issued stablecoin tokens. At the end of the arrangement, you receive 1 stablecoin token as a return on the lending arrangement.
From a taxation perspective, you must declare the market value of the newly issued tokens as assessable income. Relevantly here, market value of the DeFi interest is $1. Importantly, the cost base of these newly issued tokens for capital gains tax (CGT) purposes, is also $1 (which reflects the market value of the DeFi interest at the time you received it).
The ATO view is not free from doubt. Some tax specialists view different staking rewards not as income in some cases.
For example, proof of stake rewards paid to validators of the Ethereum network are likely to be income as they are amounts that come in, in exchange for locking up 32 Ether and validating the blockchain network.
Another example, the actual mechanics of the now defunct Anchor Protocol. It was advertised as paying 19% interest at the height of popularity, though the actual mechanism was that aUST (Anchor staked UST) increased in value using an algorhythm to obtain the 19% return. This may increase be a capital gain when aUST is converted back into UST.
It is clear that the position that all DeFi rewards are taxable, is not quite correct. Many will be income, but an analysis of the protocol is required to make that conclusion.
Additionally, it has not been made clear when income is derived. Blockchain records only show claimed tokens, not accrued returns locked in smart contracts.
While DeFi platforms offer unique opportunities for earning crypto assets, it is critical that users are aware of the tax obligations that accompany these rewards. Proper reporting and understanding of tax implications are key to ensuring compliance and avoiding potential liabilities, penalties and interest.
Tax specialists may be needed for special cases, such as institutions that stake crypto to earn yield and sophisticated traders.
Disclaimer: This material is produced by Cadena Legal, a NSW registered legal practice. It is intended to provide general information and opinions on legal topics, current at the time of first publication. The contents do not constitute legal advice and should not be relied upon as such. For specific legal advice, please contact us at firstname.lastname@example.org.
Related post: The ATO’s New Position on Lending and Borrowing in DeFi