Biographical Information Colin M. Battersby, CIPP/US, Member, - - PDF document

Tuesday & Wednesday, January 28‐29, 2020

Hya Regency Columbus, Columbus, Ohio

Workshop CC

Harnessing the Blockchain for Tax … Practical Business Strategies to Incorporate Technology and How Fully Implemented Blockchain Technology Will Transform Business Tax Departments

Wednesday, January 29, 2020 11:00 a.m. to 12:30 p.m.

Biographical Information

Colin M. Battersby, CIPP/US, Member, McDonald Hopkins, PLC 39533 Woodward Avenue, Suite 318, Bloomfield Hills, MI 48304 248-593-2952 cbattersby@mcdonaldhopkins.com Colin is a member in McDonald Hopkins’ national Data Privacy and Cybersecurity Practice Group. Colin advises clients on best practices to prevent and respond to data privacy and cybersecurity concerns, including leading data breach incident response efforts in combination with forensic technical vendors and company decision-makers, provides counsel on post-breach notice

• bligations in accordance with state data breach notice statutes or specific contractual obligations,

drafts and coordinates the delivery of required notice throughout the United States, and advises

• n post-breach remedial measures. Colin also counsels businesses on proactive measures to

secure and process protected data in conformity with best practices and existing and emerging regulatory requirements. Colin also represents large and small businesses across many industries in claims alleging breach of contract, tort, product liability, legal and accounting malpractice and securities violations. He earned his J.D. from Wayne State University Law School in 2007. Colin received a Bachelor

• f Economics from the University of Michigan in 2004.

Michael Meisler CPA, J.D., LL.M. (Taxation), Partner, Ernst & Young LLP 5 Times Square, New York, NY 10036-6530 914.773.3579 michael.meisler@ey.com Michael is a Partner in EY’s National Tax Practice, where he leads the firm’s Blockchain/Cryptocurrency Tax Center of Excellence. Michael previously served as the firm’s Global Blockchain Tax Leader between November 2016 and September 2019. Michael previously served as a partner in EY’s Financial Services Organization. He has over 30 years of experience providing tax consulting services with respect to financial products and transactions for securities industry clients, including commercial and investment banks, broker-dealers, hedge funds, private equity funds and securities and commodities firms, both domestically and

• internationally. Michael also provides tax consulting services to fintech companies and to

partnerships that specialize in investing in real estate and infrastructure projects, both domestically and internationally. He continues to serve financial services clients as he works to implement EY’s strategy related to Blockchain and related technologies, while also providing tax guidance to our client serving teams and clients around the world with respect to transactions involving cryptocurrencies, initial coin offerings and security token offerings. Michael is a CPA, licensed in the state of New York. He is also a member of the New York State Bar, Second Department, and a member of the New York State Bar Association’s Tax Section. In addition, he is a member of the Wall Street Tax Educational Corp. Michael holds a LL.M. from the New York University School of Law, a J.D. from Fordham University’s School of Law and a B.S. from the Leonard Stern School of Business at New York

• University. He serves as an adjunct professor at New York University and Baruch College and

serves as the co-chair of the Introduction to Partnership Taxation course at NYU’s Summer Tax Institute.

Harnessing the Blockchain for Tax…

January 29, 2020

Speakers

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Michael Meisler Ernst & Young LLP Partner Colin Battersby McDonald Hopkins Member

Polling Question #1

Based on your knowledge, do you believe the regulation of crypto assets is consistent across regulators?

• 1. Yes
• 2. No
• 3. I have no idea

3

Objectives

• Understand the technology behind crypto assets
• Understand security risks and preventative

measures

• Provide an overview of the relevant U.S. federal

income tax authorities that govern the taxation of cryptocurrency

• Understand U.S. federal tax issues that holders of

cryptocurrencies face

• Understand U.S. federal tax issues that issuers of

cryptocurrencies face

• Provide an overview of current IRS enforcement

activities

• Provide an overview of what areas may be

addressed by future guidance

• Discuss potential tax implications of blockchain

technology

4

Agenda

• Overview of Terminology – Crypto Assets
• Tax Considerations for Holders and

Purchasers of Cryptocurrencies

– Capital asset vs. ordinary asset – Exchange considerations and IRC Sec. 1256 – IRC Sec. 864(b) and trading safe harbor – Wash sale rules – Straddle rules – Crypto lending (monetizing without selling) – Forks and airdrops – Computing amounts realized – Determination of basis

5

Agenda (continued)

• Tax Considerations for Issuers of Crypto

Assets

– Initial Coin Offerings (ICOs) – Security Token Offerings (STOs) – Simple Agreement for Future Tokens (SAFTs) – Simple Agreement for Future Equity or Tokens (SAFE-Ts)

• State and local tax considerations
• Reporting and enforcement considerations
• Future Guidance on Crypto Assets
• Potential Tax Implications of Blockchain

Technology

6

What is Blockchain?

