master’s thesis – international business taxation the tax
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Master’s thesis – International Business Taxation
The Tax and Accounting Implications of Initial Coin Offerings
Master’s thesis International Business Taxation/track: International Business Tax Law
Tilburg School of Law, Tilburg University
Erwann Le Noac’h
Student number: 2010625
Administration number: 524660
First Supervisor: Mr. R. Taha
Second Supervisor: Pr. R. Russo
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The Tax and Accounting Implications of Initial Coin Offerings
How to ensure a fair accounting and tax treatment of Initial Coins Offerings?
Master’s thesis International Business Taxation/track: International Business Tax Law
Tilburg School of Law, Tilburg University
Erwann Le Noac’h
Student number: 2010625
Administration number: 524660
First Supervisor: Mr. R. Taha
Second Supervisor: Pr. R. Russo
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Abstract
The Blockchain revolution spreads out through every realm of the economy. In the field of financing
operations, this decentralized technology has allowed the rise of Initial Coin Offerings (“ICOs”),
which are increasingly overshadowing the traditional IPOs and crowdfunding campaigns. Taking into
account the skyrocketing amounts of cryptocurrencies gathered in those cutting-edge rounds of
financing, the need to efficiently regulate the ICOs is urgent. In most of domestic legislations, the
Initial Coin Offerings remain in a grey area from a legal, tax and accounting perspective. This
loophole is harmful for the legal security of ICO-funded companies, as well as for the public finances
of countries. Thus, on the one hand, the cryptocurrency-financed companies may struggle to meet their
accounting, direct tax and VAT obligations. On the flipside, the likelihood of tax avoidance and
evasion based on ICOs is peculiarly high, since the current accounting and tax framework is
substantially incompatible with the state-of-the-art “Blockchain Economy”. Thus, the main challenge
of this thesis is to identify the features of this two-sided loophole, before introducing an ICO-fitted
framework which will be beneficial for both companies and States, covering the realms of accounting,
direct tax and indirect tax.
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Table of Contents
Chapter 1 - Introduction...................................................................................................................6
1.1. General Introduction................................................................................................................6
1.2. Research question and sub-questions .......................................................................................7
1.3. Benchmark ..............................................................................................................................8
1.4. Motivations .............................................................................................................................9
1.5. Layout .....................................................................................................................................9
1.6. Fields covered by the thesis ................................................................................................... 10
1.7. Research method ................................................................................................................... 10
2. Chapter 2 - The Accounting Framework Of Initial Coin Offerings For ICO-issuers ........... 11
2.1. The lack of a bespoke accounting framework thoroughly covering the ICO field. ........... 11
2.1.1. The two-step ICO model, a cutting-edge operation challenging the accountancy reporting. 11
2.1.1.1. The reporting of token-sales hindered by the disparate features of tokens ....................... 11
2.1.1.2. The reporting of pre-mining operations questioned by the absence of market value ........ 17
2.1.2. The reliability of financial statements questioned by the unguided post-ICO reporting ....... 20
2.1.2.1. The financial positions of ICO-issuers artificially influenced by tokens’ price fluctuation
20
2.1.2.1.1. The increase in tokens’ value, a threat to the financial position of the ICO-issuer ........... 20
2.1.2.1.2. The decrease in tokens’ value, an opportunity to make-up the financial position of the
ICO-issuer 21
2.1.2.2. The blurred reporting of post-ICO gains in coins ............................................................ 23
2.1.2.2.1. The uncertain accounting treatment of coins................................................................... 23
2.1.2.2.2. The measurement method of coins’ value left to the discretion of ICO-issuers ................ 25
2.2. The introduction of a tailored accounting framework to establish a true and fair view on
ICO-issuers’ financial position ....................................................................................................... 26
2.2.1. An overhaul of accounting standards for ICOs ................................................................... 26
2.2.1.1. The reporting of pre-mining operations through OCI ...................................................... 26
2.2.1.2. The reporting of token-sales eased by a bespoke Security-law test for tokens ................. 28
2.2.2. A tailor-made accounting regime for cryptocurrencies ....................................................... 28
2.2.2.1. The implementation of a dedicated asset account ........................................................... 28
2.2.2.2. A different measurement method according to the purpose of cryptocurrency owners..... 30
2.3. Conclusion – Chapter 2 ....................................................................................................... 31
3. Chapter 3 - The Direct Tax Framework Of Initial Coin Offerings For ICO-issuers ............ 33
3.1. An outdated direct tax framework harmful to both ICO-issuers and value-created States
33
3.1.1. An unfitted tax treatment reducing the legal security of ICO-issuers................................... 33
3.1.1.1. The tax levy of token-sales surging coin-to-cash conversion issues................................. 33
3.1.1.2. The blurred accounting classification of cryptocurrencies raising uncertainty in the taxable
profit 35
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3.1.2. A cutting-edge operation facilitating aggressive tax planning ............................................. 36
3.1.2.1. A decentralized operation entailing profit shifting to low-tax jurisdictions ...................... 36
3.1.2.2. A peculiar financial instrument not falling beyond the scope of CFC rules ..................... 38
3.2. A direct tax regulation of ICOs to set out a fair tax duty for ICO-issuers ........................ 39
3.2.1. The need to introduce an ICO-compatible tax regime in domestic legislations to restore legal
certainty 39
3.2.1.1. A bespoke tax treatment of cryptocurrencies in accordance with their diverse features ... 39
3.2.1.2. A dedicated tax -levy scheme for ICOs to reduce coins-to-cash conversion issues .......... 40
3.2.2. An overhaul of international tax rules to prevent ICO-related aggressive tax planning ........ 41
3.2.2.1. An extended scope of CFC rules to target undistributed ICO proceeds located in tax
heavens 41
3.2.2.2. A reinforcement of tax credit methods to enhance the taxing rights of the operating
entity’s jurisdiction ........................................................................................................................... 41
3.3. Conclusion – Chapter 3 ....................................................................................................... 42
4. Chapter 4 – The Indirect Tax Framework Of Initial Coin Offerings For ICO-issuers ........ 44
4.1. The initial Coin Offering, a taxable event challenging the VAT compliance .................... 44
4.1.1. The characterization of a taxed event depending on the token’s features ............................. 44
4.1.1.1. The supposed characterization of a taxed event for utility-token sales............................. 44
4.1.1.2. The apparent enforceability of the financial services’ exemption for equity-token sales .. 46
4.1.2. The spatial-temporal compliance challenge ........................................................................ 47
4.1.2.1. An extended timespan between the taxable and the chargeable event raising cash flow
issues 47
4.1.2.2. A decentralized supply complicating the VAT/GST collection ....................................... 49
4.2. A necessary overhaul of the VAT framework to reduce the indirect tax burden of ICO-
issuers 50
4.2.1. The benefits of harmonizing the indirect tax treatment of financial instruments .................. 50
4.2.1.1. The current VAT treatment depending upon the token’s features, an insoluble compliance
issue 50
4.2.1.2. Discarding the exemption on financial services, a way to ensure tax neutrality ............... 51
4.2.2. The need to improve a dedicated VAT collection scheme for ICOs .................................... 52
4.2.2.1. Allowing the chargeability of VAT at the time of the token-sale to tackle cash-flow issues
52
4.2.2.2. The use of the ICO-related Smart Contracts to allow location and identification of
investors 53
4.3. Conclusion- Chapter 4......................................................................................................... 54
5. General conclusion .................................................................................................................. 56
Bibliography.................................................................................................................................... 58
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Chapter 1 - Introduction
1.1. General Introduction
An estimated total of 4B$ has been raised through Initial Coin Offerings (hereinafter ‘ICOs’ or ‘ICO’)
in 20171. The past year was a tipping point for these Blockchain-based crowdfunding campaigns, which
have surged fortyfold comparing to 20162. They mainly rely on two complementary features: the trade
of cryptocurrency coins against cryptocurrency tokens (hereinafter ‘Token Sale’), and the use of the
Blockchain technology. To clarify, those two digital currencies are both identified as cryptocurrencies.
The coins, such as Bitcoin, Ether or Ripple, are used as a sheer way of payment, almost like the
traditional currencies. On the other hand, the tokens represent a right to use an ICO-related good or
service. (Hereinafter ‘’token-related product’’). Since this second category is also subject to trade and
speculation on crypto-markets, the characterization as “cryptocurrencies’ is relevant as well. In the
following discussions, the terms of ‘’coins’’ and ‘’tokens’’, instead of ‘’cryptocurrency coins’’ and
‘’cryptocurrency tokens’’ will be mostly used. The mere term ‘’ cryptocurrencies’’ will include both
coins and tokens.
Generally speaking, the Blockchain, allowing the set-up of ICOs, can be defined as a digitized,
decentralized, public ledger of all cryptocurrency transactions3, although it is used for other purposes as
well. This technology has come a long way since the release of the first cryptocurrency coin, the Bitcoin,
in 2009. This innovative way of payment is identified as a digital currency that uses cryptography for
security4. At the early stage, the Bitcoin and the Blockchain technology were solely the concern of a
narrow tech-friendly community, before spreading to the mainstream society nowadays.
As a matter of fact, the Blockchain unleashed its potential owing to the development of Altcoins5, the
alternative coins launched after the success of Bitcoin.6 They stand out by their more comprehensive
features. As of now, the most popular altcoin is the Ethereum, which supports computer programs that
execute terms of a contract when specific conditions are fulfilled.7Those encoded algorithms are called
“Smart Contracts” and have allowed the deployment of Initial Coin Offerings. Basically, through a smart
contract encrypted on a Blockchain, ICO-investors trade coins against tokens issued by the ICO
initiators, these items representing a right to use the future products or services (“token-products”
1 Sergi Dromo, “ICOs Raised $4 Bln in 2017, What 2018 Has in Store”, https://cointelegraph.com, (December 31, 2017). 2 ibidem. 3 Investopedia, s.v., ‘’blockchain”, accessed March 23, 2018, https://www.investopedia.com/terms/b/blockchain.asp . 4 Investopedia, s.v., ‘’cryptocurrency”, accessed March 23, 2018, https://www.investopedia.com/terms/c/cryptocurrency.asp 5 Simona Vaitkune, “Bitcoin and Crypto Market: Astonishing Evolution and Bright Future” https://medium.com , (November 22, 2017). 6 Investopedia, s.v., ‘’altcoin”, accessed March 23, 2018, https://www.investopedia.com/terms/a/altcoin.asp 7 Dromo, “ICOs Raised $4 Bln in 2017, What 2018 Has in Store”.
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hereinafter) of the ICO-issuers.8 In this configuration, the issued tokens are identified as “utility-
tokens”9. Nevertheless, the features of a token may diverge from this common model, depending on the
smart contract’s provisions10. Hence, when they provide the ownership of company’s assets or shares to
the investor, the tokens are usually characterized as “equity-token” or “security-token”, which would
subject them to securities law.11
The first Initial Coin Offering was launched at the end of 2013 by J. R. Willett to raise capital for its
Blockchain-based company, Mastercoin12. Yet, the exponential growth of ICOs actually started in
201713. Down the road, ICOs have become serious competitors to Initial Public Offerings14, especially
for the financial strategy of start-ups, providing a broader and more convenient access to prospective
investors15. From the side of governments and central banks, the rise of Initial Coin Offerings has known
a bittersweet welcome. For instance, China’s central bank merely banned ICOs in September 201716,
officially to protect investors from fraudsters. The same is true in the traditional financial industry, which
takes a dim view on the rise of such a decentralized and peer-to-peer financial instrument. This general
mistrust in ICOs may explain why the regulatory process is taking so long in the dominant economies,
although governments start to acknowledge the need to regulate the crypto-economy.17Nevertheless,
smaller States have already triggered the regulatory process of ICOs, aiming at taking the lion’s share
and attracting ICO issuers. The fact that most of the ICO-friendly regulations are popping up in low-tax
jurisdictions, such as the Isle of Man, Gibraltar or the Cayman Islands, is not mere coincidence.18
1.2. Research question and sub-questions
From a tax and accounting perspective, the Initial Coin Offerings introduce unprecedented concerns to
deal with. The lack of regulation accentuates the difficulties of companies to apply the proper accounting
and tax treatment. Without a compatible framework, there is a substantial risk of threatening the
financial opportunities provided by ICOs, since legal certainty is a significant factor in the decision-
8 “What is an Ethereum Token: The Ultimate Beginner’s Guide”, https://blockgeeks.com/guides/ethereum-token/ (June 2017) 9 Josiah Wilmoth, “The Difference Between Utility Tokens and Equity Tokens” http://strategiccoin.com. 10 Gerald Nash, ‘’Build Your First Smart Contract’’, https://medium.com (December 8, 2017) 11 Jay Clayton, “Statement on Cryptocurrencies and Initial Coin Offerings”, U.S. Securities and Exchange Commission, https://www.sec.gov, (December 11, 2017). 12 Laura Shin, “Here's The Man Who Created ICOs And This Is The New Token He's Backing”, https://www.forbes.com, (September 21, 2017). 13 Sergi Dromo, “ICOs Raised $4 Bln in 2017, What 2018 Has in Store”. 14 Steven Krohn, “Security Tokens or Utility Tokens: What’s the Difference, https://medium.com (June 5, 2018) 15 “Benefits of an ICO Over Traditional Investment?”, http://www.chaineum.com, (October 10, 2017).
16 Lulu Yilun Chen and Justina Lee, “Bitcoin Tumbles as PBOC Declares Initial Coin Offerings Illegal”, https://www.bloomberg.com, (September 4, 2017). 17 Udibekwe, “ICOs Current State and Regulations Across the Globe”, https://steemit.com, (November 6, 2017). 18 Ivelton, “TOP ICO-Friendly Countries - Where to for your next (long) vacations?” https://steemit.com, (January 25, 2018).
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making of companies. Additionally, leaving this field unregulated surges the risks of aggressive tax
planning and tax avoidance, owing to the absence of crackdowns designed to tackle ICO-related tax
schemes. In a nutshell, overhauling the current framework should lead to a fair accounting and tax
treatment of ICOs, both beneficial for the finances of companies and States.
Therefore, the research question is the following: How to ensure a fair accounting and tax treatment of
Initial Coins Offerings?
From an accounting perspective, the sub-questions focus on the reporting of ICOs and the subsequent
valuations of coins, token and token-related products capitalized by the ICO-issuers: How to adapt the
accounting standards to ICOs and the subsequent valuations of token-related products? How to
reliability valuate cryptocurrencies owned by ICO-issuers, in accordance with the true and fair view
principle?
When it comes to direct tax, the first sub-question is related to the lack of guidance for the compliance
of ICO-issuers: How to ensure legal certainty in the determination of the tax result for ICO-issuers?
Embracing a more international perspective, the second sub-question tends to solve the risk of
aggressive tax planning strategies: By which instruments the tax authorities can tackle ICO-related tax
schemes, in order to provide a fair allocation of taxing rights among States?
