The Swiss VAT authorities have issued limited guidance on the taxation of cryptocurrencies in Section 2.7.3 of VAT-Information No. 4. Unfortunately, the information is not available in English. This is why I have prepared an English translation.
Blockchains are continuously expandable, unchangeable, digital registers or databases, which consist of digital transaction blocks strung together and serve the administration of transactions or data of any kind. The blockchain is stored decentrally via a network, i.e. it is managed as a distributed register (also called distributed ledger). The network of a blockchain consists of various network nodes, which serve as connection points for data transfer. Network nodes are computer systems that are connected to a blockchain using software. All participating network nodes store a copy of the blockchain or parts thereof. Network nodes are basically used to receive and send transaction data as well as to validate them by means of a consensus procedure (Section 18.104.22.168).
The blockchain technology uses asymmetric encryption procedures, which consist of a public and a private key (so-called public and private keys) for each user. To manage this public and private key pair, wallets are used on various media (e.g. online, desktop, smartphone, paper or hardware wallets; Section 22.214.171.124). The public key enables each user to encrypt data for the owner of the private key, to verify his digital signatures or to authenticate him. The private key enables its owner to decrypt data encrypted with the public key, to generate digital signatures or to authenticate himself.
New transactions on the blockchain are grouped together in so-called transaction blocks, verified by the network nodes and appended to the existing blockchain. The updated blockchain is then stored on all network nodes. To save peer-to-peer transactions on the blockchain or to create and validate new blocks, cryptocoins/token are used.
1.2 Qualification of Tokens
Cryptocoins/token are value units that are generated decentrally on a blockchain using a predetermined mathematical procedure within a computer network. Cryptocoins/token can be provided with any functions. There are three main types of cryptocoins/token:
- Payment coins/token: Cryptocoins and tokens that are designed as pure payment tokens serve no other purpose than that of being used as a means of payment for the purchase of goods and/or services from one or more service providers. Payment coins/token therefore do not entitle the customer to receive certain or determinable services, but only represent the agreed means of payment.
- Utility Coins/token: If cryptocoins/token entitle the user to receive certain or determinable services and/or grant a right of access to a platform, an application or similar (licence or licence-like right), these are so-called utility tokens.
- Investment coins/token (so-called asset [backed] coins/token): For example, if cryptocoins/token entitle the holder to a share of the profits, sales, revenue, a certain part of the profits or sales, derivative rights or similar, they are called investment coins or token. Investment coins or tokens are always based on a contractual legal relationship and therefore do not constitute a participation relationship under company law and do not entitle the holder to repayment of the amount originally paid in.
Cryptocoins/token can also be a combination of the above-mentioned types (so-called hybrid cryptocoins/token) in the sense of a combination of services (Art. 19(2) VAT Act and Section 4.2.1):
- Investment coins/token with additional utility function
In this hybrid form, it is assumed that the investment function is the main value, which is why such a cryptocoin/token is to be treated as an investment coin/token for VAT purposes after the predominant service.
- Investment or usage coin/token with additional payment function
In the case of a combination of several independent supplies, a combination of supplies within the meaning of Article 19(2) VAT Act may be considered. However, the possibility of using a utility or investment coin/token as a means of payment does not constitute a combination of several services for VAT purposes. Such a cryptocoin/token is therefore to be qualified as a utility or investment coin/token.
Although FINMA terminology is used for the purposes of VAT, it may be qualified differently for VAT purposes. Any qualification of cryptocoins/token by FINMA is not binding for VAT purposes.
1.3 Smart Contracts
Smart Contracts are agreements based on software, in which different contractual conditions are stored and automatically monitored, and defined actions can be executed independently when a trigger event occurs. If the general conditions under the law of obligations are fulfilled, Smart Contracts themselves can also be legal contracts. Otherwise, they only serve the automated execution of contracts.
For services automatically provided by means of Smart Contracts via the blockchain, electronic services are generally assumed. For more information on electronic services, see the VAT Sector Information Telecommunications and Electronic Services.
It should be noted that a company domiciled abroad which provides electronic services to non-taxable recipients in Switzerland becomes taxable if it generates at least CHF 100,000 in turnover within one year in Switzerland and abroad from services that are not exempt from tax under Article 21 paragraph 2 VAT Act (Art. 10 para. 2 letters a and b no. 2 VAT Act).
2. Issuance of Tokens in an Initial Coin Offering (ICO)
In an Initial Coin Offering (ICO; also called Token Generating Event [TGE] or Initial Token Offering [ITO], hereinafter referred to as ICO), a company acquires financial resources (in legal currency or cryptocoins/token) for a specific business venture. In return, the donors receive cryptocoins/token, which are generated on a newly developed blockchain or by means of a self-executing computer program (so-called smart contract) on an existing block chain and stored decentrally. The concrete design of an ICO and the cryptocoins/token created in this way differ in technical, functional and legal terms. The assessment of an ICO under VAT law and the use of the respective cryptocoins/token therefore depend on the functionality of the cryptocoins/token issued. The respective tax consequences must be examined in each individual case (e.g. on the basis of relevant documents such as the terms of agreement and conditions of use, the white paper and the like).
