International Tax Panorama

I. Introduction

Switzerland has become a major hub for initial coin offerings (ICOs) and token-generating events (TGEs) with various large-scale Initial Coin Offerings or ICOs have recently been conducted in or from Switzerland.The attractiveness of Switzerland for ICOs both for investors and issuers can be traced from its favourable Swiss tax laws. According to the ICO Alert website, there are over 40 ICO offerings worldwide as at the end of December 2017. During 2017, Swiss-based ICOs raised about $550 million in funding, which was about 14 percent of the global ICO market, worth around $4 billion.

II. ICOs and tax treatment issues in Switzerland:

What are ICOs?

ICOs are a new instrument of raising capital for the financing of commercial projects, which includes an issuance of (diverse) legal claims by digital means. They issue the so-called crypto tokens (frequently also referred to as Token Generating Event or TGE).

Identifying the contentious areas:

• Qualification issues with tokens: In an ICO the issuer can freely decide upon the design of the specific crypto tokens, i.e. the rights or claims he undertakes to grant to the investors through the tokens. Variations in design can increase the complexity of legal qualification of tokens for tax purposes as in principle cryptocurrencies are neither money nor a foreign currency, nor a financial supply for goods and services tax (GST) purposes.
• Formation of tax avoidance ICO structures: The implementation of an ICO does not require a particular type of company or actual business operation. In a Swiss TGE where the issuer, usually a start-up company, is looking for project funding does not have its headquarters in Switzerland, it will usually rely on a foundation structure or a special purpose vehicle in a corporate structure as an intermediary platform for managing the funds received from the investors and for allocating the tokens customary to an ICO.
• Such form of ICO structures as foundations will be qualified for non-profit tax status and the money raised in these ICOs are treated as a donation that may not be returned to ICO investors, as explained by Dr. Luka Muller, legal partner of Swiss law firm MME, which helped set up the Tezos foundation as well as some other big ICOs. In the Zug-based Tezos, the ICO alone raised $232 million in July 2017. But due to controversy surrounding its set-up structure the Tezos foundation is facing at least half a dozen class-action lawsuits in the US for being misleading and fraud full. This also led to the IRS-CI assigning a special team of agents to investigate whether cryptocurrencies are being used to cheat the tax authority.1
• Non-regulation by the supervisory authorities: Also the providers describe their project intentions and the functioning of the offered tokens in a so-called white paper (occasionally they also publish contract terms and conditions). In contrast to the prospectuses of a share issue, the contents of the white paper are neither prescribed by law nor checked for completeness by a supervisory authority. The generated tokens are usually sold to interested investors in an unregulated public bidding process (token sale). Thus there is a risk of sham transactions which need to be curtailed via regulation.

Thus tax and regulatory considerations remain vital for both ICO issuers and investors. But till now there has been little clarity about the resulting tax implications. The following sections focuses on the regulatory and tax considerations and guidelines for an ICO issuer.

1. Assessing the Regulatory requirements: FINMA’s Guidelines

As outlined above the non-regulation of ICO was one of the main problems that was identified by the Swiss watchdog Financial Market Supervisory Authority (FINMA) in 2017. FINMA first said it was investigating initial coin offerings to determine whether they were following banking and securities laws in September 2017. According to FINMA there has been a sharp rise in the number of ICOs launching in Switzerland, resulting an increase in inquiries about the regulations that apply to them and whether they have been breached. Thus FINMA released Guidelines to create a form of transparency and regulatory treatment in the ICO space.2

The key highlights of the guidelines are as follows:

• Treatment of some tokens sold during initial coin offerings as securities. By regarding asset tokens as securities, securities law requirements for trading in such tokens, as well as civil law requirements under the Swiss Code of Obligations will need to be complied with. Thus there could also be subject to Anti-Money laundering (“AML”) regulation.
• When assessing ICOs, FINMA will focus on the “economic function and purpose of the tokens,” with the “underlying purpose of the tokens and whether they are already tradeable or transferable” being primary factors in how they will be classified. The focus appears to be on liquidity and true value of the ICO.
• The agency outlined three categories of tokens which are the following:
  Payment ICOs (tokens that can be used for payment, or otherwise transferred). In this instance FINMA require compliance with the AML regulations;
  Utility ICOs (tokens not qualifying as securities, only existing to confer digital access rights to an application or service). If developed or seen to be used as a ‘Payment ICO’, the aforementioned will apply; and
  Asset ICOs (tokens acting clearly as securities). This type of token will strictly be required to adhere to securities regulation and extend as far as civil law requirements in trading: the ‘Swiss Law of Obligations’.