Finally, the matters in the field of indirect tax will be treated, through two sub-questions. The first one
is in relation with the divergent VAT/GST treatment of financing operations, particularly ICOs and
Initial Public Offerings (hereinafter “IPOs”): How to ensure a level playing field in the indirect tax
treatment of financing operations? On the flipside, the second sub-question introduces compliance
issues, since a major feature of the Blockchain technology is the anonymity of parties: Can the public
authorities ensure the indirect tax compliance of ICO-issuers without threatening the Blockchain
principle of anonymity?
1.3. Benchmark
Considering that most of the jurisdictions have not designed a dedicated framework for ICOs yet, this
thesis will adopt a comparative and remote perspective on the ICO-related issues arising in the
interrelated fields of accounting, direct tax, and indirect tax. To achieve this purpose, it is necessary to
identify a world-scale and broadly-used body of norms in the three fields. Such a benchmark entails the
identification of common shortcomings in the current regulations and the introduction of problem-
solving reforms, in the three covered areas.
In the field of accounting, most of the jurisdictions, excepting the United States, compel the listed
companies to use the International Financial Reporting Standards19 (hereinafter ‘’IFRS’’) guidelines in
order to ensure cross-border comparability of financial statements. Thus, the accounting-dedicated
19 International Financial Reporting Standards, Deloitte, https://www.iasplus.com/en/standards
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chapter will refer to this body of norms to emphasize shortcomings of the domestic accounting standards
falling in line with the IFRS rules.
Regarding the chapter dedicated to direct tax concerns, the baseline will be the 15 actions of OCED/G20
Base Erosion and Profit Shifting project20 (hereinafter ‘’BEPS’’), since it is the most influential world-
scaled body of norms in this field, the OECD/20 members being bound to implement it in their domestic
legislation. The EU framework concerning corporate tax regulation will also be referred to since the
direct-tax related directives illustrate a practical application of BEPS’ notional ideas.
Lastly, regarding the indirect tax issues, the EU VAT directive21 will be the base framework, since it
thoroughly harmonized the direct tax regulation of Member States. Even though the EU directives are
not enforceable for third-parties countries, the issues raised in the indirect tax chapter can mostly apply
to any VAT/GST system, since all of them are designed to tax consumption according to the destination
principle.
The use of the benchmark will be similar in the three chapters. The main drawbacks of the
abovementioned base-frameworks will be explained, before the introduction of potential reforms able
to improve the regulation of Initial Coin Offerings.
1.4. Motivations
The underlying motivation of this thesis is twofold. First, it aims at highlighting the need for bespoke
tax and accounting frameworks of Initial Coin Offerings, to restore legal certainty for ICO issuers.
Secondly, it raises concerns about the tremendous risks of aggressive tax planning and tax avoidance
through ICOs, which must be tackled by the appropriate regulation. Pursuing these two objectives must
lead to a well-balanced and fair regulation of Initial Coins Offerings and cryptocurrencies, for both ICO-
issuers and governments. Therefore, after underlying the drawbacks of the current regulation in the areas
of accounting, direct tax, and indirect tax, a proposition for new frameworks will be introduced in each
realm.
1.5. Layout
The accounting framework will be the starting point of this thesis, since the accounting rules
substantially influence the determination of the taxable result, explicitly or implicitly depending on the
jurisdiction. Thus, Chapter 2 will be dedicated to the improvement of accounting standards for ICO.
After a comprehensive focus on the accounting issues, Chapter 3 will deal with the direct tax framework,
in a logical manner. As ICO-issuers must also comply with the indirect tax regulation, Chapter 4 tackles
the VAT/GST issues arising from ICOs and cryptocurrencies’ incomes. Thus, through these interrelated
20 BEPS Actions, OECD, http://www.oecd.org/ctp/beps-actions.htm 21 Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax
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chapters, this thesis will provide a comprehensive and coherent view on the accounting and tax
framework of Initial Coin Offerings.
1.6. Fields covered by the thesis
As mentioned before, this thesis covers the fields of accounting, corporate tax, and indirect taxes. Each
part is inter-related to the others. Legal matters will also be treated since corporate law has a decisive
influence on the realm of accounting and taxation. As ICOs are mostly carried out by companies with
legal personalities, issues related to the Personal Income Tax will not be covered.
1.7. Research method
The research task of this thesis will be firstly carried out through reflections on the available scholarly
articles. Yet, owing to the pioneer aspects of ICOs regulations, the scholarly research on the subject is
quite limited as of now. Thus, this first method will be combined with analogies from other accounting
and tax framework. This thesis aiming at improving the existing tax and accounting treatment of ICO,
an overhaul of the existing framework will be introduced as well.
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2. Chapter 2 - The Accounting Framework Of Initial Coin Offerings For ICO-issuers
The current accounting framework appears outdated when applied to Initial Coin Offerings, the lack of
bespoke standards for cryptocurrencies threatening their reporting. To restore a true and fair view upon
it, an overhaul of the accounting standards seems compulsory.
2.1. The lack of a bespoke accounting framework thoroughly covering the ICO field.
The incompatibility of the current accounting framework with ICO operations is leading to reporting
brainteasers at several times, from the sheer two-step ICO in itself to the several accounting post-
adjustments following this cutting-edge operation.
2.1.1. The two-step ICO model, a cutting-edge operation challenging the accountancy reporting.
Owing to the lack of a tailor-made accounting framework, the ICO-issuers may face difficulties when
reporting the sheer ICO as well as the prior pre-mining operations.
2.1.1.1. The reporting of token-sales hindered by the disparate features of tokens
As a reminder, a token issued in an Initial Coin Offering can embrace different features, depending on
the Smart Contract’s provisions between the ICO-issuers and the investors.22 Thus, defining a token may
be insoluble, as any ICO is potentially based on a unique and dedicated Smart Contract. For the sake of
clarity, two main categories of tokens could be identified: the utility-tokens and the security-tokens (also
called “equity-token”)23. The tokens belonging to the first category ‘’serve as (future) access to a product
or service and are comparable to a gift card or software license.” 24 The second category is alike an
investment contract, where the “main use-case and the reason for the contributors to buy the tokens is
the anticipation of future profits in the form of dividends, revenue share or (most commonly) price
appreciation’’25.
22 “What is an Ethereum Token: The Ultimate Beginner’s Guide”, https://blockgeeks.com/guides/ethereum-token/ 23 Lukas Schor, ‘’8 Important Things To Know About Security Tokens / Token Regulation’’, https://medium.com, (November 22, 2017) 24 ibidem 25 ibidem
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“Still and all, in practice, many tokens adapt a hybrid nature26, in between those two categories, since
the provisions of the Smart Contracts would be unrestrictedly encoded by the developer team at the
service of the ICO-issuers.27
The categorization of tokens is one of the most preeminent issues of any Initial Coin Offering. Indeed,
a token identified as an ‘’security-token’’ is bound by the relevant domestic security law. To properly
understand the main issues with the security identification of tokens, the US legal framework offers a
pratical illustration. From an American perspective, the relevant test used by the U.S. Securities and
Exchange Commission is the Howey Test28. Even though the landmark decision of the US Supreme
Court ‘’SEC V. Howey’’ settled this four-step test in 1946, it is still enforceable nowadays. Under it, a
token sale is identified as an investment contract if 29:
1- “The token is being sold as an investment”
Concerning this first requirement, it is necessary to identify whether the token is purchased in
anticipation of future profits or price appreciation or if it is bought to obtain a service or a good. 30
The first step of the identification test for tokens
2- “It involves a reasonable expectation of profits”
Considering the high prospects of a return on investment when it comes to the crypto-economy, this test
is easily met.
26 Steven Krohn, “Security Tokens or Utility Tokens: What’s The Difference”. 27 Gerald Nash, ‘’Build Your First Smart Contract’’. 28 Lukas Schor, ‘’8 Important Things To Know About Security Tokens / Token Regulation’’, 29 ibidem 30 ibidem
Practical outcome: a
right to use a future
service/ good.
Financial outcome: a
potential profit or price
appreciation
Identified as a security-
token if it fulfils the
second requirement
Identified as a utility-
token A token purchased by
an investor during an
ICO service/ good.
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3- “There is a person upon whom investors rely, the profit deriving from its managerial efforts.”31
This second requirement aims at identifying an entity or small groups of entities which will create the
value of the token and the potential profits32. A security-token will be identified in such circumstances.
If a network of several entities creates the value, the token is likely to be identified as a utility-token, if
it fulfilled the first requirement of the Howey Test.
The third step of the identification test for tokens
4- “Substance over form”
The SEC heavily relies on the Substance over form theory, as a tie-breaker for the categorization of
tokens. The agency looks at tokens according to ‘’the way they are used rather than the way they were
intended to be used’’33. This principle is peculiarly relevant in the realm of ICOs for technical, economic
and legal reasons.
- From a technical perspective, the tokens can adopt hybrid and evolving features, which can
question the binary distinction.34 Thus, they can be encoded to adopt features from both
categories, but also switch from one classification to the other depending on the provisions of
the Smart Contracts35.
31 ibidem 32 ibidem 33 Ibidem 34 Steven Krohn, “ Security Tokens or Utility Tokens: What’s The Difference” 35 “What is an Ethereum Token: The Ultimate Beginner’s Guide”, https://blockgeeks.com/guides/ethereum-token/
Centralized ICO project
Network-based ICO
project
Identified as a security-
token if it has fulfilled
the first requirement
Identified as a utility-
token even though it has
fulfilled the first
requirement
A token
purchased by an
investor during an
ICO service/ good.
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- Economically speaking, many ICOs are launched to finance Blockchain-based and
decentralized projects, based on a collaborative network of entities. Thus, the second
requirement of the Howey Test is not likely to be met in these conditions.
- To dodge the cumbersome security law framework, many tokens are designed to avoid the
security-alike classification36. Practical-wise, the difference between utility-token and security-
token can be difficult to identify.37
Thus, relying on the economic reality, rather than the technical characteristic of the token, seems to be
a sound approach. It reinforces the effectiveness of the Howey Test, even though it is applied for such
a disruptive financing instrument, seven decades after the milestone judgment SEC VS Howey38. On the
flipside, the application of the substance over form principle39 requires an in-depth analysis of the
token’s features, since the “variety of tokens offered necessitates a case-by-case analysis”40 While this
principle should be a tie-breaker solution, it seems to be heavily required for cutting-edge ICO
operations. As a consequence, the legal security of companies is threatened. To this end, bespoke
guidelines concerning the application of the Harvey Test to token-sale could restore a soundproof legal
environment.
The US security law framework may differ to a certain extent with other domestic regulations, though
the security identifying test applied to token seems to be similar in most jurisdictions. As an illustration,
the Swiss Financial Market Supervisory Authority, FINMA, published its ICO guidelines41 in February
2018, enacting three categories of tokens:
- “Payment tokens, synonymous with cryptocurrencies and have no further functions or links to
other development projects
- Utility tokens, intended to provide digital access to an application or service.
- Asset tokens, assets such as participation in real physical underlying, companies, or earnings
streams, or entitlement to dividends or interest payments. Regarding their economic function,
the tokens are analogous to equities, bonds or derivatives.”
The Swiss regulatory institution explicitly mentions the two main categories of tokens, the utility-tokens
(second category stated) and the security/utility tokens (third category stated). Thus, the above-exposed
36 Lukas Schor, ‘’8 Important Things To Know About Security Tokens / Token Regulation’’, 37 Steven Krohn, “Security Tokens or Utility Tokens: What’s the Difference” 38 United States Supreme Court May 27, 1946, Case no 843 Securities and Exchange Commission v. W. J. Howey co
39 Lukas Schor, ‘’8 Important Things To Know About Security Tokens / Token Regulation’’ 40 Phillipp Hacker, Chris Thomale, , “ Crypto-Securities Regulation: ICOs, Token Sales and Cryptocurrencies under EU Financial Law”, https://www.law.ox.ac.uk (January 03, 2018)
41 ‘’Finma publishes ICO guidelines’’, FINMA (Swiss Financial Market Supervisory Authority), https://www.finma.ch/en/news/2018/02/20180216-mm-ico-wegleitung/ (February 16, 2018)
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analysis of the US security law framework, based on the distinction between utility-tokens and security-
tokens is likely to be applicable in every jurisdiction dealing with ICO issues.
As a reminder, most of the ICO-issuers releases security-alike tokens to avoid the burdensome Security
law regulation42. Still and all, the initial accounting report appears tremendously complex for a utility-
token sale, comparing to a security-alike sale. In any case, the token-sale must be recorded on the ICO-
issuer’s balance sheet through the offsetting of credit and debit book entry. A debit to cash for the
proceeds appears to be a logical entry, whether it is a utility -alike or security-alike ICO.43
On the credit side, the situation highly diverges, whether the token-sale is considered as an equity
financing operation or a security financing operation. For a security-token sale, a credit to equity appears
to be an uncontested and sound entry.
Debit Credit
Cash $100M
Equity $100M
Entries for security-token sale44
The matter is further complicated in the most-spread situation of utility-token sales. Since it is not
qualified as equity financing operations, a credit to equity is not appropriate45. Thus, concerning the
credit entry, the remaining options are either revenue or liability46. This issue can be solved by following
the provisions of the IFRS 15 ‘’ Revenue From Contracts with Customers’’47, which provides a five-
step revenue recognition method to identify revenue, as above-illustrated.
42 Gregory Simon, ‘’The Impending Risks of ICO Accounting: Has avoiding treating Initial Coin Offerings as Equity created
a massive liability bubble for issuers?’’ https://medium.com, (October 14, 2017) 43 Ibidem 44 ibidem 45 Ibidem 46 Ibidem 47 ‘’IFRS 15: The new revenue recognition standard’’, EY, http://www.ey.com/Publication/vwLUAssets/IFRS_15_The_new_revenue_recognition_standard/$FILE/IFRS15_low.pdf,(2014)
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Revenue recognition according to IFRS 1548
In most respect, the first three steps of this test are easily met by any token sale, through a comprehensive
Smart Contract (step 1) including the performance obligations (step 2) and the underlying transaction
price, namely, the coins received by the ICO-investors.(step 3).
The last two steps remain the core issue for to reckon a token-sale as a credit to revenue from an
accounting perspective. Step 4 indicates the appropriate moment to recognize a revenue on the issuer’s
balance sheet, while step 5 triggers the recognition of revenue at this moment49. The transfer of control
is the decisive factor in determining when the performance obligation is effectively carried out. 50
48 Ibidem 49 Gregory Simon, ‘’The Impending Risks of ICO Accounting: Has avoiding treating Initial Coin Offerings as Equity created a massive liability bubble for issuers?’’ 50 ‘’IFRS 15 Revenue from Contracts with Customers your questions answered’’, Chartered Professional Accountants Canada, https://www2.deloitte.com, (March 1,2015)
17
By applying IFRS 15, the revenue should be recognized when the supply of the token-related products
occurs. When the token-sale is carried out, only a credit entry for deferred revenue liability will be
reported, which will offset the debit entry in cash.51
Debit Credit
Cash $100M
Future Performance Obligation
(Deferred revenue liability)
$100M
Example of token-sale: Issuance of 100M of tokens with a market value of $1 for one token52
Once again, this general treatment is not suitable for every ICO. Indeed, if the investors directly receive
the product or services, a credit entry for revenue should logically be reported at the time of the ICO.