On the basis of the company’s contractual obligations, the provision of financial resources within the framework of an ICO represents remuneration for a service (Art. 18 para. 1 in conjunction with Art. 3 let. f VAT Act), provided that it is not a payment coin/token.
- The issuance of payment coins/token in return for payment constitutes an exchange of means of payment that is not relevant for VAT purposes. Example: A trading company is developing a block-chain-based e-commerce platform on which it will offer goods and services. The platform will also be available to third parties to sell their goods and services. As part of the ICO, the trading company will sell cryptocoins, which can then be used exclusively to purchase all goods and services on the platform. The issuance of the cryptocoins against payment on the occasion of the ICO does not constitute a service in the sense of value added tax law.
- The issuance of investment coins/token for a fee is exempt from tax under Article 21 paragraph 2 number 19 letter e of the VAT Act. The corresponding income does not constitute a non-remuneration for the company (Art. 18 para. 2 VAT Act). Example: A pharmaceutical company is looking for investors for the further development of its knowledge database, who in return will receive cryptocoins, which entitle them to a share in the EBIT (earnings before interest and taxes) of the pharmaceutical company. The participation in the EBIT is for an unlimited period of time and at no time provides for a repayment of the fee originally paid by the investor. The raising of funds against issuance of the cryptocoins is exempt from tax pursuant to Article 21 paragraph 2 number 19 letter e VAT Act.
- The issuance of utility coins/token against payment constitutes a service or supply and is taxable, provided that no tax exemption under Article 21 paragraph 2 VAT Act applies. Example: A start-up company intends to use blockchain technology to create a decentralized data store. The users are to be enabled to store their data in a structured and unalterable way. To use the decentralised data storage, a cryptocoin is required, which is issued against payment at an ICO. The cryptocoin represents a certain upload and download capacity and thus influences the speed of data storage. The cryptocoin is not given/consumed during data transmission. The storage space actually used must be paid for by a separate fee. The income from the ICO represents the fee for the increased efficiency in data transmission and is taxable in application of Article 8 paragraph 1 VAT Act, provided that the coin acquirer has its registered office/residence in Germany.
Advance payments for certain or at least at the time of the ICO’s determination of future services as well as services without invoicing are taxable upon receipt of the remuneration (Art. 40 para. 1 let. c VAT Act).
If a company only commits to use the financial resources collected to develop a platform or software, for example, a taxable service under contract law must be assumed. The activity of the company constitutes the service provided; the place of performance is determined in accordance with Art. 8 para. 1 VAT Act. It is irrelevant whether at the time of raising the funds the company promises a later allocation of tokens.
To prove the place of supply, the taxable person can, for example, identify himself using a know-your-customer process or, in the case of electronic services, the relevant information to provide evidence ( VAT sector information on telecommunications and electronic services).
When issuing token to closely related persons (Art. 3 let. h MWSTG), the value that has been or would be agreed between independent third parties is deemed to be the consideration (Art. 24 para. 2 MWSTG; VAT information on tax assessment and tax rates). When issuing token to staff, the provisions of Article 47 of the VAT Ordinance must be observed (VAT information on tax assessment and tax rates).
3. Usage of Tokens
The use of a payment token for the purchase of a service shall be deemed equivalent to the use of legal tender. The payment of a payment coin/token as payment for a service does not constitute an additional service, which is why it cannot be assumed that there is an exchange or similar relationship (Art. 24 para. 3 VAT Act).
The use of an investment token is understood to mean payments to the coin/token holder in the context of the debt claim against the issuer; these represent an expense for the issuer/debtor.
The use or application of a utility token is taxable at the time the service is provided (actual performance), provided the service is not covered by the tax exception under Article 21 (2) MWSTG and was not already taxed at issuance (e.g. due to an advance payment).
4. Transfer, Trade and Storage of Tokens
4.1 Transfer of Tokens
The taxation of the transfer of tokens against consideration or other token, depends on the functionality of the token (Section 1).
The transfer of payment tokens for a service constitutes a payment (and not an additional service).
If, on the other hand, services are remunerated with investment or utility tokens, a barter relationship exists in which the market value of each service is considered to be a payment for the other service (Art. 24 para. 3 VAT Act). The services in question are to be assessed for VAT purposes according to the nature of the respective service.
Details of the VAT consequences of using or actually performing the services contained in the token can be found in Section 3.
Further information on the assessment of the payment can be found in the VAT-Information “Tax Assessment and Tax Rates”.
4.2 Trade of Tokens
The purchase and sale of payment tokens is – analogous to foreign exchange trading – exempt from tax under Article 21 paragraph 2 number 19 letter d of the VAT Act ( VAT-Sector-Information “financial sector”).
