VAT implications on ICOs

At a first glance, it is hard to believe the fast adoption by enthusiasts towards blockchain technology in comparison with the spread of the Internet in the 1990s. Preliminary to going into detail on the VAT implications on Initial Coin Offerings (ICOs) and the diverse rights and obligations assigned to tokens, one needs to get a grasp on what the fuss is all about.

Initial Coin Offerings have become rapidly a new method to raise funds for research and development of a proposed project being exposed to an unlimited number of potential investors connected virtually worldwide. In exchange for the injected funds to the ICO for research and development, the investors receive crypto tokens.

Crypto tokens constitute both coins and tokens with assigned diverse rights and benefits to the investor; however most of the coins function as a currency or medium of exchange. Tokens represent any asset that is tradeable and mutually interchangeable by an identical item. Tokens can range from privileges such as commodities to loyalty points or even cryptocurrencies.

To date, if any VAT liability is due, irrespective who will be liable for the payment of VAT, one needs to make reference to the applicable law and guidelines issued by the respective tax authorities in the jurisdiction where VAT becomes liable. Unfortunately, not all countries have issued clear guidelines on the treatment of these novel transactions and we are at no point close to have any harmonised or unique treatment in the EU apart from Case Law which might give some light on the position the EU might take in respect to ICOs, bitcoins or other cryptocurrencies.

The investing in an ICO by purchasing a token or coin by fiat (conventional) money does not trigger a supply, therefore at this point, the transaction is not vatable. Reason being that the transaction is considered as an exchange of currencies, based on the interpretation by the European Court of Justice (ECJ) in Case C – 155/94.

The case in question started with Mr Hedqvist, who wished to provide services through a company, consisting of the exchange of fiat currency for the “bitcoin” virtual currency and vice versa. These transactions were to be carried out electronically via the company’s website. The company would purchase units of the bitcoin virtual currency directly from private individuals or companies intended to exchange solely between bitcoin and Swedish krona.

The query was in regards to the VAT treatment, if any, of transactions involving the exchange from bitcoin currency to conventional currency and vice versa. Before he opened the proposed company, he wanted clarity with the Swedish Revenue Law Commission on the VAT liabilities to be incurred both from the purchase and sale side of these currencies.

The Swedish Revenue Law Commission classified the purchase and sale of bitcoins as a supply of services for consideration, which was however exempt from VAT in the conventional scenario. However, the Swedish Tax Authority appealed against this preliminary decision of this VAT exemption and appealed the case with the Supreme Administrative Court of Sweden. Before giving any judgement, the Supreme Court opted to make a request for guidance to the ECJ for interpretation on this case.

This was the first time that the ECJ was to rule on the VAT treatment on the exchange of virtual currencies to fiat currency. The ECJ court made reference to the VAT Directive, mainly Articles 2(1)(c), 135(1)(e)(d)(f) and Article 15(2) exempting negotiations and exchanges of legal tender in the conventional method. Reference was also made to items which do not fall under these exemptions such as collector`s items, securities and negotiations re debt collection, among others.

Subsequent to the above interpretation by the ECJ, the Case went back to the Supreme Courts of Sweden for the final judgment. The Court based its ruling on the interpretation by the ECJ that each transaction needs to be compared to a conventional transaction in order to follow the VAT Directives for decision-making.

The characteristics of tokens earned through an ICO vary; therefore, one cannot give uniform VAT advice on the whole spectrum. One needs to analyse the rights and benefits conveyed through a particular ICO issue, case-by-case method. If the received tokens are redeemable against any crypto currency, then these transactions are also exempt from VAT being a supply for a consideration (currency).

In contrast, if the tokens do not equate to shares, securities or currency and the issuer is a taxable person for VAT purposes, than the ICO transaction may be vatable. An exemption to this statement is when purchased ICOs only give the investor the right to payment; such as a share from future profits. In such a case, this ICO investment will be exempt from VAT since the conventional transaction concerning payments, transfer or debts are out of scope for VAT.

In the case when tokens infer the right to purchase goods or services, these must be considered as “face value vouchers”. When we have vouchers, the point of supply will be at the point of redemption of rights by returning back the tokens to the issuer in exchange for goods or services from the ICO which could have been successful and launched as a company. However, this only applies in the case when tokens are clearly identified as “single purpose vouchers” in the ICO portfolio/contract. When tokens are not classified as “single purpose vouchers”, the point of supply will be when each token is redeemed, since they will have the right to redeem the tokens in intervals and in exchange to diverse goods or services.