Yet, most of the ICO-issuers deliver the final product later on.
The lack of clear guidance regarding the accounting treatment of token-sale threatens the accounting
compliance of companies. One main issue pops up in this context. Firstly, the uncertainty about the
Security Law enforceability can reduce the appealing of ICOs for both issuers and investors. Indeed, the
qualification of securities involves the application of a comprehensive security law framework while
“very few ICO projects possess the resources and legal capabilities to issue tokens that comply with all
applicable regulations of the SEC.”53
Even though the reporting of the token sale remains a complex accounting concern owing to the diverse
features of tokens, the ICO-issuers are also facing reporting issues before this moment; at the time of
the pre-mining operations.
2.1.1.2. The reporting of pre-mining operations questioned by the absence of market value
Pre-mining operations aim at freely distributing tokens to privileged stakeholders, usually employees
and founders.54 These restricted operations raise significant accounting difficulties as they are carried
out before the public-open token sale.55
51 Gregory Simon, ‘’The Impending Risks of ICO Accounting: Has avoiding treating Initial Coin Offerings as Equity created a massive liability bubble for issuers?’’ 52 Ibidem 53 Steven Krohn, “Security Tokens or Utility Tokens: What’s the Difference” 54 Gregory Simon, ‘’The Impending Risks of ICO Accounting: Has avoiding treating Initial Coin Offerings as Equity created a massive liability bubble for issuers?’’ 55 Ibidem
18
At this early stage, before the public sale, the freely-distributed tokens do not have any market value.
Within this situation, the initial recognition of the tokens, as well as the token-related deferred liability
for the company seems peculiarly complex. When this distribution of tokens to founders and employees
is carried out during the token-sale, the accounting report can be achieved by using the sale value of the
tokens56. Still, when it is realized prior to the token-sale, the lack of market value seems to question the
accounting report. Identifying the relevant accounting treatment remains feasible.57
On the credit side, the same accounting treatment is likely to be applied, and a deferred revenue liability
should be accounted as the companies are bound to deliver the token-related product.58 Concerning the
debit entry, in the typical pre-mining operations dedicated to employees and founders, the granted tokens
must be reported as wages and salaries on the debit side.59
At the time of the token sale, the market value will determine the amount to report for both debit entry
(the value of the token-related products to deliver) and credit entry (the value of the issued-token). Still,
in the pre-mining operation, the amount to report cannot rely on any existing market value. Thus, the
ICO-issuer can solely establish an estimation of the token’s market value for accounting purposes.
56 Ibidem 57 Ibidem 58 Ibidem 59 Ibidem
The traditional two steps of an Initial Coin
Offerings
Step 1 - The pre-mining operation
A prior distribution of tokens to privileged stakeholders, in
order to reward their investment in the ICO-issuing company.
As of this moment, no market value can be reckoned for the
tokens and the token-related product to deliver.
Step 2 – the token sale
A public sale of tokens to anonymous investors based on a
Blockchain-empowered Smart Contracts, in consideration of
cryptocurrencies.
This sale enables the determination of a market value for the tokens
and the token-related products to deliver.
19
Example of pre-mining operation: Issuance of 50M of tokens without any market value at this prior
stage
Considering that an extended timespan can separate the pre-mining operation and the token sale,
reporting a trustworthy estimation of the token’s value appears jeopardised. To do so, the ICO-issuer
could assess the “exit price”60, namely, the value of the token-related goods or/and services, which will
be delivered to the investors. It would comply with the Fair value measurement, providing by IAS 1361.
Yet, since no accounting framework is dedicated to ICOs, this accounting report could be questioned,
even though it appears relevant.
This assessment will occur at a very early stage when most of the prospective ICO-issuers did not clearly
establish their business model. The lack of economic relevance concerning this reporting is explicit,
although, it will have a tremendous influence on the financial position of the ICO-issuers. Since the
determined amount will be reported as a credit for deferred revenue liability and a debit for wage and
salaries, it may be falling under the scope of Personal Income Tax for the founders and the employees,62
even though the companies may not have yet a substantial economic activity. Thus, the ICO-issuer might
tend to undervalue the tokens distributed in the pre-mining operation, to reduce the tax burden related
to wages and salaries. Underestimating the value of the token reduces the reliability and comparability63
of ICO-issuers’ financial statements before the token sale. In contradiction with the general accounting
principle of true and fair view64, it is likely to distort the financial situation of the company for every
stakeholder and prospective investor. To tackle this shortcoming and to ensure a reality-based
accounting treatment, a bespoke IFRS guidance, covering the two steps of Initial Coin Offerings, would
be beneficial.
The accounting issues of reporting an ICO are not restrained to the mere operation in itself since the
subsequent accounting adjustments are challenging the true and fair view principle as well.
60 “IAS 13 –Fair value”, https://www.iasplus.com/en/standards/ifrs/ifrs13 61 ibidem 62 Gregory Simon, ‘’The Impending Risks of ICO Accounting: Has avoiding treating Initial Coin Offerings as Equity created a massive liability bubble for issuers?’’ 63 Donatella Busso, ‘’IAS/IFRS and the New Directive 2013/34/EU’’ in Accounting Perspective in Corporate Tax Base in the Light of the IAS/IFRS and EU Directive 2013/34 (The Netherlands, Kluwer Law International B.V., 2016), 27
64 Donatella Busso, ‘’IAS/IFRS and the New Directive 2013/34/EU’’, 29
Debit Credit
Wages and Salaries $???
Future Performance Obligation
(Deferred revenue liability)
$???
20
2.1.2. The reliability of financial statements questioned by the unguided post-ICO reporting
The post-ICO reporting is perceived as an insoluble issue owing to the outflow and inflow occurring in
a token sale for the ICO-issuers. On the outflow side, the transfer of tokens to investors leads to a token-
related liability, namely the delivery of the product, to be reported by the ICO-issuers. The same
company also need to report the coins received from the investors. Both of those concerns are affected
by the highly-volatile and cutting-edge features of cryptocurrencies.
2.1.2.1. The financial positions of ICO-issuers artificially influenced by tokens’ price fluctuation
The fluctuation of tokens’ value, however it is downward or upward, leads to reality-distorted
accounting adjustments. In case of a surge in value, the reported liabilities could extremely raise without
any substantial economic activity, whereas the decrease in value could allow an artificial improvement
of the company’s financial position.
2.1.2.1.1. The increase in tokens’ value, a threat to the financial position of the ICO-issuer
In a similar manner to the coins, the ICO-issued tokens are traded on a highly-volatile market65, running
on digital trading platforms. Thus, after a successfully-completed ICO, the token’s value will fluctuate,
being traded on a crypto-market.
IFRS 15 requires the deferred liability to be maintained on the balance sheet at the expected cash-
equivalent redemption value.66 The company can dodge the revaluation method by sticking to the book
value for every issued token67. This solution may enable the company to dodge many complex
accounting issues but would disallow to take into account the token’s price fluctuation in its subsequent
financial statements. Considering the highly-volatile token market68, it would prohibit from reporting
substantial surges in the token’s valuation, at the detriment of the ICO-issuer. Moreover, as mentioned
before, the pre-mining operations requires the accounting report of token’s distribution without any
market value. At this stage, the book value of the token lacks reliability. In a nutshell, establishing the
market value for any ICO seems mandatory, to underpin the true and fair view principle.69
65 “Understanding Volatility in Blockchain Tokens”, Snovio Team, https://snov.io/blog/understanding-volatility-in-blockchain-tokens/ (February 23, 2018) 66 Gregory Simon, ‘’The Impending Risks of ICO Accounting: Has avoiding treating Initial Coin Offerings as Equity created a massive liability bubble for issuers?’’ 67“ IFRS 15 – Revenue from Contracts With Customers’’, https://www.iasplus.com/en/standards/ifrs/ifrs15 68 “Understanding Volatility in Blockchain Tokens”, Snovio Team 69 Donatella Busso, ‘’IAS/IFRS and the New Directive 2013/34/EU’’, 27
21
Therefore, in this revaluation model, the increase in the token’s value leads to a surge in the underlying
deferred revenue liability.70 To offset this new credit entry, a debit entry must be reported. The only
available offsetting option is a debit for equity, which will degrade the financial positions of the
companies.71 At this moment, the ICO-issuer has a highly-reduced cash flow, comparing to its liability,
while still being in the early stage of the product’s development, in most of the cases. This unattractive
financial position may refrain prospective equity investors from investing in the company.
Entry for year-end market adjustment: increase of the token market value from 1$ to 10 $ (100M of
tokens previously issued)72
To conclude, the adjustment of the deferred revenue liability according to the token’s price fluctuation
remains an almost-mandatory choice for ICO-issuers, although, it harms the financial attractiveness of
the company in case of value increase.
On the one hand, the increase in token’s value strikingly degrades the financial position of the ICO-
issuers. On the other side of the coins, a consequent dip in the market price of tokens may allow a highly-
effective and artificial improvement of this financial position.
2.1.2.1.2. The decrease in tokens’ value, an opportunity to make-up the financial position of the ICO-
issuer
In case of a dip in tokens’ value, the liability related to the token-related product will slump, allowing
the company to increase its equity.73 This artificial boost of the financial attractiveness may enable the
company to attract equity investors, yet, it explicitly denies the principle of true and fair view.74
70 Gregory Simon, ‘’The Impending Risks of ICO Accounting: Has avoiding treating Initial Coin Offerings as Equity created a massive liability bubble for issuers?’’ 71 Ibidem 72 ibidem 73 ibidem 74 Donatella Busso, ‘’IAS/IFRS and the New Directive 2013/34/EU’’, 29
Debit Credit
Net Unrealized Gain/Loss on
Short-Term Investments
(expense)
$900M
Revaluation account
(liability)
$900M
Debit Credit
Retained Earnings (equity) $900M
Net Unrealized Loss on
Short-Term Investments
(expense)
$900M
22
Entry for year-end market adjustment: decrease of the token market value from 1$ to 0.1 $ (100M of
tokens previously issued)75
Entry for the buy-back of the tokens76
Outside of this first make-up improvement of the financial position of the company, a slump in the
token’s price valuation can allow an even more harmful mechanism: the buy-back of tokens by the ICO-
issuers77. After the token sale, the decrease in the token’s price valuation allows ICO-issuers to buy all
its tokens back. Thus, this current credit for cash overwhelming the initial debit for cash being (at the
token-sale), the outcome is an increase in the Cash Flow of the company78. Being the full owner of the
token previously issued, the company do not have to deliver the token-issued product. From an
accounting perspective, its financial position is improved by this increasing cash flow, which is likely
to appear more appealing to investors. Still and all, this make-up scheme may degrade the trust of
investors in the ICO market. Considering the current “witch-hunt” against ICO scams79, the potential
spreading of such artificial buy-back is a high-stakes issue.
75 Gregory Simon, ‘’The Impending Risks of ICO Accounting: Has avoiding treating Initial Coin Offerings as Equity created a massive liability bubble for issuers?’’ 76 ibidem 77 ibidem 78 Ibidem
79 Roger Aitken, “ U.S. SEC Halts Alleged Crypto ICO Scam From 'Decentralized' Bank Seeking $1 Billion”, https://www.forbes.com (January 30, 2018)
Debit Credit
Future Performance
Obligation
(Deferred revenue liability)
$10M
Cash $10M
Debit Credit
Future Performance Obligation
(Deferred revenue liability)
$90M
Net Unrealized Gain/Loss on Short-
Term Investments (expense)
$90M
23
Throughout the previous developments, the accounting treatment of tokens-related liabilities was in the
spotlight. In a complementary manner, the upcoming discussions will target the inflow of coins received
by the ICO-issuers, in consideration of the tokens received by the investors.
2.1.2.2. The blurred reporting of post-ICO gains in coins
Owing to their pioneer characteristics, the cryptocurrencies coins lie on the spectrum of several accounts
of assets, leaving the choice of measurement methods to the discretion of the ICO-issuers.
2.1.2.2.1. The uncertain accounting treatment of coins
The accounting treatment of the received cryptocurrency coins appears to be highly burdensome for
ICO-issuers. Considering the fact that tokens are traded on a highly-volatile market by investors80, a
joint analysis with coins can be carried out81, using the generic term of “cryptocurrencies” here-above.
Yet, from an IFRS perspective; the cryptocurrencies do not seem to fit with the definition of financial
assets provided by IAS 3282, as it is neither:
- “Cash, since it is not recognized as a legal tender
- Cash equivalent, since their value is exposed to significant changes in market value83
- Contractual right to receive cash or a cash equivalent”84
Considering the recent rise of the crypto-economy, the incompatibility of the current IFRS conception
of financial assets is understandable. Thus, it is necessary to determine if the coins could potentially be
recognized as financial assets in the future. To this end, the coin’s features should be assessed in the
light of the legal conception of money.
From a legal perspective, money has three features: Legal tender status, central management, and a
physical career85.
80 “Understanding Volatility in Blockchain Tokens”, Snovio Team 81 “Accounting for crypto-assets”, EY http://www.ey.com/Publication/vwLUAssets/EY-IFRS-Accounting-for-crypto-assets/$File/EY-IFRS-Accounting-for-crypto-assets.pdf (2018) 82 ‘’IAS 32 – Financial Instrument: Presentation’’, https://www.iasplus.com/en/standards/ias/ias32 83 Gary Berchowitz, ‘’Accounting for Cryptocurrency’’ , http://pwc.blogs.com, (November 28, 2017) 84 ibidem 85 Aleksandra Bal, Taxation of Cryptocurrency, https://openaccess.leidenuniv.nl , (The Netherlands, Institute of Tax Law and Economics, Faculty of Law, Leiden University, February 12, 2014), 64
24
The first criterion underpins “the need for money to be universal in a geographical area and can be used
for all investment and exchange there.”86 Applied to cryptocurrencies, this requirement is not fulfilled
as of now87.
The second criterion, a central management, appears more litigious since the coins are traded and used
on a decentralized blockchain-based platform88. There is a contradiction popping up between this
criterion and the coins’ features. Still and all, the broad use of cryptocurrencies, spreading in every
country, might question the relevance of this criterion.
The third criterion, a physical career, is hardly adapted to cryptocurrencies as well. Once again,
considering the digitalization of legal tenders and the correlated disappearance of cash, the increasing
obsolescence of this criterion can be underlined.89
Even though the coins do not meet this three-step recognition test, substantial-wise, these digital
currencies increasingly adopt similarities with legal tenders.90 The more they are accepted for payment
on the global scale, the more they may obtain a money-alike status.
The rise of ICO surges the spreading of cryptocurrency-financed companies. In this context, it becomes
urgent to ensure the accounting principle of comparability91 when it comes to the financial statements
of these companies. Considering the fact that these ICO-issuers compete on the market with more
“traditionally-financed” companies, applying different accounting treatment for them threatens the
enforceability of this principle, as well as the true and fair view92. Moreover, the mismatches between
countries are growing, since some States are increasingly recognizing coins as financial assets.
