Is an ICO a taxable event for the EU VAT purposes?

The question whether the issue of cryptographic tokens via initial coin offerings (ICOs) may be treated as a taxable event for VAT purposes has recently raised heated discussions between lawyers and tax authorities. As funds raised through such means of a crowdsale can be substantial (e.g., the Bancor ICO raised 153 million USD within just a few hours of the sale[1]), the question is not unimportant. Yet, many smaller start-up companies cannot afford to pay substantial percentages of hard-raised funds to the state budgets already in their fundraising phase.

To young entrepreneurs, the possible obligation to pay tax before they even started to develop their products and services (and well before such products and services have actually been offered on the market) seems counterintuitive. From the legal standpoint, similarly, the possible discriminatory treatment vis-a-vis other, “traditional” means of financing (such as VAT neutral capital contributions or debt financing) raises concerns. In the following, these issues will be looked into in more detail to provide some possible answers.

1. The Approach

According to article 2 of the VAT Directive[2] any “supply of goods for consideration within the territory of a Member State by a taxable person acting as such” shall be subject to VAT. Despite this wording (apart from being very broad) is exact and also interpreted also by the CJEU in its numerous judgements, however, problems often arise in the case of new and unregulated kinds of transactions, involving digital assets or other innovative legal instruments, such as cryptographic tokens.

To best approach this questions, one may be reminded that the VAT treatment of the issue of the tokens during an ICO largely depends on the legal status of the ICO and cryptographic tokens issued,[3] whereas their legal status is in turn dependent on their economic characteristics and substance.[4] That is why the article will first look into the economic nature of the ICO itself and the tokens issued during such means of crowd-sale. Based on these considerations, legal conclusions with regard to the legal nature of the transactions in question will be then looked into, whereby EU documents (and CJEU case-law) dealing with similar kinds of transactions (bitcoin as a “value” tokens) will also be taken into account. In the end, conclusions as to the VAT treatment of ICOs will also be tested against the normative framework regarding VAT treatment of multi-purpose vouchers, which, as it will be explained, in their substance resemble fundamental economic functions of utility tokens.

2. What are legal characteristics of an ICO?

In legal terms, an initial coin offering may best be described as a means of crowdfunding by which funds are raised for a new venture through an issue of a new cryptographic token.[5] In practice, a start-up company looking for funding develops a new cryptographic token and offers it to its supporters in exchange for the contribution of one of the already well-established virtual cryptocurrencies (such as ether or bitcoin, which may be exchanged for fiat currencies).[6] Issued tokens, as a rule, do not give rise to any traditional shareholders’ rights. On the other hand, they usually can be traded on secondary markets, such as online cryptocurrency exchanges[7] and later exchanged for services and products of the start-up company — the issuer of the token (once such products and services are developed by the start-up and offered on the market).

As stems from this description of the underlying economic substance of an ICO, the issued cryptographic tokens have a somewhat “hybrid” legal nature. During the ICO stage, the fundraising function of a token is in the foreground, as it serves as a means of collecting funds for the development of future products and services by the start-up company issuing such token. In the following stage, when the start-up develops products and services and offers them on the market, the token is used as a means of payment for such services. Then, the token’s utility function is highlighted, which is why legal practitioners usually talk about “utility tokens.” Such tokens are linked to a specific service or product by their issuer and need to be distinguished from so-called “value tokens” (such as bitcoin, ether or litecoin) which are virtual currencies strictu sensu and are designed to be used as a general means of payment.[8]

3. Existing legal guidance on VAT treatment of certain transactions in virtual currencies

One of the first EU documents dealing with VAT issues of cryptocurrencies was the EU Value Added Tax Committee Working Paper №811, issued in July 2014.[9] The paper stressed that while VAT treatment of bitcoin depends on its nature and legal status,[10] it is unlikely that it could be regarded as e-money, a currency, a security or a voucher.[11] Similarly, treating bitcoin as a digital product may be seen as “a step too far” (as the virtual currency acts a means of payment and is used in the exchange of goods and services); however, the legal characteristics of a negotiable instrument seem be met. Accordingly, specific activities concerning Bitcoin may fall within the exemption of Article 135(1)(d) of the VAT Directive.[12]

