Cryptocurrencies and VAT

With the rise of Cryptocurrencies, the Swiss Federal Tax Administration is taking a stance on the VAT consequences. With the technology developing faster than the authorities can manage, being compliant has never been more challenging. Authors: Kaisa Miller, Gerd Jäger

Cryptocurrencies have many different features. They are decentralized digital currencies, operated via a peer-to-peer network, without oversight of a central authority or a bank. They can be used as a means of payment, or as a digital asset, which is owned and transferred between parties in the network. The world of cryptocurrencies is rapidly changing and evolving as technologies develop and continue to fuel new ideas. The Swiss Federal Tax Administration (SFTA) has issued a first draft of official guidelines on the VAT treatment of cryptocurrencies, attempting to qualify something that in its nature does not easily fit into existing VAT definitions and structures.

CCTV security guard in the mall building.

Cryptocurrency as a means of payment
Similarly to conclusions made by authorities in other countries, the SFTA suggests that cryptocurrencies can be treated as an equivalent to legal tender from a Swiss VAT perspective, provided that the parties have agreed to use the cryptocurrency as a contractual means of payment and it serves no other purpose than this use. This means that the cryptocurrency would essentially be considered comparable to any other kind of legal tender.

For cryptocurrencies that are viewed as equivalent to legal tender, the exchange transaction itself, meaning the exchange of traditional currency into cryptocurrency and vice versa, is viewed as an exchange of means of payment for VAT purposes. Any commissions or fees charged in connection with this type of exchange or purchase are thus viewed as fees for “financial services”, which are VAT exempt without credit.

Settling transactions in cryptocurrencies comes with its unique challenges, some of which the SFTA has also addressed. One of these challenges is the fact that a crypto payment has to be converted into Swiss Francs for VAT reporting purposes – as the VAT reporting currency in Switzerland is CHF, it stands to reason that any remuneration charged or paid in a cryptocurrency has to be converted into CHF in order to determine the tax base and the output VAT amount due, a as well as the corresponding input VAT. An invoice issued in a cryptocurrency would also have to state the tax base and the VAT amount due in a recognized currency, which however does not have to be CHF – the final conversion to CHF is technically only required once the VAT is due to be declared in the VAT return. The SFTA publishes daily exchange rates for some cryptocurrencies, but generally refers to the relevant exchange portals that apply to the specific currency.

It’s important to keep in mind that when it comes to transfers or brokerage of other types of coins/tokens, which due to their nature do not qualify as a means of payment from a VAT perspective (e.g. utility tokens or asset-backed tokens), this type of transaction can be subject to VAT, depending on the functionality of the underlying coin or token. One of the fundamental principles of VAT is that the VAT treatment of any transaction is determined based on the nature of what is being provided, irrespective of how it is labeled. Labeling a coin or token as a “currency” therefore, does not automatically trigger the VAT treatment applicable to an exchange of means of payment. It is thus crucial to understand what the underlying coin or token really represents in order to determine how it should be treated from a VAT perspective.

Wallets / exchange platforms
Cryptocurrencies are stored in so-called wallets (electronic purses). In its draft guidelines, the SFTA suggests that the storage/custody services should be viewed as taxable services from a Swiss VAT perspective, which is in alignment with how custody services in traditional banking are generally viewed.

A variety of other services are provided in connection with cryptocurrency transactions, such as the technical solutions behind exchange platforms. From a VAT perspective, many of these services can also be subject to VAT – an assessment is typically required to be undertaken of each individual service.

Mining
One of the most complicated activities to understand for the uninitiated is probably mining of cryptocurrencies. Mining effectively creates new cryptocurrency units, as miners are awarded new cryptocurrency units for successfully solving complex mathematical problems that allow for the addition of an additional “block” to the distributed ledger.

From a VAT perspective, the SFTA has presented its view that mining activities should not constitute a supply for VAT purposes, for the reason that no service recipient can be clearly identified or determined. This is an interesting point, as one of the principles of VAT is indeed that VAT can only be due when there is a supply relationship, meaning that a defined good or service is provided by a supplier to an acquirer, in exchange for a remuneration of some kind. In the case of block rewards being awarded for mining activities, it can indeed be argued that the network as a whole benefits, but that no specific beneficiary can be identified, for which reason mining simply falls outside the scope of VAT. Coincidentally, this view appears to be commonly shared by other European tax authorities.

The SFTA addresses the VAT treatment of mining pools separately. In the event of pooled mining, a group of miners join up in a pool (widely used by individual miners) and agree to share block rewards in proportion to their contributed mining hash power. In return for being able to participate in a pool, the miners typically pay a fee to the mining pool’s owner.

The SFTA states that VAT relevant services are provided between the individual miner and the mining-pool in this event. The exact meaning of this statement is somewhat unclear, but the SFTA appears to be suggesting that miners who join a pool, are considered to be providing their mining services to the mining pool’s owner or to the pool as a whole. Since this suggests that the “recipient” of the supply can in fact be identified, a supply is considered to take place, and thus, VAT can be triggered. It is however also possible that the SFTA is merely referring to the fees charged by the mining pool’s owner to the individual miners.

The SFTA also touches upon transaction fees, which miners receive from users acquiring cryptocurrencies. As the transaction fees are paid to miners in exchange for the creation of new cryptocurrency, it is considered to constitute payment for a VAT exempt supply.

ICO / ITO
An Initial Coin Offering (“ICO”) or an Initial Token Offering (“ITO”) is essentially a form of crowdsourcing. The coins or tokens provided in the course of an ICO or ITO can differ from a functional, technical as well as legal perspective, as can the VAT implications;

— If an investor in an ICO / ITO receives payment tokens, the SFTA considers that an exchange of legal tender takes place, since payment tokens are intended to be used as means of payment. The provision of the payment tokens themselves, should thus not be viewed as a supply from a VAT perspective.
— Utility tokens on the other hand, typically represent a right to acquire a specific application or service. The SFTA is of the opinion that the Swiss VAT treatment would follow the general rule of taxable services.
— Asset-backed tokens (sometimes referred to as security tokens) represent an actual underlying asset such as a debt or equity claim on the issuer. Asset-backed tokens can represent a share in future company earnings or future capital flows. In terms of their economic function, these tokens are analogous to equities, bonds or derivatives. The SFTA has proposed that from a VAT perspective, the issuance of these types of tokens is to be viewed as a VAT exempt supply of a financial instrument.

Summary
The first draft of the SFTA guidelines provide a good indication of how the SFTA views the various transactions that are relevant in the world of cryptocurrencies. From a VAT perspective, the amount and complexity of potential transactions, coupled with the existence of a mix of classically taxable activities in the technology field as well as activities that qualify as VAT exempt financial services, makes this an intriguing and almost overwhelmingly complex topic – both with respect to assessing the correct VAT treatment of revenues, as well as in determining the deductible portion of input VAT. It is undeniably a field where tax authorities and tax advisors alike are challenged to come up with answers to questions that could never have been anticipated by the legislators of tax laws and regulations. While we at EY hold our breath for the SFTA’s final guidelines, we are equally excited to see what happens next in the market.