• There will be a formal process to get an ICO off the ground in the alpine country. Minimum requirements must be met, and a fee is charged for each FINMA assessment. This fee is significant and based on the complexity of the token structure: starting from just over over $10,500 USD to $16,000 USD. This may cut out some of the scam tokens which appear to simply chunks of other white papers, even promotional videos, then garner support via social media and suckers.

Notably, FINMA will determine the applicability of regulation to crypto tokens on a case-by-case basis, taking a similar stance to that of the U.S. Securities and Exchange Commission in guidance released last July.

2. Assessing the Tax treatment for the Issuer:

Apar from the regulatory risks tax risks for the issuer may arise in particular if the issuer is a taxpayer. The issuer can be taxpayer with regard to income tax, issuance stamp duty, withholding tax and value added tax.

Income tax treatment:

The ongoing taxation of the ICO issuer depends on its tax status; generally, a stock company pays corporate income tax at a rate of between 12% and 23%, depending on the domicile. Some ICO issuers have been structured via foundation or associations which might affect its tax status.
Also as the ICO entity must invest the funds in its own business (eg, use for an R&D activity), it may record the funds received as a provision in the same amount. Therefore, the collection of the funds will not trigger corporate income tax at the level of the ICO entity.

In a second phase, the entity will offset its future development costs against existing provisions. Therefore, if the development of the product is cheaper than expected (ie, less than the funds raised), the remaining provisions will be reversed. Such a reversal will trigger corporate income tax. The applicable tax rate depends on the canton of residence. By contrast, if the development costs exceed the funds received, such an amount will be treated as a loss for tax purposes which can be carried forward up to seven years.

If the development succeeds and the ICO entity remains profitable, the token holder will receive a certain share of its earnings. If the token holder receives payments under the tokens, such payments will constitute deductible business expenses for the ICO entity.

Withholding tax treatment

The payment of interest on bonds that qualify as collective financing schemes (Article 4(1)(a) of the VStG) and dividends on shares (Article 4(1)(b) of the VStG) are subject to withholding tax. The corporation has to withhold the tax at a rate of 35% from the gross amount at the time of payment and to transmit to the Federal Tax Administration.

Such withholding tax on dividends and interest on bonds, raises the question of whether the payments by the ICO entity to the token holders fall under one of these categories.
The term ‘dividend’ is understood in a formal manner, pursuant to which only a payment based on a corporate right (eg, a share) may qualify as a dividend. A token is not considered a corporate right for withholding tax purposes.

For a bond, it is mandatory that a domestic tax payer issues notes containing a repayment obligation. But for most ICOs or TGEs, no such repayment obligation exists which might not qualify as bond.
It seems likely that the authorities will consider payments based on profit participation tokens which were issued during an ICO or TGE as neither dividends nor interest. Thus there is greater scope of ambiguity in classification aspect.

Stamp duty

The issuance of shares by corporations and contributions to capital reserve by shareholders are subject to issuance stamp duty at a rate of 1% (Article 5(1)(a) and (2)(a) of the StG). The corporation has to pay the issuance stamp duty of 1% on the issuance amount of the shares or the contributed amount respectively to the Federal Tax Administration.

Securities transfer tax

Transacting in tokens that qualify as securities may give rise to securities transfer tax duties for domestic instruments at a rate of 0.15 percent (or 0.30 percent for non-domestic instruments) in cases where a Swiss securities dealer was involved in the transaction.

VAT

The delivery of goods and the provision of services against consideration may be subject to value added tax, if place of delivery (Article 1(2)(a) of the MWSTG) or seat or domicile respectively of the recipient is in Switzerland (Article 1(2)(a) and Article 8(1) of the MWSTG). The issuer must transmit the value added tax of 7.7% on the consideration to the Federal Tax Administration. At the time of invoicing, the issuer may contractually charge the value added tax to the recipient (Article 6 of the MWSTG).

A VAT liability can only be assumed if the token is valid with regard to the purchase of the service or if delivery was offered and purchased. On the other hand, from a VAT perspective, the issuance

of (profit participation) tokens is an exempt transaction (financial service) according to Swiss tax law. So there is a possibility that no VAT could be due on payments by the ICO entity to the token holders.3

Capital gains tax

Cryptocurrencies are an asset for capital gains tax (CGT) purposes, which only applies to someone who qualifies as a professional trader. Holders or investors of cryptocurrencies are subject to a wealth tax at the rate determined by the tax authorities on December 31 of the fiscal year

Capital duty

Since it is not uncommon that the ICO issuer is a stock company, the issuance of an equity token, i.e. the creation and increase of the nominal value of equity securities (i.e. shares, common shares, and participation certificates) as well as other capital contributions of the shareholders, may be subject to one-time capital duty of 1% (there is a tax exempt amount of CHF 1 million). The issuance of a debt token, i.e. a payment/repayment obligation on the other hand, is not subject to one-time capital duty.