At the initiative of the UK delegation, the VAT Committee in its follow-up Working document №854 further discussed the implications of treating bitcoin either as an exempt negotiable instrument or a digital product.[13] The Committee concluded that seeing bitcoin as a digital product would generate an extra administrative burden, as private individuals could be seen as taxable persons for VAT purposes in cases where annual thresholds would be exceeded. Also, the anonymity of the transactions could lead to difficulties in identifying taxable persons and place of supply.[14] If bitcoin is treated as a negotiable negotiable instrument, on the other hand, many specific transactions (such as the exchange of bitcoins for fiat currency) could fall within the scope of the exemption under Article 135(1)(d) of the VAT Directive.

Interestingly, the Court of Justice of the European Union (CJEU), in its subsequent Hedqvist decision, did not follow the approach suggested by the VAT Committee.[15] The Court explained that while bitcoin — contrary the standpoint of the VAT Committee — may not be regarded as a negotiable instrument (as it represents a direct means of payment between the operators that accept it), the transaction concerning the exchange of bitcoin for fiat currency may fall within the scope of the exemption under Article 135(1)(e) — covering, inter alia, currency, bank notes and coins used as legal tender. As a result, the VAT Committee later also realigned its standpoint in accordance with the CJEU judgement, resulting in the Working Paper №892.[16]

4. Is a token issue during an ICO taxable event for VAT purposes?

The VAT Committee’s working papers Nos. 811, 854 and 892, together with the CJEU judgement in Hedqvist (all presented above), currently represent the most comprehensive guidance on the VAT treatment of certain transactions involving virtual currencies. However, for the purposes of analyzing whether a token issue during an ICO also constitutes a taxable event and falls within the scope of EU VAT, the mentioned documents are only of a limited value. Namely, as mentioned, they only discuss particular economic activities concerning bitcoins, such as performing payments in bitcoins, the services of digital wallets, mining, and the operations of exchanges. Issuing tokens through an ICO, on the other hand, is not discussed in the documents. Similarly, the Committee’s working papers as well as the Hedqvist judgement, all dating back to 2014 and 2015, only discuss transactions involving bitcoins (i.e. value tokens) and may consequently not be very appropriate for assessing transactions involving so-called “utility tokens” that have emerged since then and that have substantially different legal characteristics and economic substance. Consequently, in order to establish whether an ICO may give rise to any VAT liability, more thorough legal analysis (i.e., not limited only to the above mentioned legal documents) needs to be performed.

In this connection it should first be noted that, according to the established case law of the CJEU, a supply of services is rendered for consideration within the meaning of Article 2 of the VAT Directive, and can, therefore, be subject to VAT, only if a direct link exists between the services supplied and the consideration received by the taxable person.[17] Such a direct link is established where there is “a legal relationship between the provider of the service and the recipient pursuant to which there is reciprocal performance, the remuneration received by the provider of the service constituting the actual consideration given in return for the service supplied to the recipient”.[18]

During the issue of tokens through an ICO, tokens initially serve the sole function of funding a start-up company, and not as a payment for any kind of services. At the moment of an ICO, neither the “service” (such services still need to be developed by the start-up company funding its operations through an ICO, whereas successful development may be also dependent on various technical or IT challenges yet to be solved by its development team) nor the corresponding price may clearly be identified. Thus, it may be argued that, at the time of an ICO, no direct link (as a precondition to the application of VAT) exists between the tokens issued and the service rendered. Consequently, issued tokens (at the moment of ICO) do not fall within the scope of the VAT and an ICO itself may not be regarded as a taxable event for VAT purposes.

Of course, any future use of such tokens as a means of payment and access to products and services offered by the start-up company (once developed), may, in principle (provided that other conditions are met) be subject to VAT. Still, with regard to such future use of tokens for the consumption of services, the possibility of applying any of the exemptions provided by Article 135 of the VAT Directive needs to be analysed in each particular case.

