Aave Lending and Borrowing Tax in the UK — HMRC Rules for DeFi Lending

You supplied 10 ETH to Aave. Got aETH back. Maybe borrowed some stablecoins against it. Now you're staring at your tax report and it says you disposed of 10 ETH worth £28,000 and owe CGT on the entire amount.

You didn't sell anything. You lent it.

This is arguably the most confusing area of UK DeFi tax, and it trips up more users than any other Aave interaction we see. The good news: most of what you did on Aave isn't taxable. The bad news: the one part that is taxable is almost impossible to track from transaction history alone.

Aave deposits are not disposals

When you supply tokens to Aave (V2's deposit() or V3's supply()), you're lending them to the protocol's liquidity pool. In return you receive aTokens — aETH, aUSDC, aDAI — that represent your claim on the deposited assets plus accrued interest.

This is not a disposal for Capital Gains Tax purposes.

You haven't exchanged one asset for a different asset. The aToken is a receipt, a claim token that tracks your position. Beneficial ownership of the underlying hasn't changed — you can withdraw at any time and get your original tokens back. HMRC's Cryptoassets Manual (CRYPTO22200) treats this the same way as moving tokens between your own wallets.

ChainTax classifies Aave deposits as TRANSFER — non-taxable, cost basis preserved. We see this misclassified constantly by other tools. A tool that treats deposit as a disposal will generate a phantom gain on your entire deposit amount, then set a fresh cost basis on the aTokens. Every number downstream is wrong after that.

Withdrawals: also not taxable

Withdrawing from Aave — burning your aTokens and receiving the underlying — is the reverse of a deposit. Same logic applies. You're reclaiming tokens you already own.

Not a disposal. Not an acquisition. TRANSFER.

Your original cost basis carries through the entire deposit-and-withdraw cycle. If you bought ETH at £1,500, supplied it to Aave for six months, then withdrew, your cost basis is still £1,500. The Section 104 pool doesn't change.

aToken interest: the hard part

Here's where it gets genuinely tricky.

Aave interest doesn't arrive as separate reward transactions. There's no "claim rewards" button you press that emits a Transfer event your tax tool can see. Instead, your aToken balance increases continuously — every block, your aETH balance ticks up by a fraction. When you deposited 10 ETH and later withdrew 10.3 ETH, that extra 0.3 ETH is interest income.

HMRC treats this as miscellaneous income, taxed at your marginal income tax rate (20%, 40%, or 45%) — not capital gains. It should be valued at fair market value on the date of receipt. The problem is defining "date of receipt" when interest accrues continuously.

For your Self Assessment, aToken interest goes on SA100 under "Other income" — not on SA108 with your capital gains. See our guide to reporting staking rewards for the full breakdown of where DeFi income sits on the return.

Borrowing against your collateral

Taking a loan on Aave — borrowing USDC against your ETH collateral, for example — is not a taxable event. You're receiving borrowed funds, not disposing of an asset. HMRC doesn't tax loans.

Repaying the loan isn't taxable either. You're returning what you borrowed.

The interest you pay on borrowed tokens is trickier. HMRC hasn't published specific guidance on whether DeFi borrowing interest is deductible — shocking, we know. In traditional finance, loan interest is sometimes deductible if the loan is used for qualifying purposes (like buying income-producing assets). Whether the same logic applies to Aave borrowing is genuinely unclear. Conservative position: don't deduct it unless your accountant confirms.

Liquidations: the painful one

If your collateral ratio drops too low, Aave's liquidation mechanism forces a sale of your collateral to repay part of your debt. Someone calls liquidationCall() and your tokens are gone.

This is arguably a disposal. You didn't choose to sell, but the tokens were disposed of at market value to cover your outstanding loan. HMRC would likely treat this as a capital gains event — proceeds being the market value at the time of liquidation, cost basis from your Section 104 pool.

ChainTax currently classifies Aave liquidations as TRANSFER. This is a known gap in the engine — liquidations should arguably be CAPITAL_GAIN. It's documented, and on our roadmap to fix. If you've been liquidated, you'll need to manually override that transaction or flag it for your accountant.

Flash loans

Flash loans are single-transaction borrow-and-repay operations. You borrow millions, use it within the same transaction, repay it plus a fee, and the net effect is whatever profit (or loss) you extracted.

The borrow and repay themselves aren't taxable — same logic as regular borrowing. But if the flash loan transaction includes a swap or arbitrage that generates profit, that profit is taxable. The flash loan is just the funding mechanism.

In practice, if you're executing flash loan arbitrage, you probably already know your tax position better than most accountants do.

V2 vs V3: does it matter for tax?

Not really. Aave V2 uses deposit() and withdraw(). V3 renamed these to supply() and withdraw(). The economics are identical — you supply tokens, receive aTokens, earn interest via balance increase.

V3 introduced efficiency mode (eMode) and isolation mode, which affect borrowing parameters but don't change the tax treatment. A deposit is a deposit. ChainTax handles both V2 and V3 method signatures across Ethereum mainnet, Arbitrum, Optimism, Polygon, and Base.

The real danger: phantom gains from misclassification

Say you supplied 50 ETH to Aave when ETH was £2,800. That's £140,000 of tokens moving to a smart contract. A tax tool that doesn't recognise the Aave lending pool contract will see £140,000 leaving your wallet and record it as a disposal.

If your cost basis was £1,500 per ETH (£75,000 total), the tool reports a £65,000 capital gain. At 24% CGT, that's £15,600 in tax you don't owe. On a transaction where you still own every single token.

Then when you withdraw, the tool records an acquisition at the withdrawal-date price — resetting your cost basis. If ETH dropped to £2,200 and you later sold, the tool would understate your real gain because it's using the wrong cost basis. The errors compound.

We see this pattern across every generic crypto tax tool. They don't read the contract address. They don't check the method signature. They see tokens move and assume it's a swap.

Aave operations: quick reference

* aToken interest accrues via balance increase without emitting per-user events. Liquidations are a known classification gap — see above.

What the NGNL regime means for Aave users

HMRC's proposed No Gain / No Loss (NGNL) regime for DeFi lending and staking would formalise everything above. Under NGNL, depositing tokens into a lending protocol and receiving a claim token back would be explicitly treated as a non-taxable transfer. The disposal is deferred until you actually sell the underlying for a different asset.

This is exactly how ChainTax already handles Aave. When NGNL is legislated, nothing changes in our engine.

How to check your Aave transactions

Open your tax report and look for any Aave deposit or withdrawal that's been classified as a disposal or capital gain. If the proceeds column shows a large number on an Aave supply transaction, something is wrong.

You can paste any Aave transaction hash into the free transaction explainer to see exactly how ChainTax classifies it — protocol, method, classification, and reasoning. No sign-up required.

For aToken interest, compare your deposit and withdrawal amounts on Aave's own dashboard. The difference is your taxable income, valued in GBP at the withdrawal date. Report it under "Other income" on your SA100 return.