Luxemburg is the most eye-catching illustration of this trend, considering the size of its financial sector
and its major economic role in the EU.93
As the ICO-issuers are torn apart between three financial accounts for the received coins without any
bespoke accounting standards94, the measurement method is left to their discretion.
86 ibidem 87 ibidem 88 Investopedia, s.v., ‘’blockchain”, accessed April 3, 2018, https://www.investopedia.com/terms/b/blockchain.asp . 89 Nathaniel Popper, Guilbert Gates and Sarah Almukhtar, ‘’Will Cash Disappear’’, https://www.nytimes.com, (November 14, 2017) 90 John Blessing, “Top Similarities Between Bitcoin and Regular Currency”, https://www.forks.net (April 28, 2018) 91 Donatella Busso, ‘’IAS/IFRS and the New Directive 2013/34/EU’’, 29 92 Donatella Busso, ‘’IAS/IFRS and the New Directive 2013/34/EU’’, 27 93 ‘’EU and Swiss regulations on virtual (crypto-) currencies’’, https://medium.com/@Competitive.Compliance/eu-and-
swiss-regulations-on-virtual-crypto-currencies-bc9982ac8426, (August 1,2017) 94 Gary Berchowitz, ‘’Accounting for Cryptocurrency’’
25
2.1.2.2.2. The measurement method of coins’ value left to the discretion of ICO-issuers
A restrained list of countries seems to recognize coins as financial assets95. In logical manners, within
those jurisdictions, the ICO-issuers could be potentially entitled to report coins received from investors
in the financial assets accounts96, leading to the recognition of capital gains97, even though it is not
underpinned by the IFRS standards. If it is the case, the coins would usually be measured at fair value
through Profit and Loss98, allowing their fluctuations to influence the financial position of the ICO
issuers directly. This accounting treatment appears to be the most relevant, considering the underlying
nature of coins, used as a way of payment to enable the economic activities of companies.99
In the jurisdiction denying the financial assets classification, the remaining options is more likely to be
either intangible assets or inventories.100 An intangible asset is defined as “an identifiable non-monetary
asset without physical substance”101. Considering the features of coins, this definition could be
compatible with those digital currencies102.
The report of coins as inventories is more litigious since inventories need to be held for sale in the
ordinary course of business103. As the ICO-issuer is supposed to provide the final product to the investors
by using the received coins to launch their economic activity, it is justified to consider this requirement
likely to be met.
Outside of the time-consuming compliance issues, this unclear accounting treatment disallows most of
the companies to report any increase of coins’ value in the Profit and Loss accounts104. This opportunity
would only be available if the coins were compatible with the current definition of financial assets of
IAS 32105, the fair value being the enforceable norm for these assets106.
95 “Cryptocurrencies by country”, Thomsons Reuters, https://blogs.thomsonreuters.com/answerson/world-cryptocurrencies-country/, (October 25, 2017) 96 “IAS 39 – Financial Instruments: Recognition and Measurement” https://www.iasplus.com/en/standards/ias/ias39
97 “Cryptocurrencies by country”, Thomsons Reuters 98 “IAS 39 – Financial Instruments: Recognition and Measurement”
99 Investopedia, s.v., ‘’initial coin offering (ICO)”, accessed May 3, 2018, https://www.investopedia.com/terms/i/initial-coin-offering-ico.asp
100 Gary Berchowitz, ‘’Accounting for Cryptocurrency’’ 101 “IAS 39 – Financial Instruments: Recognition and Measurement”
102 “Accounting for crypto-assets”, EY 103 “IAS 2 – Inventories”, https://www.iasplus.com/en/standards/ias/ias2
104 Gary Berchowitz, ‘’Accounting for Cryptocurrency’’ 105 ‘’IAS 32 – Financial Instrument: Presentation’’, https://www.iasplus.com/en/standards/ias/ias32 106 “IAS 39 – Financial Instruments: Recognition and Measurement”
26
By reporting the coins as inventories or intangible assets, the subsequent measurement would rely on
the book value.107 Carrying out a fair value measurement remains possible, although, any increase will
be reported in Other Comprehensive Income108, and not in Profit and Loss. Since the OCI remains an
auxiliary financial document109, comparing to the Profit and Loss Statement, it is less eye-catching for
prospective investors.
At the end of the day, the reporting of coins is broadly left at the discretion of ICO-issuers, leading to a
lack of comparability between the financial statements of companies.
The lack of tailor-made accounting standards threatening the true and fair view on the ICOs reporting,
an overhaul of the current accounting framework is more than needed, allowing comparability between
ICO-funded companies.
2.2. The introduction of a tailored accounting framework to establish a true and fair view on ICO-
issuers’ financial position
Any potential reform of the accounting framework must be designed to improve the reporting of the
mere ICO operation, as well as the cryptocurrency assets deriving from it.
2.2.1. An overhaul of accounting standards for ICOs
The accounting standards for ICO operations need to target their two sides, the pre-mining operation as
wells as the token-sale, in accordance with the economic reality.
2.2.1.1. The reporting of pre-mining operations through OCI
As concluded before, no market value can be determined for the token distributed during pre-mining
operations occurring before the public token sale. Moreover, extended timespans between this early
distribution and the public sale may occur since no framework is regulating ICOs. In order to promote
the true and fair view principle110 and to avoid the levy of a personal income tax on the free distribution
of tokens to privileged stakeholders111, it might be relevant to report the wage and salaries expenses of
pre-mining operations in Other Comprehensive Incomes. This auxiliary financial statement allows the
reporting of “revenue, expenses, gains, and losses not yet realized”112.Since carrying out a subsequent
107 Ibidem 108 “Other Comprehensive Income”, AccountingTools, https://www.accountingtools.com/articles/what-is-other-comprehensive-income.html (August 15, 2017) 109 ‘’IAS 32 – Financial Instrument: Presentation’’ 110 Donatella Busso, ‘’IAS/IFRS and the New Directive 2013/34/EU’’, 27 111 Gregory Simon, ‘’The Impending Risks of ICO Accounting: Has avoiding treating Initial Coin Offerings as Equity created a massive liability bubble for issuers?’’ 112 “Other Comprehensive Income”, AccountingTools
27
token sale is compulsory to gather funds and grant any value to the token distributed during pre-mining
operation, such an overhaul would be conceivable. The expected delivery of token-related products to
these privileged stakeholders could be account for OCI as well, to avoid pollution of the balance sheet,
considering the fact that at this early stage, the liability to deliver the product being related to the success
of the upcoming token-sale. Indeed, the inflow of coins is bound to allow the making process of the final
product.
Entry in Other Comprehensive Incomes at the time of the pre-mining operation, Report according to
the estimated value of the 50M of distributed token = 0.1 $
When the token-sale occurs, the ICO-issuers would report the token distribution on the Balance Sheet
and Profit & Loss accounts.
Entry in PL and BS at the time of the token-sale: adjustment with the market price (1 token = 1$)
Reporting the pre-mining operations in ICO would reconnect the accounting treatment with the
economic substance. Pursuing the same aim, a refined security-identification test may be implemented
to ensure a crystal-clear reporting of token-sale, in accordance with the underlying nature of the involved
tokens.
Debit Credit
Wages and salaries (unrealized
expenses)
$5M
Future Performance Obligation
(unrealized liability)
$5M
Debit Credit
Wages and salaries (unrealized
expenses)
$5M
Future Performance Obligation
(Contingent liability)
$5M
28
2.2.1.2. The reporting of token-sales eased by a bespoke Security-law test for tokens
In order to facilitate the accounting classification of tokens, the security identification test should be
tailored for tokens. As above-mentioned, the Howey Test hardly fit with the diverse features of tokens,
enabling the ICO-issuers to dodge the security classification easily. It leads to an over-dependence on
the Substance over Form last-ditch test, hindering the legal security and the accounting compliance of
ICO-issuers.
The current application of the Howey Test is the following113:
“1/ Identification of an investment contract,
2/ involving a reasonable expectation of profits,
3/ There is a person upon whom investors rely, the profit deriving from its managerial efforts.”
The last criterion may restrain the identification of token as securities since many ICO projects run on
the Ether technology are platform-based and do not rely on a distinguishable person but on a peer-to-
peer and anonymous network. 114 Since the laying criterion remains the first one, repealing this last
burdensome criterion would facilitate the application of the Howey Test, without involving heavy
reliance on the Substance over Form principle.
Improving the mere accounting framework of ICOs operations would be an unfinished work, since the
cryptocurrencies, proceeds of such financing operations, must benefit from a tailored treatment as well.
2.2.2. A tailor-made accounting regime for cryptocurrencies
Considering their cutting-edge features, it would be relevant to report the cryptocurrencies under a
dedicated account, introducing a sub-categorization of cryptocurrencies held for trading, which would
be measured according to the marking value.
2.2.2.1. The implementation of a dedicated asset account
In the previous sections, a particular focus was carried out on the cryptocurrency coins received by the
ICO-issuers. In the upcoming developments, the proposition for a bespoke account dedicated to
113 Lukas Schor, ‘’8 Important Things To Know About Security Tokens / Token Regulation’’ 114 Toshendra Kumar Sharma, “How is Blockchain Verifiable by Public and Yet Anonymous’’, https://www.blockchain-council.org (April 16,2018)
29
cryptocurrencies will concern the coins, but also the tokens, commonly identified as “cryptocurrencies’’.
The reason is the following: even though tokens are originally designed to grant access to the future
ICO-related product, it appears that a significant part of them are merely used as financial assets, traded
on crypto-markets by investors with an aim of profit115. Thus, any potential overhaul of the current
accounting framework should emphasize on the Substance Over From principle.116 In other words, it
should not solely distinguish the coins and the tokens by their original purpose but target their current
use.
It was previously highlighted that cryptocurrencies have become a growing recognized way of payment
on a global scale.117 Still, they are not yet likened to be considered as money from a legal perspective,
questioning their accounting report as financial assets. As previously discussed, an accounting
classification as inventories appears relevant in the sheer use for commercial purposes. Yet, it ring-
fences the use of the received cryptocurrencies to the commercial activities of the ICO-issuers, while
they should be entitled to distribute those digital currencies to stakeholders as well. This blurred
accounting treatment of cryptocurrencies threatens the comparability of ICO-issuers. Thus, the
introduction of a bespoke account of assets could be carried out, in order to harmonize the accounting
treatment of cryptocurrencies.
First, the introduction of a new accounting classification would enhance the comparability between the
financial statements of companies. Since cryptocurrencies are a very distinguishable category of
assets118, highly-volatile, usable in a ring-fenced Blockchain ecosystem, the crystal-clear identification
of the cryptocurrency coins would reinforce the true and fair view principle119. In addition, after this
first categorization, an inward distinction could be enacted between:
- The cryptocurrencies dedicated to commercial purposes
It would cover most of the cryptocurrencies collected in an ICO. Tokens would be the most tailored
category to match this definition. The coins received by the ICO-issuers from investors will be reported
in this category if they are bound to be used in the making process of the token-related product, in a
broad way.
- The cryptocurrencies held for trading
This category would target any coin destined to be traded in the short-term, with a sheer aim to financial
profits.
115 ’Finma publishes ICO guidelines’’, FINMA (Swiss Financial Market Supervisory Authority) 116 Lukas Schor, ‘’8 Important Things To Know About Security Tokens / Token Regulation’’ 117 “Cryptocurrency is growing in Africa”, Finder, https://www.finder.com.au/cryptocurrency-is-booming-in-africa 118 Aaron Brown, “Are Cryptocurrencies an Asset Class? Yes and No”, https://www.bloomberg.com (November 7, 2017) 119 Donatella Busso, ‘’IAS/IFRS and the New Directive 2013/34/EU’’, 27
30
Once again, this distinction would enhance the clearness120 and comparability121 of financial statements,
considering that these two categories of cryptocurrencies follow different purposes. Moreover, it would
allow the introduction of a bespoke accounting and tax treatment for the cryptocurrencies held for
trading, considering the fact that this second category is the most related to the already-established
definition of “financial assets held for trading’’, justifying a similar accounting and tax treatment.
Implementing a new account of assets for cryptocurrencies would allow the distinction between the
virtual currencies merely use for business purposes and the one held for trading, which should lead to a
different measurement method.
2.2.2.2. A different measurement method according to the purpose of cryptocurrency owners
The accounting treatment of financial assets, enacted by IAS 39 and leading to a fair value
measurement122, appears to be tailor-made for cryptocurrencies as well. In a similar manner,
cryptocurrencies held for trading could be subsequently reported in the Balance sheet at their market
value. The high-volatility of those digital currency can involve a complex application of the cost model,
since the current valuation a certain period might be totally disconnected with the economic value. In
this situation, the fair and true view principle123 is threatened.
In accordance with the revaluation model at fair value124, the cryptocurrencies held for trading would be
yearly revaluated to adjust the book value with the market value. It would enable trustful comparability
between ICO-funded companies: On the other hand, it would be sound to establish the cost value as a
standard for cryptocurrencies used for business purposes. As we previously mentioned, the fluctuation
in token’s prices, either downward or upward, threatens the connection between financial situations and
economic reality, notably introducing aggressive buy-back strategies125. In order to tackle this
shortcoming, the subsequent reporting of token-related liabilities at cost value would disallow any
influence of token’s market value on token-related liabilities.
120 Donatella Busso, ‘’IAS/IFRS and the New Directive 2013/34/EU’’, 28 121 Donatella Busso, ‘’IAS/IFRS and the New Directive 2013/34/EU’’, 29 122 “IAS 39 – Financial Instruments: Recognition and Measurement”
123 Donatella Busso, ‘’IAS/IFRS and the New Directive 2013/34/EU’’, 27 124 “IAS 39 – Financial Instruments: Recognition and Measurement”
125 Gregory Simon, ‘’The Impending Risks of ICO Accounting: Has avoiding treating Initial Coin Offerings as Equity created
a massive liability bubble for issuers?’’