7

Overview – Crypto Assets

What are tokens?

– Transferable units generated within a distributed network that tracks

• wnership of the units through the application of blockchain technology

– What are virtual currencies/payment tokens? – What are security tokens? – What are utility tokens?

What is a distributed ledger?

– Database that is shared and administered in a decentralized form across a network with the ledger built on a data structure known as “blocks” that combine to make a “chain”

• Network of computers or users (referred to as “nodes”) broadcast transactions

to the network and a consensus mechanism validates the transactions and adds them to the ledger

• Most common consensus mechanisms are “mining” and “staking”

What is blockchain?

– One type of distributed ledger – Secure environment that encrypts transactions – Blocks store data and through the blockchain, new blocks are cryptographically validated through nodes and added to the end of the chain

What is a digital wallet?

– Stores private and public keys that are needed to access a blockchain – Hot vs. cold wallets

8

Practical Benefits of Blockchain

• Transactions are leaner – middle

men can be cut out because system practically guarantees accuracy

• Distributed ledger ensures

records cannot be tampered with

9

Security Threats to Cryptocurrency

• Cryptocurrency is a tangible asset

– Susceptible to modern day train robberies and shipwrecks

• Risks vary depending on nature of wallet

– Hot, cold, cloud‐based

• Risks vary depending on ownership

– Direct vs. Exchange

• Risks vary in nature

– Malicious vs. pure negligence

10

Best Security Practices

• Cold wallets

– Securely stored, backups

• Good cyber hygiene

– Up to date virus protection, attention to detail

• Constant vigilance and attention to threat

landscape

– ICOs

• Due diligence

– Investor beware, capitalization, and contracts

11

Tax Considerations for Holders and Purchasers

• f Cryptocurrencies

12

For federal tax purposes, virtual currency is treated as

• property. General tax

principles applicable to property transactions apply to transactions using virtual currency.

IRS Notice 2014-21 25 March 2014

13

Additional guidance (Since Notice 2014-21)

• Rev. Rul. 2019-24 (Issued 9 October

2019)

– Addresses issues related to tax treatment

• f taxpayers following a hard fork of a

blockchain – More on forks later!

• Frequently Asked Questions (Issued 9

October 2019 and updated 31 December 2019)

– Provides additional guidance regarding transactions involving cryptocurrency in accord with the issues addressed in Notice 2014-21

14

Tax considerations for holders and purchasers of cryptocurrencies

• Capital vs. ordinary

– Notice 2014-21 and FAQs provide that cryptocurrencies are property

• Mining – Notice provides that mined tokens give rise to ordinary

income upon award, which may be subject to self-employment taxes

• No discussion of how to treat tokens received for “proof of stake”
• Rev. Rul. 2019-24 provides that tokens received following a hard

fork give rise to ordinary income on “receipt”

• Exchange considerations and IRC Sec. 1256

– Possibility of 60/40 treatment (long-term vs. short-term capital gain/loss)

• Mark-to-market treatment for timing

– Applicability to Bitcoin futures

• Trade on a Qualified Board or Exchange (i.e., CME)

– What about other futures contracts? – Mixed straddle elections?

• IRC Sec. 864(b) and trading safe harbors
• Wash sale rules
• Straddle rules

15

Cryptocurrency lending

• Given the lack of authoritative tax guidance,

does cryptocurrency lending in exchange for cash (or other) collateral constitute a sale or exchange subject to tax?

• Is this lending arrangement more akin to a car

rental or securities lending?

• Terms of the loan agreement may determine

who is the actual economic owner of the asset during the lending term (i.e., beneficiary of hard forks)

• Should we treat “interest” paid on

cryptocurrency lending as interest, rent, or something else?

• Information reporting and withholding

considerations for cryptocurrency payments

16

Forks and airdrops

• What are they?
• Forks – after years of uncertainty – Rev. Rul. 2019‐24

– New tokens received following a hard fork of a blockchain give rise to

• rdinary income based on the FMV of the token on the date received.
• Seen as an accession to wealth under general tax principles.

– Ruling raises some additional questions, but generally dismisses a number

• f tax‐free alternatives that practitioners and taxpayers had considered

previously.

• For example, forks should not be treated as akin to a stock dividend.
• Also, dismisses the “cow giving birth to a calf” theory.
• Timing – when the taxpayer exercises dominion and control

– Taxable income recognized at the time the fork is written to the distributed ledger. – Taxable income recognized when amounts are credited to taxpayers’ accounts where taxpayers hold in a wallet with an exchange.

