There is no shortage of optimism concerning the many ways blockchain/distributed ledger technologies will disrupt traditional industries and organizations.
Seventy-four percent of organizations see a “compelling business case” for blockchain technology, and more than two-thirds of 1,000-plus global executives believe their companies will lose a competitive advantage if they do not adopt blockchain, according to a Deloitte survey.
With e-commerce expected to grow 20% to $4.5 trillion in 2020 with over $1 trillion cross-border, blockchain-based commerce, “b-commerce,” looks to inherit a ravenous consumer appetite for all things digital. These expectations understandably have blockchain-based companies chomping at the bit. However, numerous hurdles must be cleared in order to exploit these valuable opportunities – including the ever-present need to give the government its due in the form of taxes.
While there is no shortage of guidance related to income taxation, there is comparatively little information available regarding the surprisingly complex challenges transaction taxes pose for blockchain-based companies. Given that global transaction taxes contribute more in government revenues than corporate income taxes, expectations should err on the side of enforcement. This is compounded by the fact that blockchain businesses are emerging at a time when cross-border e-commerce is becoming taxable in the U.S. and globally. In addition, tax rules that hold platforms vendors liable for transaction taxes owed by the merchants using their services are being implemented globally. Countries, as well as individual U.S. states, are beginning to distinguish which types of tokens and blockchain transactions qualify as taxable under value-added tax/goods and services tax (VAT/GST) or sales and use taxation.
To date, categorization of blockchain “tokens” was focused on determination of whether or not a blockchain token and the business or individuals supporting it could be subject to extensive securities regulation from the U.S. Securities and Exchange Commission (SEC) or similar agencies, as well as a myriad of money laundering and money transmission rules. Yet, avoiding one of those classifications could be an out of the frying pan and into the fire experience if the result is a large sales tax or VAT bill.
Given the uncertainty swirling around transaction taxes, it is crucial for leaders of blockchain businesses and their investors to assess their organization’s potential tax liability on direct b-commerce sales and on those conducted by other parties using their platforms. Assessment begins with recognizing the shifting e-commerce taxation environment and the ever-changing state sales tax rules in the U.S., coupled with the complexity of global tax regulations to ensure proper compliance.
E-Commerce’s Carefree (and Sales-Tax-Free) Days End
When it came to taxation, companies conducting e-commerce transactions had little to worry about, beyond their mailing address, during most of the past two decades. Those nonchalant days have come to an abrupt end, which leaders of blockchain companies should keep in mind.
While location continues to matter from an income tax perspective, there exists growing agreement among global tax authorities that e-commerce transactions should be taxed by authorities within the jurisdiction where the customer or consumer resides under what is now known as the “destination principle.” A steadily increasing number of countries in Europe and Asia (e.g., Hungary, Italy, India, South Korea) have either implemented new tax rules targeting digital activities or are considering doing so. Indeed, digitally delivered consumer services in the European Union (EU) have been taxed based upon the place of consumption since January 2015. Consumption-based taxation is now being broadened to include all e-commerce, beyond just Europe. For example, the U.K. introduced rules in 2016 and extended them in 2018 to make online marketplaces joint and severally liable for non-compliant traders selling goods to consumers through their platforms. All of these measures levy new taxes on the sales e-commerce companies generate in the countries where the buyer is located. Additionally, the Organization for Economic Co-operation and Development (OECD) has invested several years developing digital taxation rules it intends to finalize by next year. However, early global agreement has already been reached on e-commerce, and by association b-commerce, in the form of the above destination principle and also in terms of marketplace facilitators who have become partially or fully liable for the sales of third-party merchants who sell through their service. The OECD guidance was agreed upon in late March 2019 in the form of over 110 countries approval of a report entitled, “The Role of Digital Platforms in the Collection of VAT/GST in Online Sales.”
For years, most e-commerce companies did not have to address sales tax rules in other countries or in U.S. states. And while blockchain companies might be tempted to adopt that mindset – “Sales tax is not an issue, we’re a Malta-registered company” – they do so at their own risk, as that thinking has swiftly become outdated not just in Europe, but globally.
The U.S. View - Why Wayfair Matters
The U.S. experienced its own version of a transaction-tax transformation last year when the Supreme Court ruled that individual states can require online sellers – domestic as well as those based outside the U.S. – to collect sales tax on out-of-state transactions. Since that decision was finalized in June 2018, the vast majority of states have been scrambling to update their existing sales tax rules in response. Check out our Wayfair Knowledge Center to see the recent changes.
Under most of these new, post-Wayfair rules, online sellers and “marketplace facilitators” – any platform through which virtual transactions occur – are required to collect and remit sales tax when their sales to customers within a state surpass specific thresholds (based on annual revenue amounts, such as $100,000 or a number of transactions per year). In Iowa, for example, marketplace facilitators that generate $100,000 or more in annual sales or conduct 200 or more discrete transactions are required to collect and remit sales tax and file returns. Some states that had marketplace facilitator tax rules on their books prior to the Wayfair decision have updated or are in the process of updating these rules. Other states, such as Connecticut and Minnesota, quickly added new rules on tax requirements for marketplace facilitators.