31
Entry for ICO incomes: An inflow of coins evaluated at $1M at the time of the token-sale
Entry for year-end market adjustment: An increase in the value of the coins from $1m to $3m
2.3. Conclusion – Chapter 2
The accounting treatment of Initial Coin Offerings is threatened by a lack of bespoke standards. First,
the diverse features of tokens require a high-stake distinction between utility-alike token and security-
alike token, the secondary category having dedicated financial accounts and potentially falling under
the cumbersome security law framework.126 The current criteria of the Howey Test127, applicable in the
United States but similar to many others security identification test, underlines the lack of compatibility
between the existing framework and the characteristics of cryptocurrencies. The third criterion, requiring
the proper identification of the person(s) who will produce the underlying profit owing to their managing
effort, is not easily applicable in the decentralized crypto-economy, reducing the enforceability of
Security law. Even though the Substance over form test could be invoked as a backup solution, heavily
relying on case-by-case analysis do not ensure satisfying legal security for ICO-issuers. From an
accounting perspective, the report of tokens is questioned as well since many security-alike tokens could
dodge an accounting report as equity128, threatening the true and fair view principle.129 To correct this
126 Lukas Schor, ‘’8 Important Things To Know About Security Tokens / Token Regulation’’, https://medium.com, (November 22, 2017) 127 Ibidem 128 Ibidem 129 Donatella Busso, ‘’IAS/IFRS and the New Directive 2013/34/EU’’, 29
Debit Credit
Cryptocurrency held
for trading (assets)
$1M
Gain on asset disposal
(revenue)
$1M
Debit Credit
Cryptocurrency held
for trading (assets)
$2M
Revaluation account $2M
32
shortcoming, an overhaul of the security identification test could be carried out in every jurisdiction with
the use of only two criteria: the identification of an investment contract and a main view to sheer
financial profits. This simplified two-step test may be a decisive factor to restore the legal security and
ease the financial reports of token-sale.
At this point, the identification and reporting of security-alike tokens seem satisfactorily improved. Still,
the accounting treatment of the most-plebiscite utility-token remains a complex topic. Through the
extended application of IFRS 15 “Revenue From Contracts with Customers’’130, the reporting of token-
sale leads to an insoluble issue owing to the fluctuation in token’s value: a surge leads to a
disproportionate increase of liabilities, while a dip allows buy-back operations to improve the financial
situation of the company artificially.131 In order to fix this inappropriate accounting treatment, it seems
necessary to distinguish the cryptocurrencies used for business purposes with the cryptocurrencies held
for trading. The first category, represented in most of the ICO, could be reported at their cost value,
disallowing such fluctuation’s outcomes. The second category, like financial assets held for trading,
should be yearly revaluated at the market value. Hence, this needed distinction would substantially
reduce the underlying accounting risks of token’s value fluctuation. Furthermore, such a bespoke
accounting treatment of cryptocurrencies would simplify the accounting reports of ICOs and reinforce
the true and fair view principle. Instead of facing a complex choice between financial assets, intangible
assets or inventories132, the ICO-issuers would benefit from a tailor-made account for cryptocurrencies,
including token and coins. To put in a nutshell, this comprehensive overhaul of accounting standards
would facilitate the financial reports, limit the influence of tokens’ value on the financial positions and
restore the effectiveness of the true and fair view principle.
130 “IFRS 15 – Revenue from Contracts with Customers”
131 Gregory Simon, ‘’The Impending Risks of ICO Accounting: Has avoiding treating Initial Coin Offerings as Equity created a massive liability bubble for issuers?’’ 132 Gary Berchowitz, ‘’Accounting for Cryptocurrency’’
33
3. Chapter 3 - The Direct Tax Framework Of Initial Coin Offerings For ICO-issuers
The current corporate tax framework is thoroughly incompatible with ICOs, enabling tax planning
opportunities. In this context, reshaping this framework is compulsory to tackle the ICOs tax challenges.
3.1. An outdated direct tax framework harmful to both ICO-issuers and value-created States
From a general perspective, the enforceable corporate tax regulations remain unfitted with ICOs, from
both domestic and international tax perspectives. It altogether hinders the legal certainty of ICO-issuers,
although it enhances international tax planning schemes for them as well.
3.1.1. An unfitted tax treatment reducing the legal security of ICO-issuers
The current taxation of token-sales leads to a fluctuation-related issue since it involves coins-to-cash
conversions, but also a sheer tax-related matter, as the blurred accounting treatment of coins questioned
the taxable result’s certainty.
3.1.1.1. The tax levy of token-sales surging coin-to-cash conversion issues
From a technical perspective, the token sale can be analysed as a twofold trade133:
- Tokens (namely a right-to-use the product) from the ICO-issuers against coins of investors
- Products of the ICO-issuers against coins
The accounting treatment is based upon the second trade,134 leading to a report of a deferred revenue
liabilities and coins’ revenues.
133Vincent Renoux, Simon Bernard, ‘’ Crypto-monnaies et Initial Coin Offerings : voyage en terre inconnue’’, [Cryptocurrencies and Initial Coin Offerings, a journey to unchartered land], Droit fiscal no 5, 150 (1er février 2018), 6 134 Gregory Simon, ‘’The Impending Risks of ICO Accounting: Has avoiding treating Initial Coin Offerings as Equity created
a massive liability bubble for issuers?’’
34
Token-sale
Delivery of
the product
Token-sale taxed at
realization, in Year 2
Year 2 Year 1 Year 3
Example of token-sale: Issuance of 100M of tokens with a market value of $1 for one token135
Adopting this perspective seems relevant since a token sale eventually leads to a transfer of
goods/services, a criterion of the IFRS 15136. Substance-wise, the alleged intention of the investors is
likely to receive the final product, not the mere token.
Thus, in accordance with the laying principle of taxation at realization137, the taxable income arising
from token sales is chargeable under the fiscal year in which ‘’the taxpayer had transferred to the buyer
the ownership of the goods’’138. In other words, it occurs when the ICO-issuers eventually supply the
token-related goods or services to the investor, an event which may occur a few years after the ICO.
The potential gap between the token-sale and the delivery of the product
A cash flow issue is likely to pop up with respect to this taxation at realization139. As a matter of fact,
the ICO-related product is often the first completed project of the ICO-issuers140. Thus, until the delivery
of the goods or services, the cash flow of the company can be limited. Therefore, at the year of delivery,
135 Gregory Simon, ‘’The Impending Risks of ICO Accounting: Has avoiding treating Initial Coin Offerings as Equity created a massive liability bubble for issuers?’’ 136 ’ IFRS 15 – Revenue from Contracts With Customers’’ 137 Proposal 2016/0337 (CNS) for a Council Directive on a Common Corporate Tax Base, art 16 138 Ibidem 139 Vincent Renoux, Simon Bernard, ‘’ Crypto-monnaies et Initial Coin Offerings : voyage en terre inconnue’’,
[Cryptocurrencies and Initial Coin Offerings, a journey to unchartered land], 6 140 “Why is an ICO Project Important”, Talenthon ICO, https://medium.com (February 24, 2018)
Debit Credit
Cash $100M
Future Performance Obligation
(Deferred revenue liability)
$100M
35
the ICO-issuers will be taxed for the whole cryptocurrency incomes received in the prior ICO, at once.141
It is likely that an ICO-financed company cannot afford this all-in-once taxation without converting its
coins to cash. The need to convert such a huge amount of coins can highly amplify risks of a drop in
the value of these digital assets.142 As a result, this massive reselling of coins will hinder the value of
the ones remaining in the company’s stock. Hence, it appears necessary to tackle this all-in-one taxation
scheme and introduce an alternative tax model.
The taxation of coin received by the ICO-issuers raises cash-flow and market liquidity issues. Still, it
also leads to uncertainty in the sheer taxable result, owing to the blurred accounting classification.
3.1.1.2. The blurred accounting classification of cryptocurrencies raising uncertainty in the taxable
profit
As previously mentioned, the unclear accounting treatment of cryptocurrencies leads to decision-making
of companies involving three options when it comes to reporting the received coins: financial assets,
inventories or intangible assets.143
As a reminder, the relationship between financial and tax accounting can diverge amongst the
jurisdiction, covering a wide scope from practically formal dependence to informal independence.144
Yet, since no jurisdiction has maintained a fully-independent system145, the accounting treatment will
have an influence on the tax results to a certain extent.
To connect the dots, the accounting classification of cryptocurrencies will influence their tax treatment.
Hence, it appears necessary to underline the different tax outcomes arising from divergent accounting
classification. There is a growing tendency toward a potential recognition of cryptocurrencies as
financial assets.146In this hypothetic situation, those peculiar assets may benefit from a dedicated tax
treatment as well. Hence, it may entitle the assets to be considered as ‘held for trading”. It may enable
the ICO-issuer to report provisions for currency risk, in case of a drop in the market value. Since the
CCTB proposal is trumpeting for taxation on capital gain for financial assets held for trading147, the
short-term-held cryptocurrencies could be concerned as well, if this European framework end up by
being enforceable. On the other hand, the cryptocurrencies merely used for business purposes could
141 Vincent Renoux, Simon Bernard, ‘’ Crypto-monnaies et Initial Coin Offerings : voyage en terre inconnue’’ [Cryptocurrencies and Initial Coin Offerings, a journey to unchartered land], 6 142 Ibidem, 6 143 Gary Berchowitz, ‘’Accounting for Cryptocurrency’’ 144 Essers, ‘’ The relationship between tax accounting and financial accounting in the USA and Members States of the EU’’ (lecture), Tilburg University, Tilburg The Netherlands, September 18, 2017 145 Ibidem 146 “Cryptocurrencies by country”, Thomsons Reuters 147Proposal 2016/0337 (CNS) for a Council Directive on a Common Corporate Tax Base, art. 21
36
follow the generic CCTB regime for financial assets, enacted by Article 16148 and entailing taxation at
realization.
The coins are generally reported as intangible assets.149 This accounting classification enacts the assets
to be amortized150 over their useful life, which does not seem to be tailored to coins, since it may be
cumbersome to accurately determine their useful life. The principle of taxation at realization151 being
applied, the coins will be taxed only for the fiscal year of disposal.
The coins can also be reckoned as inventories.152 In this context, they are pooled and cannot be
individually identified153. This accounting treatment has a significant influence on the taxable result.
Whatever the chosen calculation method, the gap of value at the beginning and the end of the year will
be taken into consideration to determine the taxable result.154 Thus, this accounting classification leads
to yearly-based taxation on the coins’ stock of the ICO-issuers.
3.1.2. A cutting-edge operation facilitating aggressive tax planning
Owing to its decentralized features, Initial Coin Offerings can be easily carried out in low-tax
jurisdictions, while the CFC rules, designed to tackle tax avoidance, cannot tackle such an
international tax planning.
3.1.2.1. A decentralized operation entailing profit shifting to low-tax jurisdictions
It is not mere coincidence that many ICO-friendly States are often considered as low-tax jurisdictions
as well, or squarely tax heavens, like the Caiman Islands155. As a consequence, the spreading of
aggressive tax planning based on Initial Coin Offerings could be a potential outcome.
148 Ibidem, art. 16 149 “Accounting for crypto-assets”, EY 150 “IAS 38 – Intangible Assets”, https://www.iasplus.com 151 “Proposal 2016/0337 (CNS) for a Council Directive on a Common Corporate Tax Base, art. 16 152 Gary Berchowitz, “Accounting for Initial Coin Offerings (‘ICOs’)” 153 Ronald Russo, “CCCTB Stock, WIP, Financial assets, Intangibles’’ (lecture), Tilburg University, Tilburg The Netherlands, October 16, 2017 154 ibidem 155 Alexey Schlerbin, “Best Countries for ICO”, https://hackernoon.com, (February 1, 2018)
37
Located in a low-tax and ICO-friendly
jurisdiction Located in the business activities’
jurisdiction
Transfer of the ICO-related
incomes after the ICO
The ICO-vehicle subsidiary
ICO-related incomes in the subsidiary
tax base, onward taxed by the
subsidiary’s jurisdiction
The operating parent company
Exemption granted by the parent’s
jurisdiction for the ICO-related taxes paid
in the subsidiary’s jurisdiction
The leading principle in international tax is the residence principle.156 Considering the scope of
companies, the state of incorporation is entitled to tax its residents on their worldwide base, based on
Article 6 of the OECD Tax Model Convention.157 As an exception, the source principle allows States to
tax the incomes generated in their jurisdiction through a permanent establishment.158 In the case of ICOs,
many of them are carried out through a dedicated vehicle159, likely to be incorporated in an ICO-friendly
state.
Tax planning by ICO-issuers
Not fitting with the definition of dividends enacted by Article 10 of the OECD Tax Model Convention160
considered as a distribution of dividends, the transfer of the received coins from the ICO-purposed
subsidiary to the operating vehicle will be treated as a distribution of foreign business income under
most of the tax conventions161. Under the OECD model for tax conventions, one of the tax relief
methods is the exemption on foreign business incomes distributed to resident shareholders.162 Under the
common tax treaties’ rules, by granting an exemption on the incomes arising from an ICO realized in a
low-tax jurisdiction, the operating entity’s State loses all the taxing rights on the ICO.
156 Eric Kemmeren, ‘’ Principal of International Taxation 3 (lecture), Tilburg University, Tilburg The Netherlands, January 29, 2018 157 Model Tax Convention on Income and on Capital, OECD, Article 7: “Business Profits”, (1) 158 Eric Kemmeren, ‘’ Principal of International Taxation 3 (lecture) 159 Ezequiel Djeredjian, “Law and legislation for ICOs” ,https://medium.com (February 19, 2018) 160 Model Tax Convention on Income and Capital, OECD, Article 10: “Dividends”,(3) 161 ibidem, Article 7: “Business Profits”, (1) 162 ibid, Article 23A: “Exemption Method”
38
The toolbox of tax jurisdiction has recently welcomed the CFC rules, designed to tackle profit shifting
in low-tax jurisdictions. Yet, the absence of cryptocurrencies in the qualifying assets compromises the
enforceability of this mechanism for ICOs.
3.1.2.2. A peculiar financial instrument not falling beyond the scope of CFC rules
The ‘’Controlled foreign company (CFC) rules have the effect of re-attributing the income of a low-
taxed controlled subsidiary to its parent company’’163. It aims at targeting the shifting of profits from
high-taxed jurisdictions to low-taxed jurisdictions.164 This mechanism would be perfectly tailored to
tackle the tax planning arising from ICO operations. Still, the scope of the CFC rules165 is unlikely to be
compatible with the tax identification of ICO’s incomes.
The EU example is particularly relevant. Under the ATAD directive,166 the CFC rules are enforceable
for the following categories:
- “interest or any other income generated by financial assets; (ii)
- royalties or any other income generated from intellectual property; (iii)
- dividends and income from the disposal of shares; (iv)
- income from financial leasing; (v) income from insurance, banking, and other financial
activities; (vi) income from invoicing companies that earn sales and services income from goods
and services purchased from and sold to associated enterprises, and add no or little economic
value;”
Ironically, the willingness of States to consider coins as financial asset forbids the application of the
CFC rules to tackle ICO-based tax planning. No CFC-targeted category appears to be compatible with
incomes received in coins. As a conclusion, the aggressive tax planning carried out by ICO-issuers
located in Tax heavens remain out of the scope of the current CFC rules.
The current direct tax framework can hardly tackle the crypto-economy challenges, on different scales,
if it remains in its current shape. With this in mind, the need for an overhauled framework is tangible. It
would be designed to tackle aggressive tax planning, from both domestic and international perspectives
163 Council Directive (EU) 2016/1164 laying down rules against tax avoidance practices that directly affect the functioning of the internal market [2016], preamble (12) 164 Arthur Hofman, “Avoidance of Double Taxation within groups”(lecture), Tilburg University, Tilburg The Netherlands, October 10, 2017 165 Council Directive (EU) 2016/1164 laying down rules against tax avoidance practices that directly affect the functioning of the internal market [2016], preamble (12) 166 Idem, art 7, 2, (a)
39
3.2. A direct tax regulation of ICOs to set out a fair tax duty for ICO-issuers
Overhauling the direct tax regulation of ICOs should be orientated toward two directions since it should
target the domestic corporate tax legislations as well as the international tax regulations.
