Do You Know the Tax Impact of Your U.S. or Non-U.S. Token Sale?

November 10, 2017

When Wesley Bricker, chief accountant at the Securities and Exchange Commission (SEC), gives you a warning, it’s wise to listen.

In short: Don’t ignore the SEC or your tax obligations.

“An entity involved in initial coin or token offering activities will need to consider the necessary accounting, disclosure and reporting guidance based on the nature of its involvement,” Bricker said at the 2017 American Institute of Certified Public Accountants (AICPA) National Conference on Banks & Savings Institutions.

Initial coin offerings (ICOs) offer blockchain-based companies a new and exciting way to raise capital — but companies need to give more than token consideration to the underlying accounting.

The Chain of Events

An ICO raises money for projects that use blockchain technology. Traditional equity sales allow investors to buy shares of a company, but ICOs sell units of cryptocurrency called “tokens.”

Tokens serve a dual purpose:

  • They’re the “fuel” that make the online service work, and they act as units of payment for the service. The more tokens people have, the more they can use the service.
  • They’re an asset to be traded on cryptocurrency exchanges and have a dynamic price.

For example, a blockchain-based ride-sharing service would allow passengers to arrange rides with the drivers directly. No central computer system would transfer payments and take a commission. Instead of making payments in dollars, the passengers would pay using the ride-sharing service’s cryptocurrency token. Drivers could then redeem the tokens they were paid for whatever cryptocurrency they desired.

Uncle Sam’s Two Cents

The IRS wants to collect tax on token and cryptocurrency transactions.

Companies sell the tokens to raise money for the services they’re developing. Buyers pay for the tokens using other cryptocurrencies, such as bitcoin or the Ethereum network’s virtual currency, ether. This essentially invites buyers to invest in the future of those services. The buyers chase the promise of greater returns if the service hits the mainstream and the token’s future value.

Like anyone else selling securities, companies pursuing an ICO may have to register with the SEC if the token being sold is considered a security, Bricker pointed out, as cited in a report the SEC released this year.

“An organization should consider applicable accounting and reporting guidance, for example in U.S. GAAP [generally accepted accounting principles], when preparing financial statements,” Bricker said.

There’s one major problem with that: When it comes to cryptocurrency ICO accounting guidance, there isn’t much to go off.

The Internal Revenue Service and the Financial Accounting Standards Board have given little instruction on accounting for ICOs. These agencies have let the phenomenon evolve before issuing clear guidelines on how to tackle it. This leaves significant challenges for companies creating token sales.

According to the IRS, cryptocurrencies are considered property. The question arising from token sales is: will the IRS consider tokens to be property, too?

Not only must companies account for the tokens they create, sell and/or transfer, but they must also account for the cryptocurrency they collect, as well as account for the receipt, use and change in value of cryptocurrency.

Accounting for tokens and cryptocurrencies is just as important as accounting for traditional currency, though it is more detailed.

At some point, financial and tax regulators will take a hard line on ICO finances — and companies need to be on the right side of this from the start.

A Stitch in Time

The volatile and highly innovative nature of ICO structures makes each new deal different:

  • There are different types of tokens sold, which have different uses.
  • The products and services tokens support differ widely in nature.
  • ICOs happen in different jurisdictions with different rules.
  • How and when a company has to report proceeds as income for GAAP and tax purposes may differ.

But companies that don’t seek professional tax and accounting advice on an ICO risk trouble further down the line.

A common tactic is launching an ICO overseas in hopes of escaping U.S. tax regulators. This is sometimes done via a nonprofit foundation. This is very complex, and often U.S. citizens and residents are launching ICOs outside and inside the country without any U.S. tax advice.

Some of the questions that must be considered when a U.S. resident (individual or entity) launches an ICO in a foreign country are:

  • Was the IP created in the United States and transferred outside?
  • Will the IP transfer be taxable or not?
  • Will the foreign entity do business in the United States as a result of actions by its officers, directors, contractors or other parties in the United States?
  • Will the foreign entity be considered a controlled foreign corporation for U.S. tax purposes and trigger the anti-deferral rules under Subpart F?
  • Will the U.S. officers or directors have to report their relationship to the foreign entity and its assets on their personal U.S. income tax returns?

Heed Bricker’s advice and keep your accounting and tax matters top of mind. Then, you’ll be ready when (not if) financial and tax regulators take a hard stance on ICO finances.

By investing in expert advice before conducting an ICO, companies will protect themselves from future regulatory problems.

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