News & Views

Creating a Nordic Framework for Taxation of ICO Income

13 November 2018

Author: Stefan Stellato

Uncertain legal and tax implications of blockchain solutions are adversely affecting the adoption of the technology and its numerous applications. Similarly, the rather unsettled tax treatment of initial coin offerings (ICOs) hinders, on a practical level, the carrying out of ICOs in the Nordic countries. For example, the Finnish Tax Administration’s guidance on cryptocurrencies does not bring clarity to the topic. In this blog post, we discuss our view on how Finland – and perhaps, more broadly, the Nordic countries – should tax ICO income.

Firstly, regard to broader policy objectives requires that there are no unnecessary and potentially harmful and distorting gaps between the taxation of similar phenomena just based on technology. In other words, tax treatment should not be tied to the use or non-use of blockchain technology (technology neutrality).

For the sake of comparison, in a traditional equity investment, the investor invests fiat currency in exchange for shares representing the issuer’s capital. In an ICO, cryptocurrency may, quite similarly, be invested in exchange for tokens representing the issuer’s capital. Some tokens pay coupons, just as a debt investment is characterised by payment of interest on the loan capital. Conversely, certain ICOs are better viewed as prepayments for goods or services provided by a network or for access to the network. In such case, levying income and consumption taxes on ICO proceeds would seem natural and in line with the tax treatment outside of the ICO world.

The remarkable variation in ICO and token characteristics increases the difficulty of creating a tax framework for ICO income and ICOs more generally. There may have been a pre-sale through a simple agreement for future tokens (SAFT) and/or a transfer of tokens to another entity which is ultimately to carry out the ICO. Before the ICO, the issuer may quite freely determine the economic and other features of the token or the discounts or bonuses to be offered to early investors, etc. A description of such characteristics is typically included in the ICO whitepaper.

The tax framework should take into account the different features of different tokens. Hence, the tax framework should include criteria which determine a token’s classification for tax purposes and the tax treatment applicable to each classification. The criteria should be simple and easy to apply for relevant stakeholders, including the tax authorities. Furthermore, the criteria should not leave too much room for interpretation in order not to compromise legal certainty but, as a flip side to the same coin, the criteria should also be open-ended enough to survive rapid technological development.

One potentially feasible distinction for tax purposes could be between utility tokens, securities tokens, and currency tokens. For utility tokens, which provide utility on a network by, for instance, entitling to a discount, services, or goods, tax treatment similar to prepayments for goods or services could be motivated. Hence, the related ICO income would be subject to income and consumption taxation. Conversely, tax treatment similar to traditional equity and debt investments could be motivated for securities tokens. Hence, the related ICO income would be exempt from income and consumption taxes. The definition of a securities token could be tied to the so-called Howey test (developed by the US Supreme Court), the issuance being structured as a security token offering (STO), or directly to the token’s characteristics such as payment of dividends or interest, sharing in profits, or being invested in other tokens or assets. However, for currency tokens that bear no resemblance to equity or debt investments but are rather comparable to sale at a gain of fiat currencies, a tax treatment with income taxation but no consumption taxation could be more suitable.

Admittedly, these definitions would not always be clear-cut, and a token could, depending on its features, fit into more than one category (or no category at all). This is why a tiebreaker rule could provide for treatment in accordance with, for instance, a token’s principal nature.

Whatever the ultimate tax framework, the current situation with a lack of clear laws and administrative guidance is clearly unsatisfactory. A tax framework is needed, not only for ICO income but also for ICOs and blockchain solutions more generally, in order to make the Nordic countries an attractive environment for crypto and blockchain. The framework should be created sooner rather than later, which is why comprehensive legislative action could be preferable to what is likely to be a more patchy and slow formulation of a tax framework through case law. Until a clear tax framework is in place, it is recommendable to seek advance comfort through a tax ruling to avoid unanticipated consequences.

Hannes Snellman’s lawyers regularly advise clients on matters related to blockhain technology and are happy to discuss any questions you may have.

Make sure to check out our previous posts on blockchain as well. These are available on the Hannes Snellman blog and cover topics related to taxation, IPR, and financial regulation, among others.