3.2.1. The need to introduce an ICO-compatible tax regime in domestic legislations to restore legal
certainty
From a domestic perspective, the introduction of an ICO-compatible tax regime will require a bespoke
tax treatment of cryptocurrencies, establishing a fair taxable income, but also a special tax levy to reduce
coins-to cash conversion issues.
3.2.1.1. A bespoke tax treatment of cryptocurrencies in accordance with their diverse features
In the current section, the scope of the proposed tax overhaul includes both token and coins owned by a
company, including any ICO-issuer. Thus, the term ‘’cryptocurrencies’’ will be used to cover both of
those digital currencies.
As previously discussed, the introduction of tailored accounting treatment of cryptocurrencies is
necessary to restore the true and fair view of ICO-issuers financial statements. The main idea was to
distinguish the cryptocurrencies held for trading from the ones dedicated to business purposes.
From a tax perspective, the same pattern can be carried out, in order to apply a bespoke tax treatment
based on the features on cryptocurrencies. As a reminder, the relationship between tax and financial
accounting can diverge depending on the jurisdiction. In States relying on a tight connection, the
improvement of the accounting treatment may correlatively refine the tax categorization of
cryptocurrencies, even though, the implemental of dedicated tax rules will remain necessary. On the
other hand, in countries applying loosen connection, the tax overhaul is likely to be be more
comprehensive, including an independent and dedicated tax categorization of cryptocurrencies.
The tax treatment of cryptocurrencies could be designed according to this twofold distinction:
- Cryptocurrencies dedicated to business purposes
- Cryptocurrencies held for trading
In order to distinguish the second category, the definition of ‘’financial assets held for trading’’ in the
Common Corporate Tax Base Proposal167 could be particularly adequate:
167 Proposal 2016/0337 (CNS) for a Council Directive on a Common Corporate Tax Base, art 21
40
“A financial asset or liability shall be treated as held for trading if it is one of the following: (a) it is
acquired or incurred principally for the purpose of selling it or repurchasing it in the short term;’’
The sheer use of the coins dedicated to business purposes would be the investment in resources necessary
to deliver the ICO-related product. Regarding tokens, it could target the ones granting a right to use a
product which is useful for the company’s aim. For this first category, applying taxation upon realization
seems relevant, as they are less convertible in cash. Depending on the Smart Contract’s provisions, the
ICO-issuers can even be bound to use the received coins for the purposes of delivering the final product.
Maintaining a tax on realization for these business-dedicated cryptocurrencies is, then, appropriate.
The cryptocurrencies destined to be traded on a crypto market, with a main financial purpose from the
investors, could be considered as “held for trading’. As a reminder, it can be both the case for coins and
tokens, even if the last category was not originally designed to be a mere subject of financial investments.
168Since these assets are easily convertible in cash, taxation on capital gain could be implemented. It
would raise the accountability of the ICO-issuers to smartly use the received cryptocurrencies but also
allow the States to levy taxes at an early stage.
In a logical manner, after improving the determination of the taxable result, the next step is to introduce
a tailor-made tax-levy scheme, in order to reduce the risk of value’s decrease at the time of the coins-
to-cash conversion, required to pay taxes.
3.2.1.2. A dedicated tax -levy scheme for ICOs to reduce coins-to-cash conversion issues
The ICOs have introduced a complex tax issue since the deriving income is constituted of coins,
unestablished currencies needing to be converted in order to afford the levying of CIT.169 Yet,
considering the tremendous amounts raised through ICOs, such an all-in-one conversion of coins to
cash, just in order to pay taxes, surge the risk of instability of the market..170 An alternative model of
taxation could be implemented, restraining this threat on the cryptocurrency market.
As an alternative, an intermediary model could be introduced: instead of levying taxes during the mere
year of realization, the ICO-issuers could opt for a spreading the tax payment from the year of the ICO
until the year of the supply of goods/services. In a similar manner to the regime of financial assets held
for trading in the CCTB proposal171, the profit deriving from the ICO could be yearly taxed according
168 Vincent Renoux, Simon Bernard, ‘’ Crypto-monnaies et Initial Coin Offerings : voyage en terre inconnue’’ [Cryptocurrencies and Initial Coin Offerings, a journey to unchartered land], 6 169 ibidem 170 ibidem 171 Proposal 2016/0337 (CNS) for a Council Directive on a Common Corporate Tax Base, art. 21
41
to the market value of the tokens at the end of the fiscal year. It would also constitute an incentive for
the ICO issuers to deliver the final product, as the tax liability starts right after the ICO.
After improving the domestic tax framework, the complementary move is to reinforce the Anti-BEPS
rule in the international tax field, in order to implement a comprehensive tax regulation dedicated to
ICOS.
3.2.2. An overhaul of international tax rules to prevent ICO-related aggressive tax planning
In a complementary manner, the overhaul of international tax rules must include an extension of CFC
rules to tackle non-distributed ICO’s incomes in tax heavens, in addition with a reinforcement of tax
credit method to grant more taxing rights to the operating entity’s jurisdiction.
3.2.2.1. An extended scope of CFC rules to target undistributed ICO proceeds located in tax heavens
On the global scale, countries could ensure an ICO-fitted overhaul of the CFC rules, including coins in
the qualifying assets. Thus, the parent’s jurisdiction (the operating vehicle) would be entitled to tax the
coins’ income arising in the subsidiary’s jurisdiction (the ICO-issuing vehicle). It would prevent the
retaining of the received coins in some ICO-friendly tax heavens, but also raise the accountability of
ICO-issuers to provide the final product since they cannot merely cover their taxable incomes in a low-
taxed jurisdiction.
The overhaul of CFC rules172 would tackle non-distributed coin revenues located in a low-taxed
jurisdiction, allowing the operating entity‘s jurisdiction to tax it. In a seamless and complementary way,
the reinforcement of tax credit methods would increase the taxing rights granted to this jurisdiction.
3.2.2.2. A reinforcement of tax credit methods to enhance the taxing rights of the operating entity’s
jurisdiction
The typical legal structure for ICO is the following: an operating vehicle (the parent) which will carry
out the business, and an ICO-issuer vehicle (the subsidiary), solely created to launch the ICO. Still, the
operating vehicle will be the final supplier of the services or goods.
In the current model, the taxing rights of the operating vehicle’s jurisdiction are almost nil. The
distribution of coins from the ICO-issuer’s jurisdiction to the operating vehicle’s jurisdiction will be
treated as business incomes, under OECD-like tax conventions.173 Therefore, the State of the operating
172 Council Directive (EU) 2016/1164 laying down rules against tax avoidance practices that directly affect the functioning
of the internal market [2016], preamble (12) 173 Model Tax Convention on Income and on Capital, OECD, Article 7: “Business Profits”, (1)
42
vehicle may benefit from an exemption for this income.174 In this context, it would be wise to use a tax
credit175, rather than an exemption scheme. Following the Capital Export Neutrality theory176, a tax
credit, the equivalent of the tax paid in the subsidiary’s country, would be granted to the parent’s
company.177 Afterward, it will be taxed on its worldwide incomes at the domestic rate. Thus, this method
repeals the tax paid in any ICO-friendly tax heaven and treat any resident taxpayer the same way,
however the location of their subsidiary. Combining the tax credit scheme with the previously-discussed
overhaul of the CFC rules would highly restrain the opportunities of profit shifting to low tax jurisdiction
since the ICO-issuer would be taxed at the parent’s jurisdiction rate in any case:
- Retaining of the cryptocurrency’s income by the subsidiary in the ICO-host tax heaven: the CFC
rules allow the parent’s jurisdiction to include it in the parent’s tax base
- Distribution of the cryptocurrency’s income to the parent’s jurisdiction: Using a tax credit rather
than an exemption scheme does not erode the taxable base of the parent’s jurisdiction, this
method canceling the tax levied in the subsidiary’s jurisdiction.
3.3. Conclusion – Chapter 3
Applying the principle of taxation at realization, the proceeds from a token-sale is taxed at once in
respect of the fiscal year where the ICO-related products are delivered to the investors. Considering the
tremendous amount of coins, mostly Ethers, potentially raised in a token-sale178, the tax levy may require
an important conversion of coins into cash for payment purposes. Such a consequential coin-to-cash
conversion can lead to a decrease in coins’ value179, considering the lack of market liquidity of these
virtual currencies. With regard to this concern, introducing a spread tax payment option would be
relevant. In this scheme, the ICO-issuers would have to pay instalments from the token-sale to the
delivery of the final product, in order to mitigate the fluctuation risks deriving from coin-to-cash
conversion. The companies will have to determine if this earlier tax burden is less cumbersome than the
fluctuation risk of all-at-once tax levies.
174 Model Tax Convention on Income and on Capital, OECD, Article 23a: “Exemption Method’’ 175 Idem, Article 23b, “Credit Method’’ 176 Eric Kemmeren, ‘’ Principal of International Taxation 4 (lecture), Tilburg University, Tilburg The Netherlands, February 5,2018 177 ibidem 178 Oscar Williams-Grut “The 11 biggest ICO fundraises of 2017”, http://uk.businessinsider.com (January 1, 2018) 179 Vincent Renoux, Simon Bernard, ‘’ Crypto-monnaies et Initial Coin Offerings : voyage en terre inconnue’’ [Cryptocurrencies and Initial Coin Offerings, a journey to unchartered land], 6
43
Since the correlative relation between financial and tax accounting is established, implicitly or explicitly,
in most of the jurisdictions180, the cumbersome accounting reports of cryptocurrencies involve
repercussions in the tax treatment as well. The accounting classification of financial assets leading to
divergent tax consequences, the legal security of ICO-issuers related to their tax burden is threated.
Regarding this issue, an overhaul, introducing the tax categories of cryptocurrencies used for business
purposes and held for trading would be highly beneficial. The first category could be subject to a tax at
realization, while the latter should be taxed according to the capital gains. This distinction based on the
CCCTB’s category of financial assets held for trading181 would fairly correlate the tax treatment of
cryptocurrencies with their underlying utilization. Considering the expansion of speculation-purposed
coin, this yearly taxation on capital gain may amplify the accountability of investors, and fairly grant a
favorable tax treatment to ICO-investors using coins for long-term investments.
Adopting a more international-based perspective, the rise of ICO has amplified the tax planning
opportunities, since this decentralized operation is mostly carried out through a dedicated subsidiary
located in low-tax and ICO-friendly jurisdictions. In accordance with most of the tax conventions based
on the OECD Tax Model Convention182, the business profits arising from token-sale would be taxed in
these favorable tax jurisdictions, leading to a tax-relief exemption183 when these proceeds are transferred
toward the business-purposed parent company. As a consequence, the parent’s jurisdiction, where the
economic activity is carried out, is deprived of any taxing right. In order to reconnect creation of value
and taxing right, new paradigm in international tax184, as well as restraining aggressive tax planning, a
switch from tax exemption mechanisms to tax credit mechanisms would be beneficial. It would
neutralize the limited tax burden paid in the low-tax jurisdiction before allowing the parent’s jurisdiction
to tax the proceeds from token-sale, in coherence with the creation of value. Pursuing the same purpose
of tackling aggressive tax planning, an overall of the Controlled Foreign Company rules would be
beneficial. These rules allow the parent’s jurisdiction to tax undistributed passive incomes of
subsidiaries located in low-taxed jurisdictions. Since the current scope of those anti-tax-avoidance
mechanisms does not include cryptocurrencies funds, the parent’s jurisdiction cannot tax the ICO’s
proceeds raised in tax-and-ICO heavens. For the sake of tackling aggressive tax optimization,
jurisdiction should overhaul the list of qualifying assets by integrating cryptocurrencies. In combination
with the prevalence of tax credit upon tax exemption concerning ICO-tax structures, the ICO-based tax
planning would be substantially prevented.
180 Peter Essers, ‘’ The relationship between tax accounting and financial accounting in the USA and Members States of the
EU’’ (lecture), Tilburg University, Tilburg The Netherlands, September 18, 2017 181 “Proposal 2016/0337 (CNS) for a Council Directive on a Common Corporate Tax Base, art. 21 182 Model Tax Convention on Income and on Capital, OECD, Article 7: “Business Profits”, (1) 183 idem Article 23a: “Exemption Method’’ 184 Sylvia de Jong,Willem Neuvel, Ágata Uceda, ‘’Dealing with Data’ in a Digital Economy’’, International Transfer Pricing Journal, 2018, volume 25, no.2, IBFD, https://www.ibfd.org/ (February 7, 2018)
44
4. Chapter 4 – The Indirect Tax Framework Of Initial Coin Offerings For ICO-issuers
In the waiting of crystal-clear case law, it seems that most of the ICOs are potentially taxable events
from an EU VAT perspective, challenging the tax compliance by their cutting-edge and diverse feature.
Such pioneer financing operations highlight the need for a comprehensive VAT overhaul, to restore the
level playing field.
4.1. The initial Coin Offering, a taxable event challenging the VAT compliance
The indirect tax treatment of ICOs remains hazed from both theoretical and compliance perspectives.
The EU VAT framework will provide an appropriate illustration of the legislative shortcomings, which
can be related to other indirect tax frameworks on a global scale. The diverse features of tokens
questioned the characterization of a VAT-taxed event, while the decentralized and multi-step
characteristics of the operation raise a significant compliance challenge.
4.1.1. The characterization of a taxed event depending on the token’s features
Depending on the tokens’ features, either security-like or utility-like, an ICO would tend to fall or
not in the VAT scope.
4.1.1.1. The supposed characterization of a taxed event for utility-token sales
The utility-token sale represents most of the ICOs. By relying on the EU VAT directive185, it is likely to
be considered as a taxable event since:
- it is a supply of services or goods for consideration (Article 2)186
- carried out by a taxable person, since the ICO-issuers are mostly start-ups companies with a
legal personality (Article 9)187
- The ICO-issuers are effectively independent, acting on their own name and for their own interest
(Article 9)188
- The token released in an ICO grant a right to use a future product of the company, confirming
that ICO-issuers are carrying out economic activities (Article 9)189
185 Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax 186 Idem, art 2 187 Idem, art 9 188 Ibidem 189 Ibidem
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- Even though some ICO-issuers are still early-stage start-ups, the ECJ’s case law190 confirms that
any prospective undertaking is a taxable person, even at an early-stage, if it has the purpose of
carrying out an economic activity.
Still, many exemptions are implemented in the EU VAT system, even though the relevant transactions
are technically entitled to be VAT-taxed like it is apparently the case for utility-token sale. In its Hedqvist
ruling191, the ECJ ruled that the exchange of traditional currencies for coins, and vice-versa, is out of the
VAT scope.In a logical manner, the European judges relied on Article 135-1 (e) of the EU directive,
granting a VAT exemption for financial services192. The underpinning provision of the article was the
following:
“ transactions, including negotiation, concerning currency, bank notes, and coins used as legal tender.’’