The validity of such conclusion is further substantiated by the fact that the opposite standpoint (i.e., that the ICO represents a taxable event for VAT purposes) would lead to double taxation, as VAT would be applied both (1) upon the issue of a token; as well as (2) upon its subsequent use as a means of payment (exchange) for specific services offered by the start-up.

5. Possible analogy with VAT treatment of multi-purpose vouchers

In connection with VAT treatment of ICOs, an analogy with the VAT treatment of the so-called multi-purpose vouchers (MPVs) may also be drawn. Such vouchers are (under Council Directive (EU) 2016/1065 amending VAT Directive[19]) not subject to VAT at the time of sale of the voucher itself; instead, only “the actual handing over of the goods or the actual provision of the services in return for a multi-purpose voucher accepted as consideration or part consideration by the supplier shall be subject to VAT” (Article 30b of amended VAT Directive).

The reason for such VAT treatment lies in the difficulties of establishing the direct link between the payment of the voucher itself and the services that can be (at the moment of the purchase of the voucher) only generally identified and will be consumed at a later date. Thus, one may argue that a parallel with utility tokens in this aspect is more than evident. Even the more so: in the case of multi-purpose vouchers, it is usually at least known for which kind of services such voucher can be exchanged (for example, when purchasing a gift card for a massage salon in the value of EUR 20, it is possible to know in advance what kinds of massage the particular salon offers and for what price). A fortiori, at the time of issue of cryptographic tokens, services for which such token may be exchanged in the future usually do not even yet exist (as they first need to be developed by the start-up IT development team).

Such analogy with a multi-purpose voucher is further substantiated by the fact that the VAT Committee itself already in its very first working paper, dealing with the VAT treatment of bitcoin (Working Paper №811), tried to test legal characteristics of bitcoin against those of multi-purpose vouchers.[20] Back then (in 2014), such comparison was rejected on the grounds that the holder of bitcoin can freely choose the goods or services (offered by multiple possible suppliers; only subject to its acceptance by such suppliers), whereas multi-purpose vouchers may only be exchanged for goods or services from within a limited range. While this argumentation certainly holds for cases of early forms of value tokens (such as bitcoin), it should be recalled that different kind of tokens with substantially different features have emerged since then. In case of “utility tokens”, no particular reason can be found as to why such tokens — giving their holders rights to access services offered by the issuer — could not be seen as having the same fundamental legal characteristics as multi-purpose vouchers.

6. Conclusion

As explained in the above analysis, an ICO itself does not represent a taxable event for the purposes of VAT. Instead, issued utility tokens may only be subject to VAT once they are actually “traded” for identifiable services of the start-up that had previously issued such tokens (that is, once such services are developed and offered on the market).

Still, legal practitioners and ICO founding teams alike would appreciate if national tax authorities would in the future address such issues and publish appropriate written guidelines, as that would substantially contribute to greater legal certainty in the field of the tax treatment of businesses dealing with distributed ledger (blockchain) technologies.

References

[1] Joon Ian Wong, Ethereum unleashed the “initial coin offering” craze, but it can’t handle its insane success, https://qz.com/1004892/the-bancor-ico-just-raised-153-million-on-ethereum-in-three-hours/ (accessed 18.10.2017); See also the case of Tezos, collecting 232 million USD during its ICO (Omri Barzilay, Tezos’ $232 Million ICO May Just Be The Beginning, https://www.forbes.com/sites/omribarzilay/2017/07/15/tezos-232-million-ico-may-just-be-the-beginning/#52e849e94c52 (accessed 19.10.2017).

[2] Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax (OJ L 347, 11.12.2006).

[3] See, by analogy, European Commission, Value Added Tax Committee, taxud.c.1(2014)2772524 — Working Paper №811, VAT treatment of Bitcoin, Brussels, 29 Jul. 2014, https://circabc.europa.eu/sd/a/4adc83f8-a7ab-48ee-b907-468459c0dad7/49%20-%20VAT%20treatment%20of%20Bitcoin.pdf (accessed 19.10.2017), page 5, emphasising that the “VAT treatment of Bitcoin and its related activities depends on the legal status of the digital currency.”