The volume of these changes inspired the publication Tax Notes to brand 2019 as the “year of marketplace legislation.” While that may be good news for state revenue departments, it is troubling news for blockchain businesses that qualify as a marketplace facilitator – and given the business models of many blockchain “platforms” and “distributed applications,” they are likely to meet these definitions. Even worse, the definitions and determinants of that characterization vary by state, making it almost more beneficial to setup to pay everywhere rather than trying to keep track of it all. The confusion surrounding changing state tax rules on marketplace facilitators has become so intense that the Pennsylvania Department of Revenue (DOR) recently took to social media to make an important clarification: “If you receive a letter from a business letting you know that you may owe Pennsylvania use tax,” the tax agency’s Facebook post read, “it is not a scam.”
All that said, determining whether a blockchain business has sales tax liability in a specific state is only one part of a complex process. Determining the amount of sales tax owed on transactions poses a high-level challenge given that there were 5,886 standard new and changed sales tax rates in the U.S. over the past decade, an average of 588 per year.
B-Commerce and States of Uncertainty
In addition to continually updating their tax rates, U.S. states and nation-states around the globe are busily writing new legislation and rules specifically focused on blockchain-based businesses. These rules generally seek to differentiate among different forms of “tokens” for regulatory oversight and tax determination purposes. So far, three categories have emerged (nomenclature may differ):
- A commodity/currency class like Bitcoin;
- A securities class which requires regulatory oversight by securities regulators; and
- A utility/consumption class where tokens can be traded for goods or services (e.g., tangible personal property).
U.S. states are not alone in adopting these types of formal classifications; countries such as Switzerland have made similar moves. As is the case with tax rates and marketplace facilitator definitions, there is significant variation among state and nation-specific rules targeted to blockchain tokens, transactions and companies.
Alabama treats virtual currencies as marketplace facilitators with sales tax liability. In Massachusetts, companies that disseminate virtual currencies as marketplace facilitators are subject to the state’s sales tax collection and remittance requirements. New Jersey issued guidance it intends to treat virtual currency as intangible property (in conformance with federal tax treatment of virtual currency) making transactions subject to sales tax. Wyoming recently exempted tokens, also known as digital assets, from their sales tax by defining them as intangible property rather than taxable tangible personal property. However, due to the destination principle, that only applies to Wyoming citizens and does not shield blockchain businesses based in Wyoming from being liable for collecting and remitting taxes from consumers of their product or services in other locations.
“There exists no uniformity with respect to how businesses that deal in virtual currencies (also known as ‘cryptocurrencies’) such as Bitcoin are treated among the states,” asserts a JD Supra article from law firm Carlton Fields that highlight current U.S. state-specific regulations on virtual currency and blockchain technologies. This is before we even consider that b-commerce businesses start globally from day one.
Despite this lack of conformity and clarity, there are practical steps leadership teams can and should take to reduce tax complexity – and their eventual transaction tax compliance burdens.
Preparing the Tax Ledger
Like most entrepreneurial technology start-ups, blockchain-based companies likely place the parsing of current and future transaction tax requirements low on their to-do lists if they even make the list at all. There are far too many high-priority items – most of which are directly connected to driving growth and securing funding – and far too few, if any, tax experts on staff to wade into tax management minutia.
However, it is far more time- and cost-efficient – not to mention more risk savvy – to address transaction tax risks and liabilities in a proactive manner. A proactive approach involves several relatively straightforward considerations. Start by:
- BEING AWARE: Recognize that your business may be subject to transaction tax compliance requirements – if not today, then possibly in the near future. It is important to be aware of the surging global movement regarding e-commerce taxation and how this transformation is likely to result in the customer’s country and/or state of residence determining where transaction taxes are collected and remitted. Given the marketplace facilitators/platform laws being enacted, do not assume you will not be held liable for collecting taxes on third-party commerce conducted via your site/platform/distributed application.
- CONSULTING WITH OUTSIDE EXPERTS: Seek out guidance and expertise on tax matters from trusted sources; external audit providers and tax firms, as well as outside legal firms that specialize in tax and online organizations like the Accounting Blockchain Coalition.
- BEING AWARE: If your company has not previously evaluated potential transaction tax liabilities, now is the time to get started. If your company has not previously submitted state sales tax returns, now is the time to ramp up this capability. Evaluate the financial statement impact of transaction tax liabilities, which can run as high as 22% VAT in Finland, as well as compliance with nation state-specific marketplace facilitator definitions and requirements. Consider supporting tax technologies that contain and automatically update sales tax rules and rates.
While many blockchain-based companies are poised to make a fortune from the emergence of b-commerce and their innovative products and services, their timing – from a tax-perspective is unfortunate given that global tax authorities are rapidly recalibrating how and where they apply transaction taxes to online e-commerce or b-commerce. For this reason, the most prudent way for blockchain companies to address tax risks is by acting now, well before the risk of non-compliance becomes a reality.
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