In this case, the transaction was identified as a currency exchange service, 193 justifying the
enforceability of Article 135-1. Thus, the enforceability of the financial services exemption194 seems
sound, the case facts involving a mere cash-to-coins exchange. However, the extension to the scope of
ICO require a more in-depth analysis, the situation not being comparable. At this stage, it seems
necessary to distinguish the utility-token sale and the equity-token sale.
Concerning the utility-token sale, two transactions can be identified: the trade of coins against tokens,
but also the supply of a good and/or service in exchange of coins. The first could be considered as a
currency exchange, which is VAT exempt according to Hedqvist195 while the second falls may under
the VAT scope according to the step-by-step analysis above discussed. Yet, the ECJ provides a crystal-
clear case law to determine which trade should prevent from a VAT perspective. Indeed, the main
outcome of Card Protection Plan196 indicates that a single supply should be identified if ‘’one element
is to be regarded as constituting the principal supply, whilst another is to be regarded as an ancillary
supply’’197.
Applied to ICO operations, this principle allows to distinguish:
- The principal supply, constituted by the supply of the token-related product against coins
- The auxiliary supply, being the trade of tokens to the investors, since it theoretically represents
a right to access the token-related product
190 CJEU 14 February 1985, Case 268/83 D.A. Rompelman and E.A. Rompelman-Van Delen v Minister van Financien (1985) ECR 00655 191 CJEU 22 October 2015, Hedqvist (2015), C-264/14, ECLI:EU:C:2015:718 192 Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax, art 135-1 (e) 193 Vincent Renoux, Simon Bernard, ‘’ Crypto-monnaies et Initial Coin Offerings : voyage en terre inconnue’’ [Cryptocurrencies and Initial Coin Offerings, a journey to unchartered land] 194 Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax, art 135-1 195 CJEU 22 October 2015, Hedqvist 196 CJEU 25 February 1999, Card Protection Plan (1999), C-349/96, I-00973 197 ibidem
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To sum up, the taxable event in the case of a utility-token sale is likely to be the supply of the token-
related products, either goods or services, by the ICO-issuers against the coins transferred by the
investors. This transaction, identified as a typical supply of services or goods for consideration is
unlikely to fall under the scope of the financial services exemption198. Only subsequent transactions of
the received token against another digital or physical currencies, carried out by the investors, might be
falling under the financial services’ exemption.
If the utility-alike token sales seem to be VAT-taxed supplies, the equity-like token sales are likely to
fall under the scope of the financial services exemption.
4.1.1.2. The apparent enforceability of the financial services’ exemption for equity-token sales
Even though it represents the minority of the released ICOs199, the equity-token sales might be one of
the most litigious issues from an indirect tax perspective. As a reminder, these tokens are granting capital
rights to the investors, which tend to acquire a status similar to shareholders. Unlike the utility-token
sale, it seems that only one transaction should be identified: the granting of a capital right to the
investors, against coins. Since the token directly constitutes this right to the equity of the company200,
the Composite Supply doctrine201 does not appear to be necessary. The situation was different in the case
of a utility-token sale, as the token represents a right to access the ICO-related product or goods202,
which involve a twofold transaction.
As a reminder, an equity-token grants a capital right to the investors. Thus, this token allows them to
access the equity of the ICO-issuer. In this context, the financial services exemption seems to be
enforceable. Article 135 of the VAT directive203, providing the exemption on financial services, may
apply, but through a different provision than the one invoked in the Hedqvist ruling, the 1-(f):
‘’1. Member States shall exempt the following transactions:
transactions, including negotiation but not management or safekeeping, in shares, interests in
companies or associations, debentures, and other securities, but excluding documents establishing title
to goods, and the rights or securities referred to in Article 15(2);’’
199 Gregory Simon, ‘’The Impending Risks of ICO Accounting: Has avoiding treating Initial Coin Offerings as Equity created a massive liability bubble for issuers?’’ 200 ‘’Finma publishes ICO guidelines’’, FINMA (Swiss Financial Market Supervisory Authority) 201 CJEU 25 February 1999, Card Protection Plan (1999) 202 ‘’Finma publishes ICO guidelines’’, FINMA (Swiss Financial Market Supervisory Authority) 203 Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax, Art 135
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The scope of this exemption seems to include the equity-token sale since this category of tokens is likely
to be identified as security under many domestic laws.204 Considering the broad wording of this
provision, covering the dealing of ‘’shares, interests in companies (…) and other securities’’205, the
enforceability of the exemption for equity-token is particularly high. To sum up, even though the equity-
token are often designed in order to dodge the legal qualification as security206, the financial services’
exemption is likely to apply to equity-token sales.
Yet, as we are still walking through unchartered territories, the haze surrounding the VAT treatment of
ICO is peculiarly dense. Clear guidelines from the European Commission, through a directive, or the
European Court of Justice, through upcoming case law, would be beneficial for all stakeholders of the
crypto-economy.
From a theoretical perspective, the ICOs are already cumbersome transactions to deal with in the VAT.
Yet, the onward issues of tax payment and compliance are also complex owing to unique spatial-
temporal challenges.
4.1.2. The spatial-temporal compliance challenge
The VAT compliance of ICOs is a high-stakes matter owing to the extended timespan between the
taxable and chargeable event, as well as the decentralized characteristic of such Blockchain-based
operations.
4.1.2.1. An extended timespan between the taxable and the chargeable event raising cash flow issues
As above-discussed, the utility-token sale appears to be a taxable event from a VAT perspective.
Therefore, it is crucial to determine the chargeable event for this supply, since it determines the moment
where the ICO-issuer will have to pay the VAT.
Article 63 of the EU VAT207 directive provides that:
‘’The chargeable event shall occur, and VAT shall become chargeable when the goods or the services
are supplied.’’
Applied to the context of a utility-token sale, the VAT is chargeable when the token-related products
are delivered by the ICO-issuer to the investors. Yet, a complex issue pops up through the application
of this rule: the timespan between the token-sale and the delivery of the product/services is often
204 ’Finma publishes ICO guidelines’’, FINMA (Swiss Financial Market Supervisory Authority) 205 Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax, Art 135 (1)-f 206 Gregory Simon, ‘’The Impending Risks of ICO Accounting: Has avoiding treating Initial Coin Offerings as Equity created
a massive liability bubble for issuers?’’ 207 Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax, Art 63
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particularly extended. Excepting a few ICOs where the token grants direct access to a platform208, most
of these financing operations tends to allow the production of cutting-edge products, still at an early-
stage development209. This time lag between the taxable and the chargeable events leads to two crucial
concerns concerning the chargeability of the VAT.
First, concerning the sheer chargeability, Article 65 of the EU VAT directive210 provides that:
‘’ Where payment is to be made on account before the goods or services are supplied, VAT shall become
chargeable on receipt of the payment and on the amount received.’’
Yet, the following article of the directive211 grants an exception:
‘’Member States may provide that VAT is to become chargeable, in respect of certain transactions or
certain categories of taxable person at one of the following times: (a) no later than the time the invoice
is issued; (b) no later than the time the payment is received;’’
It appears that many Member States implemented exceptions, particularly concerning the VAT
chargeability concerning services. For instance, in France, concerning the supply of a service, the VAT
can be charged at the payment. However, it remains necessary to check in every jurisdiction the
enforceable rules.
Still and all, the rule of Article 65 of the directive212 is broadly applied when it comes to the delivery of
goods. Applied to the utility-token sale, it leads to a complex situation owing to the extended timespan
between the token-sale and the delivery of the good. Throughout this period of time, the ICO issuer will
have to track all the issued tokens, and while delivering the product, make sure that it also charges the
VAT to every investor. It means that the investors also have to consider the payment of the VAT in their
cash flow management, while the time of product delivery is seldom known in advance.
Concerning the right to deduct the input VAT, it arises “at the time the deductible tax becomes
chargeable’’213. Nevertheless, as previously explained, the chargeable event of a utility-token sale arises
at the time of product delivery, potentially several months after the ICO. Therefore, the ICO-issuer will
have to wait until this moment to deduct the input VAT on its expenses related to the ICO-related
product. Since the ICO-related products are mostly pioneer and innovative, the cost of making may be
peculiarly high, while the production time can be extended. Without the ability to steadily deduct the
input VAT during the making process, since it will be fully deducted only from the delivery, the cash
flow of ICO-issuers could be particularly hindered.
208 Vincent Renoux and Simon Bernard, “Crypto-monnaies et Initial Coin Offerings : voyage en terre inconnue” [Cryptocurrencies and Initial Coin Offerings: voyage to unchartered lands] 209 Noah Jessop, “An Investor’s Guide to The Four Kinds of ICOs”, https://hackernoon.com (November 15,2017) 210 Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax, Art 65 211 Idem, Art 66 212 Ibidem 213, Idem, Art 167
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Besides the timing issue, the VAT/GST collection is also challenged from a geographical perspective
by the underpinning decentralized aspect of ICOs.
4.1.2.2. A decentralized supply complicating the VAT/GST collection
Initial Coin Offerings totally symbolized the decentralized and borderless crypto-economy.214 The
digital economy already hindered the VAT underlying mechanisms by intensifying and facilitating the
cross-border supplies of goods and services.215 However, the existence of domestic and regional market
was still effective, restraining the establishment of a fully global market. Yet, the crypto-economy may
lead to this outcome since it is totally integrated on Blockchain’s platforms, fully unrestrained from
geographic borders.
From a VAT perspective, the Initial Coin Offering, integrated into this crypto-economy, is carried out
on a global scale, meaning a substantial part of the token transactions is cross-border.
From a European context, the MOSS scheme216 is a crucial tool to ensure the compliance of non-EU
companies supplying services towards EU-customers. For the sake of explanation, this digital-based
payment service enables those foreign suppliers to manage all their EU VAT returns by a single
registration in one Member State 217. When it comes to utility token-sales, it would highly reduce the
compliance burden of non-EU ICO-issuers who are dealing with European investors, but only when it
comes to electronically-supplied services. The delivery of ICO-related goods towards those clients will
still be treated as importation218, involving a VAT payment at the customs by the purchasers, which is a
far less appealing VAT implication. In this sense, the expansion of the MOSS to electronically-delivered
goods, recently approved by the European Commission, would also contribute to facilitate the VAT
treatment of utility-token sale, when the final product is identified as a good.
Moreover, the anonymity of ICO-investors is also a tremendous concern from an indirect tax
perspective. As a matter of fact, the traceability of token-transactions is highly threatened by the
anonymous principle underlying the Blockchain Technology.219 For the sake of clarity, an Initial Coin
Offering is carried out on a blockchain, which guarantees the anonymity of participants by granting
them an encrypted identity. Thus, the ICO-issuers may struggle to determine the identity as well as the
location of the investors. Therefore, in the current situation, the VAT compliance of the ICO-issuer
seems almost impossible.
214 AJ Agrawal, “How a decentralized economy helps society”, https://thenextweb.com (January 2018) 215 Communication from the Commission to the European Parliament, the Council and the European Economic and Social Committee on an Action Plan on VAT towards a single EU VAT area, COM(2016) 148 (April 7, 2016), 3 216 Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax, Chapter 6 217 “Mini One-Stop-Shop (MOSS SCHEME)”, https://europa.eu/youreurope/business/vat-customs/moss-scheme/index_en.htm, 218 Council Directive 2006/112/EC of 28 November 2006 on the common system of value added, Art 2 219 Toshendra Kumar Sharma, “How is Blockchain Verifiable by Public and Yet Anonymous’’
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Highlighting the shortcomings of the current VAT framework, from both substantial-ruled and
collection perspectives, justifies an overhauling of the VAT system, to ensure a level playing field.
4.2. A necessary overhaul of the VAT framework to reduce the indirect tax burden of ICO-issuers
The overhaul of the VAT system could be twofold. On the substance side, it becomes urgent to
harmonize the indirect tax treatments of financial instruments, the ICOs introducing hybrid tokens
complexing the identification of exempt token –sales. On the compliance side, the improvement of the
VAT collection for ICOs remains the main improvement work.
4.2.1. The benefits of harmonizing the indirect tax treatment of financial instruments
The enforceability of the financial services exemption depending on a complex identification of
token’s features and leading to insoluble compliance issues; it could be sound to discard this highly-
discredited exemption, to achieve tax neutrality among financial instruments.
4.2.1.1. The current VAT treatment depending upon the token’s features, an insoluble compliance issue
As above-explained, the enforceability of the financial services exemption seems to merely cover the
scope of equity-alike token sales. Surprisingly, the application of this exemption without credit for
equity- token sale, leads to a VAT burden220 for the ICO-issuers. In brief, the exemption scheme repeals
any output VAT on the token-sale for the investors, but, correlatively, the input VAT on the prior
expenses made by the ICO-issuers to carry out the ICO cannot be recovered.221 Therefore, the ICO-
issuers would be tempted to include this VAT burden in the token’s price, which will hinder the
competitiveness of this token sale on the crypto-market.
With this in mind, two major concerns crop up. Firstly, considering that equity-alike token sales may be
also subject to the constraining security law framework in many jurisdictions, this additional unfavorable
indirect tax treatment, with respect to utility-token sales, could amplify the wish of ICO-issuers to dodge
the identification of their tokens as securities. Thus, the attempts of ICO-issuers to hide the security’s
features of their tokens, in order to identify them as utility-tokens, are likely to surge if any VAT-related
case law or legislation are released. Moreover, from a compliance perspective, the divergent VAT
treatment of equity-token and utility-token sales highly hinders the VAT compliance of companies. As
220 Herman Van Kesteren, “ Deduction of input VAT” (lecture), Tilburg University, Tilburg The Netherlands, October 11, 2017 221 Ad Van Doesnum, Herman Van Kesteren and Gert-Jan Van Norden, Fundamental of EU VAT law, (The Netherlands, Kluwer Law International, July 22, 2016), 262
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previously mentioned, from an accounting perspective, the distinction between these two types of
financing operations may be complex, considering the hybrid features of many tokens222, being tailor-
made through the Smart Contract empowering the ICO.223 From a VAT perspective, the stakes are high,
considering that only the utility-token sales may entitle the ICO-issuers to recover its input VAT. On
the other hand, the identification of an equity-token sale forbids the ICO-issuer to charge output VAT,
as well as deducting its input VAT.224 Thus, the unclear distinction between equity-token and utility-
token is a high-stakes issue, considering the potential tax reassessment due to non-appropriate VAT
returns.
Considering the hybrid features of tokens, the application of the financial services’ exemption for a ring-
fenced part of them impedes the tax neutrality. In order to restore it, the exemption on financial services
should be discarded.
