By Thomas Linder, Tax Partner MME and Monika Molnar, Tax Partner MME, both members of the Crypto Valley Association Working Group Tax / Accounting / Structuring
After a long-lasting drafting procedure including two public review rounds, the VAT Department of the Swiss Federal Tax Administration (FTA VAT DEP) published on 17 June 2019 its long-awaited practice adjustments for VAT on supplies in connection with blockchain and distributed ledger technology. This blog is based on an initial publication prepared by MME and has been complemented with further input from other members of the CVA Working Group Tax / Accounting / Structuring (CVA WG TAS).
The adjustments to the Swiss VAT practice have been made under the following different publication titles:
General comments by MME & CVA WG TAS
The published practice adjustments to supplies in connection with blockchain and distributed ledger technology have undergone some important and correct changes compared to the revised first practice draft of 29 January 2019 on crypto currencies. However, from our point of view, unfortunately, they still do not fully reflect the economic, accounting and cybernetic, self-governing aspects of a decentralized, public open-source blockchain system. These would have to be considered for the legal effect of transactions on the blockchain. The VATability of a token transaction depends strongly on whether the token is synchronized with relative or absolute rights or not. If the transmission of a token in a cybernetic system does not trigger a synchronous transmission of an underlying legal relationship, the transaction should be irrelevant for VAT purposes.
Crowdfunding activities such as Initial Coin Offerings (ICOs), with which companies raise funds (in legal currency or crypto currency) for a specific entrepreneurial or open source project, are to be distinguished from these. An ICO usually consists of a bunch of contractual or factual obligations promised by the fundraiser. These can be related to the token function but can also exist independently of it. If, for example, the fundraiser also provides various supplies (e.g. production order/software development or transfer of ownership of an intellectual property right), the transaction may be relevant for value-added tax, irrespective of the token function.
Unfortunately, the published practice adjustments in these areas are incomplete. The following is a brief summary of the most important points.
Main types of tokens
According to FTA VAT DEP, the following three main types of cryptocoins/token can be distinguished:
- Payment coins/token: Cryptocoins/token which are designed as pure payment coins/token serve no purpose other than the use as means of payment for the purchase of supplies and/or services from one or more service providers. Payment coins or tokens therefore do not entitle the holder to certain or determinable services, but merely represent the contractually agreed means of payment.
- Utility coins/token: If cryptocoins/token entitle to certain or determinable services and/or grant you access rights to a platform, application or similar (licence or licence-like right), this is referred to as usage coins/token.
- Asset coins/token: For example, if cryptocoins/token are entitled to participate in earnings, turnover, profit, a certain part of earnings or turnover, derivative rights or the like, they are so-called assetcoins/token. Investment coins/token are always based on a contractual legal relationship and therefore do not establish a corporate ownership relationship and do not entitle the holder to repayment of the amount originally paid in.
MME & CVA WG TAS comments:
The categories discussed are very narrowly defined, disregard the dual function of DLT-based tokens (i.e. always existing technical function that may be synchronized with a legal function) and show large gaps. In our view, comments on “native tokens” or tokens with voucher, equity, debt or investment fund character are missing. In addition, mixed forms are insufficiently covered.
- According to FTA VAT DEP, payment coins/token can only be used as a means of exchange, i.e. as digital currencies. However, this individual functionality could only be ensured in a self-contained payment system, in which an alternative use (centrally controlled) can be excluded. However, it is not considered that especially with open, decentralized protocols and applications, the corresponding “native tokens” (e.g. BTC, ETH, XTZ, ADA) are only digital information and settlement units without synchronized legal content. An agreement on the use shall only be concluded between the parties outside the blockchain.
For example, a BTC would not qualify as a pure “payment token” as defined, since a BTC per se is not necessarily a means of payment or exchange and can in fact also be used for other purposes. The Bitcoin blockchain does not define a purpose, but only posts transactions according to the algorithmically recorded transaction and consensus rules. The basic function of a BTC is therefore a technical, Bitcoin protocol-specific usage functionality. Use as a means of payment is neither guaranteed by the system nor by a counterparty and there is no contractual relationship with an operator. Although a BTC can de facto be used as a means of payment between two parties, such an agreement is only ever concluded outside the block chain “peer-to-peer”. BTC, on the other hand, can in fact also be used as an information carrier without assuming a payment function (e.g. “colored coins”).
