New Swiss VAT practice for Governance Tokens

What is a Governance Token?

Governance tokens give their holders a voting right to influence the decision making of a DAO or another decentralised platform. Often such tokens do not offer much additional utility other than voting rights, at least in an early phase of a project.

How did the VAT qualification change?

In the past, such governance tokens were  typically qualified as utility tokens, since this was the closest of the existing token categories. As consequence, the sale of such tokens to Swiss recipients was subject to Swiss VAT. In return, the Swiss seller was able to fully recover its input VAT in connection with the token sale. The latter was very important for Swiss-based projects, which often incur large input VAT on their development costs.

As published earlier, the tax authorities have started to change this practice and revoking existing tax rulings that had qualified governance tokens as taxable utility tokens. After a period of uncertainty it seems that some criteria have evolved by now, which can be summarised as follows:

New VAT practice regarding Governance Tokens

According to the newly emerged, unofficial practice, Governance Tokens can broadly be categories into:

  • True Governance Tokens
  • Pseudo Governance Tokens

Note that those terms are not official names given by the tax authorities.

True Governance Tokens are tokens that give its owners ultimate control over a decentralised autonomous organisation (DAO).  Typically these are smart contracts through which users can vote on any update of the DAO and the related blockchain or DApp. Once the predefined quorum is achieved, no central authority can stop the update from happening. Governance rights can include functionality updates but also the use of platform revenues or the spending of a DAO treasury. In addition tax authorities request that the DAO is “sufficiently decentralised”. This term is not yet fully clear, but it seems like the founding team of the project should not control more than 50% of the tokens which can be used for voting and the founder team should not have a “backdoor key” to override the decisions made by the token holders.

If a token is a true governance token it is exempt from VAT just like a traditional financial instrument (“share in a DAO”). Consequently the sale of such a token does not trigger VAT. In exchange any costs related to the sale of such token do not qualify for input VAT recovery.

A Pseudo Governance Token is any token which does not qualify as a true governance token. This could include a governance token of a DAO which is not (yet) sufficiently decentralised. But it would also include any token where the token holder merely has a consultative voice, or where the decision of the token holders would have to be executed by a board of a foundation or association.

For all those pseudo governance tokens, the governance functionality is merely an auxiliary function but does not determine the qualification of the token. The token will therefore be qualified based on its residual functionality (e.g. payment, utility or asset token). If it has no residual function it will be treated as a non-relevant revenue (similar to a payment token).

It is also possible that a token starts out as as pseudo governance token and develops into a true governance token over time. For the VAT consequences it is relevant what the token is at the time it is being sold.

What is the impact of the new practice?

On a positive note, Swiss issuers of governance tokens do not need to worry anymore about VAT on tokens sold to Swiss investors or granted to Swiss employees or contributors. On the other hand, a Swiss issuer who’s sole revenue comes from the sale of governance tokens would be denied to register for VAT and would not be able reclaim its input VAT. This could lead to a significant VAT hit. To make a numerical example: If a Swiss association sells governance tokens for CHF 10m and spends the same amount on invoices from the developers abroad, those invoices would be subject to CHF 770’000 reverse-charge VAT which could not be reclaimed anymore.

Going forward the following three measures might help to mitigate the adverse VAT treatment:

  • Include additional functionality into the token mechanics to make it clearly a utility token;
  • Add additional revenue streams to the Swiss entity which entitles the entity to reclaim input VAT outside of the token sale;
  • In certain situations it might make sense to merge or group existing Swiss entities into one to improve VAT recovery. Historically issuers have often separated the token sale and the operating activities in distinct entities. Such a separation might not be beneficial anymore in the future.

If you have issued or are planning to issue a governance token with limited or no additional utility please reach out to discuss how your business can best react to the changed practice.