4.2.1.2. Discarding the exemption on financial services, a way to ensure tax neutrality
The enforceability of the financial services exemption225 for equity-alike tokens leads to a VAT burden,
namely, the non-recovery of the input VAT for the ICO-issuers. Still, from the ICO-issuer’s perspective,
equity-token sale and utility-token sale lead to the same outcome: an inflow of coins enabling the
production of an upcoming product. The diverging VAT treatment for those financing operations
appears then critical, especially since most of the tokens reveal hybrid features, being tailor-made
through the encoded provisions of the Smart Contract.226 At the end of the day, the tax neutrality is
substantially threatened.
From a wider perspective, the exemption on financial services must be questioned, the divergent VAT
treatment of token-sale being another additional argument. Already implemented in the first EU VAT
directive in 1967227, it was compatible with the 20th century economy, prior to the utter financialization
trend which reach its peak during the nineties228. As a typical illustration, the financial services were
reckoning for 2.8 percent of the US Gross Domestic Product against 8.3 percent in 2006229. Before this
era, the financial services were mostly dedicated to private individuals, the VAT exemption being
justified since it was not properly considered as an economic activity, but more like a supporting
223 “What is an Ethereum Token: The Ultimate Beginner’s Guide” 224 ibidem 225 Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax, art 135 226 “What is an Ethereum Token: The Ultimate Beginner’s Guide” 227 First Council Directive 67/227/EEC of 11 April 1967 on the harmonisation of legislation of Member States concerning turnover taxes
228 Robert Parenteau, “The Late 1990’s US Bubble: Financialization in the Extreme”, http://www.peri.umass.edu/fileadmin/pdf/financial/financhapter5.pdf (2005) 229 Robin Greenwood, David Scharfstein, ‘’ The Growth of Finance’’, Journal of Economic Perspectives – Volume 27, no 2 , http://www.people.hbs.edu, (Spring 2013), 1
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function. As of now, the financial industry is the leading economic sector, and the exemption for
financial services appears ill-justified. It mostly leads to cost-surging compliance issues and threaten the
tax neutrality since many financial services dodge the exemption by adopting hybrid features.230 As an
illustration, the utility-alike token sale, as much as the crowdfunding campaign, are unlikely to fall under
the financial services exemption, even though their ultimate purpose is to finance the commercial
activity. On the other hand, Initial Public Offering and equity-token sales, two financing operations
leading to a similar outcome, are VAT-exempt and involve a VAT burden. In a nutshell, such a divergent
VAT treatment of financial operations hinders the effectivity of the tax neutrality, while being
considered as the underlying principle of any VAT/GST system231. A mere abolition of the financial
services’ exemption would be justified in this context, enabling the restoration of a level playing field.
For the sake of complementariness, the overhaul should target not only the VAT substantial rules, but
also the collection mechanisms in order to facilitate the compliance of ICO-issuers and ensure a level
playing field
4.2.2. The need to improve a dedicated VAT collection scheme for ICOs
The improvement of VAT collection should tackle two ICO issues. To face the timing challenge, the
VAT chargeability should be arising at the time of the token-sale. On the other hand, the problem arising
from the anonymity of investors, threatening their identification and location, could be tackled by
providing dedicated Smart Contracts’ provisions.
4.2.2.1. Allowing the chargeability of VAT at the time of the token-sale to tackle cash-flow issues
As mentioned before, The EU VAT directive established that the VAT is chargeable when the goods or
the services are supplied232. Applying this main rule to the token-sale involve complex compliance issue
since the timespan between the token-sale, and the delivery of the final product might be extended.
Moreover, since the right of deduction233 is arising at the time of chargeability, the ICO-issuers has to
carry the input VAT burden for an extensive period.
Wisely, for a delineated scope of transactions, the Member States are entitled to determine another
timing of chargeability, at the time of invoicing or payment.234 In order to improve the indirect tax
treatment of ICOs, it would be pragmatic to enact in domestic legislation the right of ICO-issuers to
230 Gregory Simon, ‘’The Impending Risks of ICO Accounting: Has avoiding treating Initial Coin Offerings as Equity created a massive liability bubble for issuers?’’ 231 OECD International VAT/GST Guidelines on Neutrality, Committee on Fiscal Affairs, OECD, https://www.oecd.org (June 28, 2011), 7 232 Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax, Art 65 233 Idem, Art 167 234 Idem, Art 66
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charge VAT at the time of the token-sale, namely, the payment of the token-related products. Owing to
this overhaul, the ICO-issuer will see their VAT-burden reduced by two factors:
- They can directly include the output VAT in the price of the token, which would avoid upward
tracking of the investors and tokens.
- They are entitled to directly deduct the input VAT which may have already arisen from the
production of the final product
Through this improvement of the VAT chargeability framework, the compliance issues of ICO will be
effectively reduced, facilitating the development of this financing instrument.
The timespan challenge being solved by designating the token-sale as the chargeable event, the
remaining issue with ICO remain the anonymity of investors, which could be tackled by tailored Smart
Contract’s provisions allowing the identification and location of them.
4.2.2.2. The use of the ICO-related Smart Contracts to allow location and identification of investors
The Blockchain laying principle of anonymity235 may constitute the most preeminent obstacle to VAT-
compliance. Since the ICOs operations are empowered by this technology, the ICO-issuers are unlikely
to know the location and the identity of the investors. It leads to two major concerns:
- Since the investors are identified through a Blockchain-dedicated public address236, it is
complicated for them to report the VAT paid upon a token as deductible. It seems unlikely that
they can report the input VAT upon a token-sale as deductible since it has been carried out under
an encrypted identity.
- By application of the destination principle237, the place of the customer is generally the
enforceable VAT jurisdiction. To illustrate, a utility-token sale related to the supply of service
will be VAT-taxed under the legal framework of the investor’s jurisdiction. Yet, owing to the
anonymity principle238, the location of the investors cannot be determined. In this context, the
identification of the enforceable VAT framework is jeopardized.
Nevertheless, this restrictions about the identifications and the locations of the investors could be
circumvented by implanting special provisions inside the Smart Contract signed between the ICO-
issuers and the investors. In other words, the drafting of the Smart Contract being entirely dependent on
the will of the ICO-issuers239, it can perfectly stipulate a right to localize the investors, which would
235 Toshendra Kumar Sharma, “How is Blockchain Verifiable by Public and Yet Anonymous’’ 236 ibidem 237 Communication from the Commission to the European Parliament, the Council and the European Economic and Social Committee on an Action Plan on VAT towards a single EU VAT area, COM(2016) 148 (April 7, 2016), 7 238 Toshendra Kumar Sharma, “How is Blockchain Verifiable by Public and Yet Anonymous’’ 239 Gerald Nash, ‘’Build Your First Smart Contract’’
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facilitate the tax compliance of the ICO-issuers. The possibility to identify the investors remain more
litigious since it would go against the underpinning spirit of the Blockchain. However, since it is
beneficial for the investors, enabling them to deduct the VAT paid on the tokens, it seems sound to
consider this option. Anyhow, regulating the content of Smart Contracts, even for the sake of tax
compliance, remain a litigious issue. To a certain extent, the domestic legislatures will need to determine
the legal status of Smart Contracts before implanting a tax-related control of their provisions.
4.3. Conclusion- Chapter 4
The VAT treatment of Initial Coin Offerings is heavily dependent upon the features of the token. In case
of utility-token sale, the characterization of a taxable event is more likely. By applying the Main Supply
doctrine240 deriving from the ECJ case Card Protection plan241, the transaction should be identified as a
supply of goods or services for consideration. Even though the ECJ case Hedquist242 has entitled the
jurisdiction to grant the exemption for financial services to cash-to-coins trades, it is unlikely that this
outcome could be transposed to utility-token sales which has a thorough different nature, being a trade
of goods/services against coins. It leads us to a VAT duty for every ICO-issuers carried out a utility-
token sale. On the other hand, the VAT treatment of security-like token totally appears distinguishable.
In accordance with Card Protection plan, the granting of capital rights, namely, securities against coins
should be identified as the main supply. In this context, even though a taxable event can still be
identified, the exemption on financial services scheme243 seems to be applicable, as it covers any
security-involved trades. As a consequence of such an exemption, no output VAT could be levied on
the security-token sale. On the flipside, the ICO-issuer would not be entitled to deduct any input VAT,
leading to an indirect tax burden. Generally speaking, it would lead to a logical distinction between
taxed utility-token sales and exempt security-token sales. With this in mind, the ICO-issuers have to be
particularly cautious regarding the features of their token, the identification of them as utility-alike or
security-alike leading to opposed VAT regimes. Considering the hybrid features of many tokens, this
divergent VAT treatment could lead to insoluble compliance issues and a threat to the legal security of
ICO-issuers. This discriminatory treatment of security-alike tokens, involving a VAT burden, could be
another argument to justify the discard of the financial services exemption. On the grounds of
comparison, the purposes of utility-like and security-alike token sales are altogether similar: financing
a company. Thus, applying a different VAT treatment may hinder the tax neutrality244 in the field of
240 Gert-Jan Van Norden, “ Scope of VAT – Taxable Transactions” (lecture), Tilburg University, Tilburg The Netherlands,
September 13, 2017 241 CJEU 25 February 1999, Card Protection Plan (1999) 242 CJEU 22 October 2015, Hedqvist 243 Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax, Art 135 244 OECD International VAT/GST Guidelines on Neutrality, Committee on Fiscal Affairs, OECD, https://www.oecd.org (June 28, 2011), 3
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ICO. Considering the evolution of finance operations, from support-activities to core business, repealing
the financial services exemption would be justified in many senses. In the field of ICOs, it would both
facilitate the VAT compliance, enhance the legal certainty and reinforce the tax neutrality.
From a compliance perspective, the ICOs are also raising high-stake concerns. First, an extended time
span can occur between the token sale, identified as the taxable event245, and the chargeable event246,
the delivery of the token-related product. It involved a need to cautiously design an audit trail, in order
to efficiently trace the different token transactions through the lens of time. Furthermore, since the
deduction of input VAT only occurs at the time of output VAT chargeability, the ICO-issuers will have
to keep eagle-eyed attention on their cash flow management. For the sake of simplicity, it could be
relevant to introduce an alternative VAT scheme allowing ICO-issuers to straightaway charge the output
VAT to the investors during the token-sale. Thus, the ICO-issuers would be entitled to deduct the input
VAT paid at this stage directly. The onward input VAT paid for the making process of the product would
be steadily deducted afterward.
Finally, the anonymity of the Blockchain technology247 threatens the location and the identification of
investors by the ICO-issuers. In this context, identifying a place of supply as much as ensuring a reliable
audit trail for invoicing purposes looks particularly complex. With respect to this manner, the Smart
Contract signed by ICO-issuers and investors could be regulated, involving the integration of provisions
allowing a location of the investors at least, their identifications at best. Yet, since such regulation of
ICO-based Smart Contracts would contradict the underpinning spirit of the Blockchain technology,
being anonymous and peer-to-peer, it may be unlikely to see those burden-easing solutions
implemented.
245 Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax, Art 14 246 idem, Art 65 247 Toshendra Kumar Sharma, “How is Blockchain Verifiable by Public and Yet Anonymous’’
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5. General conclusion
The Initial Coin Offering may be considered the most cutting-edge financing instrument of the past
decade.248 Nevertheless, it is opening a Pandora’s Box in the fields of accounting and tax, leading to
unchartered territories. The underlying risk is a wide disconnection between the economic reality and
the onward accounting and tax treatment.
In the sheer realm of accounting, the lack of bespoke standards for ICOs is tangible. The current
framework appearing incompatible with these innovating operations, the ICO-issuers facing tremendous
difficulties in determining the appropriate accounting treatment for pre-mining operations, token-sales
and onward related transactions. In most respect, it leads to violation of the true and fair view principle,
the financial statements failing to represent the economic situation of the ICO-issuers. To restore this
laying foundation of accounting standards, a potential overhaul could be carried out, in order to adjust
the existing framework with ICO-fitted rules, embracing the particular features of cryptocurrencies.
This search of economic substance finds its counterpart in the field of direct tax as well. ICOs being
decentralized operations, they are often carried out through the establishment of an ICO-dedicated
subsidiary located in a low-taxed jurisdiction. Even though the business-driven parent will be the source
of value creation, its jurisdiction of incorporation will not be entitled to tax any proceed deriving from
the token-sale. The correlative explanation is twofold. First, the exemption method249 repeals any taxing
right of the parent’s state on the incomes attributable to an ICO-dedicated subsidiary. Second, the CFC
rules250, allowing parent’s jurisdiction to tax passive incomes located in low-tax jurisdictions, did not
include cryptocurrencies in the qualifying assets. Thus, in order to tackle the ICO-based tax planning, a
double-layer mechanism should be introduced. To put in simple term, tax credit systems should prevail
upon exemption methods in case of ICO-related proceeds. In a complementary way, CFC rules should
extend their scope to integrate any cryptocurrencies as potential qualifying assets. By restraining the
opportunity of ICO-based tax planning, the reconnection between taxing rights and creation of value,
which occurred in the operating vehicle’s jurisdiction is ensured. From a domestic perspective, the all-
at-once tax levy, at the time of realization, require a huge coins-to-cash conversion for many ICO-
issuers, involving instability risk. To tackle this concern, an alternative payment scheme could be
introduced to spread the tax duty from the token-sale to the delivery of the final products. Finally, in an
accounting-alike manner, a tailored tax classification of cryptocurrencies, distinguishing the ones use
248 ‘’ICO The Beginning of a New Revolution’’ ICODaddy, https://medium.com/@icodaddy.io/icos-the-beginning-of-a-new-revolution-15152425bcdb (May 22, 2018) 249 Model Tax Convention on Income and on Capital, OECD, Article 23a: “Exemption Method’’ 250 Council Directive (EU) 2016/1164 laying down rules against tax avoidance practices that directly affect the functioning of the internal market [2016], preamble (12)
57
for business purposes from the ones held for trading, would introduce a clear and fair tax treatment of
those digital currencies.
Last but not least, the VAT framework is strikingly troubled by the rise of Initial Coin Offerings. First
and foremost, depending on the nature of the token released, either utility-alike or security-alike, the
VAT treatment of token sale will widely differ. The second category likely to be VAT-exempted251, it
may suffer from an indirect tax burden, which should not be the case for the utility-alike tokens. This
threat to tax neutrality252, applied to two purpose-alike financing operations, may bring a decisive
argument to discard the ill-justified exemption for financial services. From a compliance perspective,
the ICOs are also bringing tremendous issues to the table. Considering the extended timespan between
the taxable event and the chargeable event, the ICO-issuers suffer from highly-delayed VAT
deductibility. Allowing a deduction of the input VAT from the time of the token-sale would solve this
issue. Finally, the Blockchain-features anonymity challenges the audit trail and the place of supply’s
identification. With this respect, implementing tailored provisions to allow location and identification
of the investors within the Smart Contract would highly ease the VAT compliance burden, though it is
widely contradictory to the Blockchain-principle of anonymity.
251 Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax, Art 135 252 OECD International VAT/GST Guidelines on Neutrality, Committee on Fiscal Affairs, OECD, https://www.oecd.org
(June 28, 2011),7
58
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