The FTA VAT DEP has unfortunately ignored the dual function of DLT-based tokens (i.e. always existing technical function that may be synchronized with a legal function). A definition for “native tokens”, whose function is limited to programmed technical functionalities in a cybernetically functioning blockchain system, would also have to be supplemented and assessed separately.
- Utilization coins/token entitle according to FTA VAT DEP to the purchase of certain or determinable services and/or grant an access right to a platform, an application or similar (license or license-like right). To meet these requirements, the token must be synchronized with the underlying relative or absolute right.
However, a general qualification of all technical functionalities as a utility goes too far. For example, the usage and settlement functions of “native tokens” in decentralized protocols or applications are usually only factual usage options, but not corresponding enforceable rights. A concrete supply is missing. Only the transfer of defined, determinable usage rights would be taxable. Furthermore, a (taxable) prepayment character is only given if both the supply itself and the location of the supply could be determined. However, this is not the case for “native tokens” (no supply) or tokens with voucher function (supply only when redeemed). The qualifications of native tokens and vouchers must therefore be assessed separately.
- According to FTA VAT DEP, investment coins/token (so-called asset coins/token) entitle the holder, for example, to a share in earnings, turnover, profit, a certain portion of earnings or turnover, derivative rights or similar rights and are always based on a contractual legal relationship.
However, the most important categories of asset tokens, which reflect shareholdings under company law (equity) or entitle to repayment of the amount originally paid in (debt capital / investment funds), are excluded from this definition. This does not go far enough for a comprehensive presentation. A capture of all asset token types would be desirable.
Initial Coin Offerings / Token Generating Events
In an Initial Coin Offering (ICO), Token Generating Event (TGE), Initial Token Offering (ITO) or Security Token Offering (STO), a company raises funds (in legal or crypto currency) for a specific business or open source project. The donors are usually assigned blockchain-based coins/token, which are generated on a newly developed blockchain or by means of a digital, self-executing computer program (so-called Smart Contract) on an existing blockchain and stored decentrally. This can happen step by step or only at the start of a new blockchain (so-called Genesis block) or application.
The FTA VAT DEP qualifies ICOs in the practice adaptations as follows:
- The transfer of financial resources within the framework of an ICO represents a remuneration for a service ( 18 para. 1 in conjunction with art. 3 lit. f of the VAT Act) on the basis of the contractual obligations of the company, unless it is a matter of a payment coin/token.
- The issuance of payment coins/token against means of payment represents an exchange of cash that is not relevant for VAT purposes.
- The issuance of investment coins/token against means of payment is exempt from VAT without credit based on 21 para. 2 ch. 19 lit. e of the VAT Act. The corresponding revenues do not constitute non-remuneration for the company (art. 18 para. 2 of the VAT Act ).
- The issuance of usage coins/token against means of payment constitutes a supply of services or goods and is taxable, provided that no exemption under 21 para. 2 of the VAT Act applies.
- If a company only (?) undertakes to develop a platform or software with the funds collected, for example, a taxable supply can be assumed. The supply is provided by the company and the location is determined in accordance with 8 para. 1 of the VAT Act. It does not matter whether the company has the prospect of a later allocation of cryptocoins/token at the time of borrowing.
- In order to prove the place of performance, the taxable person uses, for example, identification as part of a know-your-customer process or, in the case of electronic services, the information suitable as evidence in this respect.
MME & CVA WG TAS comments:
The concrete design of an ICO (hereinafter also referred to as TGEs and lTOs) and the coins/token created in this way differ substantially in technical, functional and legal respects. However, the focus is usually on raising capital for the project. In return, the fundraiser enters into a bunch of contractual or factual obligations, which are related to the token function, but can often exist independently of it. The VAT assessment of an ICO, therefore, depends to a large extent on its individual structure. The respective tax consequences must be examined on a case-by-case basis and are difficult to describe in general terms.
In general, we believe that the same VAT rules should apply as for crowdfunding in general. Therefore, the close link between the VAT consequences and the token qualification falls short.