Source taxation and social security contributions

In the context of granting Tokens to employees, a risk may also arise with regard to source taxation (Article 83 et seq. of the DBG) and social security contributions on the employment income. The grant of Tokens has to be analysed from the point of view of employee participations (Article 17a et seq. of the DBG).

Swiss IFA 2018: Analysis of key proposals for tax treatment

On 8 February 2018, representatives of Swiss tax administrations presented for the first time considerations on the tax treatment of Initial Token Offerings (ITO).The considerations were incorporated in the form of a Memorandum by Dr. Marcel R. Jung4 to explain and to analyse these considerations within a refined overall framework and to point out tax risks in particular from the point of view of the issuer.

In brief the following steps must be followed to untangle the tax treatment complexities associated in an ICO:

1. First Step: A legal analysis of the legal relationship between the issuer and the investor and the Token holder respectively. The legal relationship can be structured in different ways. The issuer may commit to the investors to pay a particular amount, to deliver a particular good or to provide a particular service.
2. Second Step: A legal qualification of Tokens generated by the issuer. At the level of the issuer, the legal relationship may trigger at the beginning a booking entry in an asset account, in a debt account, in an equity account, in an expense account and /or in a revenue account.Tokens have to be classified for tax purposes at the time ITO as tax risks for the issuer may arise during that time.

According to the Token Framework established by Kogens / Luchsinger Gähwiler, Tokens may be qualified within three categories

• Tokens with financial claims to Debt Token: The issuer commits to the Token holder to repay the paid amount and, if applicable, interest.Equity Token: The issuer does not commit to the Token holder to repay the paid amount. The Token holder has a right to participate to a proportion of the annual profit and/or the liquidation proceeds.Participation Rights Token: The issuer does not commit to the Token holder to repay the paid amount. The Token holder has a right to participate to a proportion of a particular success measure of the issuer (e.g. EBIT, licence revenue).

• Utility Token: Tokens for other purposes.

3. Third Step: Tax Compliance by the Issuer:
The issuer must know the tax law obligations related to the ITO and must fulfil these obligations in accordance with the tax law. The issuer must know whether the financial proceeds from the ITO have to be accounted as revenue, the generation of the Tokens is subject to issuance stamp duty, the payments to the Token holders are subject to withholding tax and delivery of goods and the provision of services are subject to valued added tax. The issuer must also know whether the Tokens granted to the employees are subject to source taxation and social security contributions. Tax rulings should be reviewed on a regular basis by the issuer and, if appropriate, supplemented and amended, if the tax ruling does not answer all legally relevant questions and, thus, is incomplete and/or tax risks were not identified or the tax practice has developed more advantageous than ruled in the tax ruling.

Conclusion and outlook

As stated Switzerland has emerged as a prospective global hub for virtual currencies which had both pros and cons.Apart from the investment boom the ITO and Tokens demonstrate the tax challenges of the digital economy for the tax practice and the legislator.
The tax and regulatory difficulty pertains to the different tax consequences that have to be taken into account depending on the specific token design. In terms of regulatory issues the FINMA provides for the control of the regulatory risks associated with ICO tokens, which is in mutual benefit for the wider cryptocurrency trading community.

In addition, the tax risks associated with the issuer must not be overlooked which can surpass multiple levy stages at both domestic and cross-border levels. The proposals from the Swiss IFA can be a good starting point for both tax authorities and issues to avoid any tax treatment issues. Also the issuer must always be aware of the Swiss tax consequences of token transactions as well as the corresponding rights and obligations, with proper appraisal via definitive and certain tax rulings.6

https://blog.froriep.com/hubfs/CONTENT/DOWNLOADS/DOCUMENTS/Tax/Marcel-R.-%20Jung-

ITOs-im-Schweizer-Steuerrecht%2021022018_en.pdf?hsCtaTracking=cd3be0f3-2db7-4df4- b06d-8d4d36030ace%7C7187e41a-1720-491c-bbcf-009c97660ee7

6http://www.mondaq.com/x/659078/tax+authorities/

Taxation+of+Initial+Coin+Offerings+in+Switzerland