To ICO Or Not To ICO – That Is The (Tax) Question
Will blockchain and initial coin offerings – or ICOs for short – be so compelling a funding tool that venture capitalists need to start looking for something else to do?
On the surface, it sounds like a ridiculous question. The messaging app provider Telegram would likely disagree.
The company put the crowning touch on ICOs’ monster 2017 by raising $850 million. Before that, Filecoin ($257 million), Tezos ($236 million), EOS ($200 million) and Paragon ($183 million) all helped make 2017 a monster year for ICOs. In fact, 90% of funds generated through ICOs stem from offerings during 2017.
This animation provides an excellent illustration of just how fast things have been moving along:
While the ICOs are unquestionably successful, they also raise questions for both companies pursuing them - and their investors. For example, how to deal with ICOs in relation to tax laws and regulations governing accountancy.
BDO is advising blockchain companies and investors, as well as companies pursuing ICOs, across the globe. I spoke to three of my BDO colleagues who are currently working in ICOs about their take on what is happening – and what companies need to be aware of. They are: David Butcher and Ollie Chinneck, Partners at BDO in UK, and Harry Chana, Tax Partner at BDO in Canada.
Jakob Sand: If we start with the ICOs themselves, they are sometimes described as the new, innovative, democratic way of raising funds for a company. Could you briefly sum up some of ICOs’ main advantages over traditional forms of funding? And what do you see happening to ICOs in coming years?
Harry Chana: The comparison that comes to mind when talking about ICOs is crowdfunding. Both are relatively fast ways of raising capital. You have access to capital without necessarily giving up ownership and/or future equity. Both also create awareness about a company, functioning as a kind of free advertising. Raising capital is often a lengthy process for start-ups. Especially in the technology space where banks are often reticent to lend due to the high failure rates. It is also a space where a 50 to 100-day delay in getting to market can have a significant impact on the success of a technology company. Others may simply get there faster.
Thanks to cryptocurrency and blockchain’s big 2017, there is also a lot of awareness and interest in ICOs, which makes for a beneficial investment climate for companies looking for funding.
David Butcher: It would be worth mentioning that said awareness is mainly in the communities that are interested in ICOs, blockchain and cryptocurrency, but then that is also the central area where many start-ups are finding their backers.
Ollie Chinneck: It is still relatively early days with ICOs, and my personal view is that dynamics in the market will change in coming years as more investors and companies – of a larger size than we are currently seeing – will consider ICOs. The entrance of more prominent, large-scale players and also changes in regulation will result in a slow-down in the speed of ICOs as increased diligence and investor sentiment may move the process more in line with traditional fundraising.
David Butcher: We suspect that we will also see consolidation. As more established businesses consider ICOs, and institutional investors are setting up funds specifically to invest in ICOs. The scale will lead to more due diligence and more thorough audits than is generally the case at the moment. That is something that is beginning already. For example, there is news that Kodak is pursuing an ICO.
Jakob Sand: In regards to ICOs, taxation and other financial regulations may be an aspect that companies are not entirely clear on. What would be some advice you would give in relation to ICOs and taxes? For example, what kind of regulations can affect money raised through an ICO? Is there more personal liability for founders if one pursues an ICO?
Ollie Chinneck: There are several regulatory hurdles with regards ICOs. This has attracted significant interest in certain jurisdictions. We are entering a phase where regulators are starting to shape some process and requirements around ICO’s, after having gone through some of the initial challenges associated with cryptocurrencies.
David Butcher: The first piece of advice we give many clients is to get a lawyer involved. This doesn’t have to be a crypto specialist but should be someone with a detailed understating of the regulatory and capital markets environment. You will require a lot of legal advice in connection with setting up for an ICO. For example, to understand the financial regulations that apply to your ICO. Another important aspect is to consider what kind of token you are offering in the ICO. There are two kinds: a security token is like buying a share in the company. Utility tokens, on the other hand, are something you can use to purchase services/products from the company. Each comes with its own set of regulatory, audit and tax-related issues and challenges.
Harry Chana: Many of the companies that are looking at ICOs have a technology background. They have an excellent understanding of how cryptocurrencies and ICOs work. Tax and regulatory issues are often a different matter. The main taxation issues to consider include which jurisdiction the ICO is going to occur. We have seen many examples were these are being undertaken in non-treaty countries, this can cause those entities to be taxable in Canada, thereby negating any tax benefits sought. In addition, the taxation of ICO’s and crypto currencies is still an evolving space for many tax authorities, this causes a lot of uncertainty when you are trying to structure an ICO and understanding how various jurisdictions will tax the proceeds and trading of crypto currencies
David Butcher: One of the areas that has not been nailed down is the accounting for the funds raised on ICOs. Being aware of the possible tax implications is essential. As Harry mentions, although tax authorities are still developing their approach to ICOs, the profits derived from them could be regarded as taxable in many jurisdictions. In addition, there may be other taxes to be considered, such as VAT or GST, as well as employment taxes where tokens are provided to employees. It may be beneficial to consider setting up an ICO in certain geographic locations, but that then raises issues regarding company structure that need to be addressed.
Ollie Chinneck: One last piece of advice would be that one kind of funding does not exclude the other. For example, we are working with a company with already established blockchain technology that is pursuing a ‘traditional’ Round A funding, crowdfunding and also considering an ICO.
Jakob Sand: With ICOs being a very new phenomenon, related regulations and laws are likely going to be subject to changes as legislators play catch-up. There are also regional and national differences. Some countries have outright banned ICOs while others seem to have a more positive view. How should a company consider this when planning an ICO? And what are some changes that could be happening in the near future?
Ollie Chinneck: Compliance will be an issue. For example, the fifth money laundering regulation set is coming 2019. ICOs and cryptocurrencies, in general, have been susceptible to money laundering and also to cyber-attacks, it is important to find ways to ensure that you are not falling within that area. You want to have an accredited investor base.
David Butcher: Legislation, laws and regulations governing ICOs are likely going to be subject to change in years to come.
Ollie Chinneck: I agree. I would draw a parallel to what we saw with regards to online gaming in the early 2000s. They are still updating the regulation for the area, and a similar scenario could play out in regards to ICOs and cryptocurrency.
Harry Chana: This is an important point, I think. Here in Canada, regulators are looking very carefully at ICOs. However, most regulatory bodies move relatively slowly. Getting to actual changes in regulation and taxation laws could well take years. That being said, the amount of investment happening in what is still a somewhat grey area will incentivise countries to act sooner rather than later.
Ollie Chinneck: An exciting new development is that Gibraltar recently issued a white paper setting out its proposed regulation of utility token ICOs covering the initial sale and distribution, the operation of a secondary market and the provision of investment and ancillary services. The proposal also would require those receiving proceeds being subject to AML and countering financing of terrorism legislation. The regulated ICO would require an authorised sponsor who would be responsible for establishing their own methodology as this will still need a degree of flexibility between start-up organisations and those with an established business and track-record. This will invariably lead to more focus on audits, due diligence, penetration testing, working capital review etc. but it does offer an excellent opportunity for many of the companies pursuing their ICOs to do so in a regulated environment and should lead to increased consumer confidence.