• Additional information regarding FMV provided in the

Frequently Asked Questions released on the same day.

• While ruling deals with a hard fork followed by an airdrop, it’s

not clear that this guidance applies to all airdrops.

– Could be a reasonable conclusion based on the application of general principles.

17

Computing amounts realized

• Tokens received on a cryptocurrency exchange – use

amount recorded by the cryptocurrency exchange, net

• f fees – FAQ, Q&A 25
• If transaction is not recorded or is an “off-chain”

transaction, use value that would have been recorded in an on-chain transaction – FAQ, Q&A 25

• Peer-to-peer transactions – use value as determined by

a cryptocurrency or blockchain explorer that analyzes worldwide indices of cryptocurrencies and calculates values at an exact date and time – FAQ, Q&A 26

– Appears to mean a global pricing index rather than an “explorer” – If the taxpayer does not use a value determined by a global pricing index, the taxpayer must establish that the value used is an accurate representation of FMV – FAQ, Q&A 26

• When transaction involves an exchange of

cryptocurrency for other property or services and there is no FMV available for the cryptocurrency, use the FMV of the property received – FAQ, Q&A 27

• Compare Notice 2014-21, Q&A 5

18

Determination of basis

• Generally, cost basis, including fees, commissions and
• ther acquisition costs, expressed in US dollars – FAQ,

Q&A 7

• For assets received in exchange for goods or services, FMV
• f cryptocurrency when it is received – FAQ, Q&A 12 and 20
• Basis of property received in exchange for cryptocurrency

equals the FMV of the property when received – FAQ, Q&A 17

• Lot identification considerations

– Specific identification permitted – FAQ, Q&A 38

• Document the specific unit’s unique identifier such as a private key, public

key, and address or

• By records showing the transaction information for all units of a specific

virtual currency held in a single account, wallet, or address – FAQ Q&A 39

– If specific identification isn’t used, FIFO accounting should be used – FAQ, Q&A 40

• What should taxpayers do if they have used another

method of accounting to date?

– What if a taxpayer has been using weighted average cost?

19

Polling Question #2

For hard forks and airdrops, what is your view

• n when such asset acquisition is taxable to

the recipient:

• 1. At the moment of the fork/airdrop
• 2. Upon universal acceptance by the

community

• 3. When the recipient actually receives the

asset in their possession

• 4. When the recipient spends or otherwise

uses the asset

• 5. It depends on the facts and circumstances

behind the actual event

20

Tax Considerations for Issuers of Crypto Assets

21

Initial Coin Offerings (ICOs)

• Fundraising mechanism by which projects are funded

through the issuance of tokens

• Token issuers generally receive either other

cryptocurrencies or fiat currencies in exchange for tokens

– Taxpayers may have claimed like-kind exchange treatment for pre-TCJA exchanges of tokens

• Tax considerations: security token vs. utility token

– Debt? Equity? Sale or exchange of goods or services? – ICOs, based on their specific facts, may be considered security offerings and subject to the Securities and Exchange Commission’s (SEC) oversight – Token issuers have generally asserted that tokens are either utility tokens or tokens providing right to exchange token for goods or services and not securities for regulatory purposes

• Acquirer vs. issuer considerations
• After a spike in ICOs through the start of 2018, there

has been a significant downturn in these offerings into 2019

22

Security Token Offerings (STOs)

• Issuer concedes that tokens are securities for

regulatory purposes

• Generally, backed by assets

– Real estate – Currencies – Rights to intangible property of the company – Equity rights related to company’s business

• Profits/right to dividends
• Voting rights
• Liquidation rights
• STOs can grant rights to goods or services (just like

ICOs)

– Similar analysis could be involved to determine appropriate tax treatment

• Potentially, stronger arguments for either debt or equity

treatment

– Potential difference in strength of argument for partnerships

• vs. corporations?
• Again, no guidance at the moment

23

Simple Agreement for Future Tokens (SAFTs)

• SAFTs are investment contracts offered by

token developers to interested investors or participants in a project

• SAFTs are intended to be treated as

forward contracts for federal income tax purposes

– Intent to avoid immediate taxation

• IRS has provided no guidance indicating

whether it agrees or disagrees with this treatment

• IRC Sec 451(c) considerations following

the TCJA

– Consider how proceeds are treated for GAAP purposes

24

Simple Agreement for Future Equity

• r Tokens (SAFE‐Ts)
• SAFE‐Ts are investment contracts offered

by cryptocurrency developers offering investors equity and/or tokens

– Agreements generally contain elements of both SAFTs and SAFEs

• Contingent stock right?
• SAFT with an equity kicker?
• Investment unit consisting of both equity and a

SAFT?