The UK Tax Authority acknowledged that “crypto currencies have a unique identity and cannot therefore be directly compared to any other form of investment activity or payment mechanism”. This statement can be mostly accredited through the analysis of tokens created through smart contracts by which technology incorporated unique detailed terms into each specific token issued as part of an ICO in order to assign the desirable rights to be more attractive for crowdfunding.

Then again, the service provided by a third party currency exchange company to process the transaction, which mostly translated to a conversion fee or commission, would be subject to VAT only if the same services given for fiat currencies exchanges would be vatable. This is quite simple to understand since the type of service being provided by the company is completely the same, while only the type of currency being converted is diverse.

The German Federal Government in a brief statement made on the inquiry of “Kleine Anfrage” dated 20 June 2013 classified tokens as an economic asset. As a consequence, these should be considered for VAT purposes comparable to the VAT implications for the trading of coins, vintage cars or collectable stamps which are not exempt from VAT as per the VAT Directive.

From a VAT perspective, Germany is applying the decision taken by the EU in the case (C-264/14) by the ECJ courts considering bitcoins are a means of payment and as a consequence being out of scope for VAT. During the court case in question, the judge added to explain that his judgement covers “new types of tokens”. He gave the example of tokens being swapped for memory space on a particular platform. He explained that although this is not a traditional payment transaction, this example confirms that tokens are just replacing fiat currency to conclude a purchase of goods or service.

The Swiss Federal Tax Administration updated their taxation guidelines in July of this year through the VAT-INFO 04 guidelines draft. Summarising the draft in question, they distinguished between three types of tokens being: payment tokens, utility tokens and asset tokens.

With respect to payment tokens, if this will be the only purpose of these tokens, then VAT treatment is the same as a payment by any other currency. However, tokens used as a payment method for services related to a trading platform for crypto currencies, are not exempt from VAT. This applies if the recipient of these services is resident in Switzerland for VAT purposes.

Conversely, utility tokens are considered as a pre-payment, providing the investor a future possibility to receive a service from the issuer. These transactions qualify as a provision of service and are subject to VAT if the recipient is resident for VAT purposes in Switzerland. The latter only applies if on the date of transaction, the value of such service is available.

With regards to Asset tokens, these entitle the holder to a certain share in profit, revenues, and claims to derivative rights or similar rights from the successful project to the investor. These tokens qualify as turnover in connection with uncertificated securities and derivatives which are exempt from VAT without the right to reclaim input tax. In a comparable traditional case, the purchase of shares is outside the scope of VAT. Furthermore, as per VAT Directive Article 135(1)(b) or(f) of 2006/112/CE, those assets have the right to dividend exempt under this directive.

With regards to hybrid tokens, the Swiss authorities have not yet issued clear guidelines. To date, hybrid tokens made up of asset and utility tokens can be classified as payment tokens. However, in that case, one cannot treat these hybrid tokens separately to take advantage of one of the VAT treatments of one of the hybrid tokens. As declared by the Swiss authorities: “It varies from token to token.”

On 1 November, the Commissioner for Revenue issued guidelines under Article 75(2) of the VAT Act (Chapter 406 of the Laws of Malta). The guidelines issued cover Distributed Ledger Transactions (DLT) assets and these have been drafted in agreement with the interpretation given by the ECJ on virtual currency exchanges.

The guidelines point out the definition of “negotiation” by making reference to Schedule 5, Part 2, item 3 of the VAT Act. “Negotiation refers to the activity of an intermediary who does not occupy the position of any party to a contract, relating to a financial product and whose activity amounts to something, other than the provision of contractual services, typically undertaken by the parties to such contracts.” If negotiations in an ICO contract satisfy this definition, then the consideration paid to the intermediary will be exempt without credit under the VAT Act. As per Article 135(1)(d)(e)(f), any other service which is not covered by these exemptions, would be vatable.

Overall, as per Article 2 of the VAT Directive, there needs to be a direct link between the delivery of a good or service and the taxable person for VAT to be applicable. Most ICOs fail this link test since when the project they invested in fails, they do not receive any remuneration back for their investment. This lack of link, would deduce that in these failed cases, no VAT should be payable. In a nutshell, only the use of the token as a payment for goods or services could be subject to VAT once there is a clear link between the investor and the issuer or supplier for redemption of rights or services. However, utility tokens rights needs to be analysed in line with the ICO portfolio since a chargeable event for VAT purposes can arise at later stages.

Shanice Finch is a tax advisor for Erremme Business Advisors Limited Contact details: sfinch@easl.com.mt