[4] See, for example, Article 5 of Slovenian Tax Procedure Act (Zakon o davčnem postopku; ZDavP-2, Official Gazette of the Republic of Slovenia, №13/11, with subsequent changes), providing that “The subject of taxation and the circumstances and facts essential to taxation shall be assessed according with their economic (economic) substance.”

[5] Investopedia, “Initial Coin Offering (ICO)”, http://www.investopedia.com/terms/i/initial-coin-offering-ico.asp (accessed 19.10.2017).

[6] See also Securities and Exchange Commission, Release №81207 / July 25, 2017, Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO; available on https://www.sec.gov/litigation/investreport/34-81207.pdf, p. 5 (accessed 19.10.2017).

[7] This may, in some cases, incentivize the supporters who buy such tokens with substantial discounts during the ICO phase and then speculate on a significant price increase once the token becomes publicly traded on one of the online exchanges.

[8] Nejc Novak, LL.M. (UCL), A call for legal, ethical and sustainable token offerings, Medium, https://medium.com/@nejcnovaklaw/a-call-for-legal-ethical-and-sustainable-token-offerings-4d7cd16c64ac (accessed 19.10.2017).

[9] European Commission, Value Added Tax Committee, taxud.c.1(2014)2772524 — Working Paper №811, VAT treatment of Bitcoin, Brussels, 29 Jul. 2014, https://circabc.europa.eu/sd/a/4adc83f8-a7ab-48ee-b907-468459c0dad7/49%20-%20VAT%20treatment%20of%20Bitcoin.pdf (accessed 19.10.2017).

[10] Ibid, p. 5.

[11] Ibid, p. 23.

[12] Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax (OJ L 347, 11.12.2006).

[13] European Commission, Value Added Tax Committee, taxud.c.1(2015)2066488 — Working Paper №854, VAT treatment of Bitcoin (II), Brussels, 30 Apr. 2015, https://circabc.europa.eu/sd/a/19f564ce-3878-4a61-9b8c-f0dbf545465f/854%20-%20Commission%20-%20VAT%20treatment%20of%20Bitcoin%20(II).pdf (accessed 19.10.2017).

[14] Ibid, p. 11–12.

[15] CJEU, 22 October 2015, C-264/14, ECLI:EU:C:2015:718, Hedqvist.

[16] European Commission, Value Added Tax Committee, taxud.c.1(2014)2772524 — Working Paper №811, VAT treatment of Bitcoin, Brussels, 29 Jul. 2014, https://circabc.europa.eu/sd/a/4adc83f8-a7ab-48ee-b907-468459c0dad7/49%20-%20VAT%20treatment%20of%20Bitcoin.pdf (accessed 19.10.2017).

[17] CJEU, 5 February 1981, 154/80, EU:C:1981:38, Coöperatieve Aardappelenbewaarplaats, para 12; CJEU, 8 March 1988, 102/86, EU:C:1988:120, Apple and Pear Development Council, para 12; CJEU, 3 March 1994, C-16/93, EU:C:1994:80, Tolsma, para 13; CJEU, 29 October 2009, C-246/08, , EU:C:2009:671, Commission/Finland, para 45, and CJEU, 27 October 2011, C-93/10, EU:C:2011:700, GFKL Financial Services, para 19.

[18] CJEU, 27 March 2014, C‑151/13, EU:C:2014:185, Le Rayon d’Or, para 29 and the case-law cited therein.

[19] Council Directive (EU) 2016/1065 of 27 June 2016 amending Directive 2006/112/EC as regards the treatment of vouchers, OJ L 177, 1.7.2016, pp. 9–12.

[20] European Commission, Value Added Tax Committee, taxud.c.1(2014)2772524 — Working Paper №811, VAT treatment of Bitcoin, Brussels, 29 Jul. 2014, https://circabc.europa.eu/sd/a/4adc83f8-a7ab-48ee-b907-468459c0dad7/49%20-%20VAT%20treatment%20of%20Bitcoin.pdf (accessed 19.10.2017), p. 11.

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