A link to the bookkeeping of ICOs according to the Q&A of the Commission for Financial Reporting of EXPERTsuisse (German / French),which has published the following positions (as of April 30, 2019) in collaboration with the CVA WG TAS, would have been particularly recommended here:
- Development and access to open source blockchain protocol in AG / GmbH; utility token (“native token”); logic of long-term production orders; prepayments
- Development and access to open source blockchain protocol in foundation; utility token (“native token”); logic of use of foundation capital / donation; foundation capital or prepayment
- Development and access to open-source blockchain protocol in foundation with dual financial statements according to OR/FER 21; utility token (“native token”); logic of use of earmarked fund; earmarked fund (debt)
- Development and temporary access to blockchain protocol; utility token (“voucher”); analogy to investment subsidy; deferred revenue; advance payments
- Investments in real estate; Asset Token; Analogy to investment funds / capital contribution; PS capital
- Development and marketing of robots and payment of revenue participation; asset token; analogy to investment subsidy; ongoing accrual for revenue participation; prepayments
The decentralized character of DLT-based systems must also be taken into account when verifying the place of supply.
Mining / Staking
FTA VAT DEP distinguishes between block reward and transaction fee and links different tax consequences to these qualifications. This can also influence the right to deduct input tax.
MME & CVA WG TAS comments:
The decentralized character of blockchain protocols is also insufficiently considered when it comes to mining / staking. An analysis of the corresponding tax consequences must be carried out on a case-by-case basis.
Settlement must be carried out in the local currency. The supplier must convert the remuneration for supply rendered on the reporting date into a legal (domestic or foreign) currency at the current rate for a fee in cryptocoins/token at the time the remuneration is received or invoiced (art. 40 of the VAT Act).
According to FTA VAT DEP, the invoice must show the fee for the supply separately and the VAT amount divided according to tax rates in a legal currency. Reporting the remuneration for individual supplies only in cryptocoins/token does not constitute separate invoicing under VAT law. The conversion can be carried out using suitable conversion portals, whereby the selected conversion source must be kept constant. For certain cryptocoins/token the FTA publishes daily courses (course lists of the FTA). It should be possible to check the documentation of the conversion easily and immediately at any time.
This procedure according to the VAT Act must also be applied to the declaration of supplies subject to acquisition tax (art. 45 para. 1 of the VAT Act). Further information on acquisition tax can be found in the VAT information on acquisition tax.
Losses suffered in the sale of cryptocoins/token against legal currency or in the use of cryptocoins/token to obtain services may not be deducted from the fee.
MME & CVA WG TAS comments:
A “prohibition” of invoicing in crypto currency only, diametrically contradicts the qualification of a “payment token” as a means of exchange and payment. If such a token is assigned a payment function, it must also be possible to issue a corresponding invoice. Anything else seems impractical. If a fiat equivalent is missing in an invoice statement, application of the published rates of the FTA (or the effective rate at the time of invoice creation/transaction time stamp, based on any other stable source of crypto currency exchange rates) for the preparation of VAT declarations should be sufficient to provide appropriate results for all parties involved.
In addition, Bitcoin, for example, is in several countries already equal to the legal national currency, so that a statement of the remuneration would only have to be permissible in Bitcoin accordingly. Equal treatment of cryptocurrencies and foreign currencies is therefore necessary.
Finally, example c) under “2.4.5 Invoices in foreign currency” illustrates the difficulties of implementation in a vivid way: 2 pizzas are sold as of 22 May 2019 for BTC 10,000 and a receipt for USD 30 is issued, which should be relevant for Swiss VAT. It is not comprehensible how the conversion was carried out. At a BTC rate of around USD 8,000 per invoice date, the equivalent of BTC 10,000 BTC would have been around USD 80 million! An invoice with USD 30 does not only seem wrong to us under these circumstances, but also latent criminal. The example is, therefore, useless in practice and should be changed or even removed.
Given the still prevailing need for clarity in tax matters (in particular VAT) for many of the crypto businesses, the CVA WG TAS is currently planning for an upcoming meet-up (scheduled for late September 2019) to discuss the current different Swiss tax practices. Further details will be shared once they are available.