The trading of investment and usage coins represents a service provided in one’s own name, which is to be treated for VAT purposes as an independent service according to the content of the service contained in the token.
Purchases and sales of investment tokens are, according to the regulations in the area of securities, book-entry securities and derivatives, exempt from tax pursuant to Article 21 paragraph 2 number 19 letter e of the VAT Act (VAT-Sector-Information “financial sector”).
Purchases and sales of utility tokens constitute taxable services provided that the place of performance of the service contained in the token is within Switzerland and no tax exemption pursuant to Article 21 paragraph 2 VAT Act applies.
The operation of a trading platform and, in connection therewith, the reciprocal transfer of the traded tokens, constitutes – depending on the functionality of the brokered token – a taxable or exempt service.
For the allocation of services (Art. 20 MWSTG), please refer to Cipher 5. In the case of brokerage services in the financial sector, the brokered underlying transaction is used as the basis, which can be assigned either to the taxable or the tax-exempt sphere (VAT-Sector-Information “financial sector”).
Further information on the assessment of the remuneration can be found in the VAT-Information “Tax Assessment and Tax Rates”.
The mere provision of a technical marketplace without involvement in the transfer of tokens and payment flows does not establish a contractual relationship between the trading platform operator and the customer. Accordingly, there is no contract between the parties for the acceptance and transmission or acquisition or sale of tokens. A corresponding platform usage fee, connection fee or similar is subject to tax at the standard rate, whereby the place of performance is determined in accordance with Article 8 paragraph 1 of the VAT Act.
4.3 Storage of Tokens
Tokens are stored and retained by means of wallets (Section 1). The storage of tokens by a third party on a storage medium (e.g. hard disk) or storage program (e.g. wallet software) and the storage of private keys constitute taxable services. The determination of the location is based on article 8 paragraph 1 MWSTG.
If a Wallet Provider stores payment tokens against consideration which do not qualify as safe custody assets within the meaning of Article 16 of the Banking Act, this constitutes an exempt service pursuant to Article 21 paragraph 2 number 19 letter c of the VAT Act (VAT-Sector-Information “Financial Sector”).
5. Validation and Verification of Transactions
5.1 Block-Rewards and Transaction Fees
Transactions on a blockchain must be validated and verified by the nodes of the respective blockchain network by a defined consensus mechanism. Each blockchain has its own consensus mechanism, which ensures that all nodes agree on their data. Two widely used mechanisms are called Proof of Work (so-called Mining) and Proof of Stake (so-called Staking), whereby other methods or hybrids are also used. These mechanisms are used to determine the validator of a transaction.
The compensation for such validation or verification activities carried out by means of software is usually in the form of a so-called Block-Reward (newly created units of the corresponding token) and/or a transaction fee.
If the validation or verification activity is compensated exclusively by means of new tokens (so-called Block-Reward) automatically generated by the network, there is no counterparty that will spend an asset to receive a service. Under these circumstances, there is no service relationship when transactions are validated, which is why the Block Reward is a non-remuneration (Art. 18 para. 2 VAT Act). Validation or verification, which is only compensated with a Block Reward, is not an activity aimed at the sustainable generation of income from services and is therefore not considered entrepreneurial. With regard to the deduction of input tax for non-entrepreneurial areas, the VAT-Information “Input tax deduction and input tax corrections” provides information.
If the compensation for the validation of a block is in the form of a transaction fee, which is paid to the validator by the sender(s) for a specific transaction via the network, there is, on the other hand, a basically taxable service relationship between the sender and the validator. The validation of a transaction for a recipient in Switzerland is subject to tax at the standard rate as an electronic service (Art. 18 para. 1 VAT Act in conjunction with Art. 8 para. 1 VAT Act). If a block reward is generated for the validation service in addition to the transaction fee paid, this has no effect on the input tax deduction (Art. 33 para. 1 MWSTG).
5.2 Pool Mining and Cloud Mining
In the case of pool mining, the individual miner joins a mining pool and commissions it to operate the mining. The miner makes his computing power available to the mining pool, for which he is compensated (with units of certain tokens created by the mining pool). The mining pool operates the mining software and regularly provides additional services. Tax-relevant services exist between the individual miner and the mining pool, the place of which is determined in accordance with Article 8 paragraph 1 of the VAT Act.
In pool staking, the holders of staking tokens can join a staking pool by handing over their stakes, for which they are usually compensated with a share of the transaction fee collected through staking. The staking pool operates the staking software. Tax-relevant services exist between the staking pool and the individual participant. The place of these services is governed by Article 8 paragraph 1 MWSTG.
The servicing of nodes (e.g. so-called master nodes) on behalf of a third party (e.g. cloud mining) is generally a taxable service (determination of the location in accordance with Art. 8 para. 1 MWSTG).