• While intending forward contract

treatment, issuers of SAFE‐Ts may have additional arguments supporting at least partial equity issuance treatment

25

Polling Question #3

What type of asset class do you feel has the best use case for tokenization:

• 1. Real estate
• 2. Stock/securities
• 3. Commodities
• 4. Retail/consumer products
• 5. Authentic collectibles
• 6. Large assets (such as airplanes)
• 7. People/pets
• 8. Other

26

State and local tax implications

• How are cryptocurrency transactions sourced

to different state and local jurisdictions?

• Cryptocurrency is not physical property, which

makes physical identification and location difficult

• Many state and local jurisdictions utilize

customer-based sourcing

• How should trades through a licensed

exchange be sourced if the end customer in the transaction is not identifiable?

• Sales and use tax considerations

27

Reporting and enforcement considerations – reporting considerations

• Gains or losses from disposition or spending

virtual currency – report on Form 8949, transfer information to Schedule D – FAQ, Q&A 42

• Ordinary income from virtual currency is reported
• n Form 1040 along with other similar types of

income – FAQ, Q&A 43

– Wages – line 1

• Wages paid in cryptocurrency are subject to FICA and FUTA

taxes

– Self-employment income – Schedule C – Like-kind exchange treatment and the impact of the TCJA

• n IRC Sec. 1031)
• Form 1040, Schedule 1, Additional Income and

Adjustments to Income

– “At any time during 2019, did you receive, sell, send, exchange, or

• therwise acquire any financial interest in any virtual currency?”

– Includes “Yes” or “No” boxes available to select

– Similar to Schedule B question regarding offshore bank accounts

• Potential for similar enforcement activity related to that question

28

Reporting and enforcement considerations – reporting considerations

• 2019‐2020 Priority Guidance Plan includes

virtual currency information reporting project under section 6045.

– Section 6045 generally provides for information reporting on Form 1099‐B for brokers and barter exchanges.

• Reporting of foreign bank and financial

accounts (FBAR, FATCA)

29

Reporting and enforcement considerations – enforcement considerations

• Recent DOJ/IRS announcement regarding dark

web arrests related to payments in Bitcoin

• J5 ‐ Joint international coalition to investigate

cryptocurrency related tax crimes and money laundering, including US, UK, Australia, Canada, and the Netherlands

• Coinbase summons
• LB&I compliance campaign
• IRS issues approximately 10,000 letters to

taxpayers regarding cryptocurrency transactions

– Letters ranged from informational to providing calculations of tax due – Any calculation of tax due could have been overstated to the extent that the IRS lacked information regarding calculations of adjusted basis

• Potential implications of Form 1040, Schedule 1

30

Future Guidance on Crypto Assets

31

Areas Where Guidance is Needed

• Chapter 3 withholding and FDAP
• Anti-Deferral Regimes (i.e., PFICs, subpart F,

and GILTI)

• UBTI considerations
• Reporting

– Section 6045 information reporting – Basis reporting – FBAR/FATCA account reporting

• Classifications (commodities, securities, other)

32

Potential Tax Implications

• f Blockchain Technology

33

Future impact of Blockchain on tax

• Proof of concept phase projects and ideas
• Indirect taxes
• Transfer pricing
• Legal
• Payroll taxes
• Other withholding taxes
• Potential use of cryptocurrency in connection with

cross-border transactions

• Keep your eye out for “future shock”
• How will tax be calculated and collected in the future?

2019 Tax Educators Symposium | 34

Potential uses of Blockchain and tokenization

• Decentralized asset exchanges
• Supply chain management
• Transfer pricing
• Can governments digitize the tax process to efficiently

collect income taxes?

• Pro: The open-source and tamper-proof nature of

cryptocurrency can potentially help governments track activity and fight crime, as well as fraud and tax evasion.

• Pro: This could ease the burden of tax reporting for

both taxpaying citizens and the government.

• Con: Would require universal adoption.
• Con: Taxpayers may be concerned about privacy with

the government accessing all their activities.

2019 Tax Educators Symposium | 35

Potential uses of Blockchain and tokenization (cont.)

• Actual use cases of Blockchain recently in the news
• JPM Coin
• Guangdong Province in China – electronic invoices for

e-commerce

• Potential use of smart contracts to automate

collection of taxes

• The Marshallese Sovereign (SOV)
• Libra

2019 Tax Educators Symposium | 36

Summary/Questions?

37