Tax Alert No. 31 - 

International taxation  17.9.2018

Israeli tax ramifications of token offerings (ICOs) for foreign companies, and more… - 17.9.2018

The world of cryptocurrencies is characterized by rapid change and extreme volatility. The moods of active crypto players swing in keeping with the surprising fluctuations of coin values. Our office has met with dozens of such clients, and in recent months with quite a number of groups who are at various stages of ICOs (Initial Coin Offering) or TGEs (Token Generation Event) (hereinafter “ICO” or “token offering”). The business environment and the legal environment faced by investor groups wishing to perform an ICO is quite different from what it was as recently as a year ago, primarily due to advancements in regulation. The securities regulation agencies in Israel and throughout the world have been focusing attention in this area, and the question of whether particular tokens are defined as utilities or securities, as well as many other related legal questions, consume much time and resources of investors.

The Tax Authority issued a circular in March 2018 on the tax ramifications of ICOs. The circular addresses the tax ramifications of issuing utility tokens only, and clarifies the Tax Authority’s position on some issues.
We won’t be focusing on the general legal questions in this short alert; instead we present several areas in which tax issues should be addressed and treated in every ICO.

Country of incorporation of the offering entity
Since the attention of security regulation agencies around the world (including Israel) is focused on these issues, it would be a good idea to select a “user-friendly” country for incorporation of the entity which will be holding the offering. The entity holding the offering is typically a company, but it may also be another kind of entity; a foundation, for example, in the case of an open platform developed for public use and modification. It would be best for the entity holding the offering to be incorporated in a country with a positive general approach to cryptocurrency, and in particular to ICOs.
Countries considered “user-friendly” in this regard today are mainly Gibraltar, Switzerland, Malta, Estonia and Hong Kong. Of course you should take into account the rapid development and frequent changes of attitudes in different countries, and consult with reputable local professional advisors, getting up-to-date information before choosing a country of incorporation.

Structural changes and preparation for an offering
In some cases, carrying out token offerings in “user-friendly” countries of incorporation requires transfer of part or all crypto activity to the offering entity after incorporation, including intellectual property and other rights developed prior to the ICO. It’s important to consider the tax ramifications that such changes may incur in Israel or abroad, and issues such as control and management of that company, various anti-avoidance rules, transfer pricing principles, etc.
Sometimes, in cases where the company or concern is engaged in ordinary business activity, it may be necessary to transfer the real activity of the company to the foreign issuing entity, or to give it rights to use the transferred assets, typically in cases where in parallel to developing a crypto strategy and financial framework for it, the offering company plans to open up independent real activity based to some extent on its previous activity. In these cases too, it is important to consider the potential tax aspects indicated above.

Tax ramifications of token offering for token recipients
Careful attention should be paid to the tax ramifications on employees who receive tokens as part of the offering, as well as on service providers in Israel and abroad and the offering initiators who may also receive tokens, often a significantly large number of them. Issues of quantification and timing of expenditure deductibility at the company level need also be addressed. The Israel Income Tax circular (2018/7) addresses these issues as well, and to some degree allows for employees to defer tax events to the exercise date of the tokens.

Test for eligibility for benefits due to Encouragement of Capital Investment Law (ECIL)
Benefits from ECIL in Israel may be granted to an offering company on revenues derived from ICO “money”, at the time of their recognition in accordance with established rules, as long as it satisfies conditions established by law. Thus, for example, if revenues from sale of a product that a company develops is eligible to benefit from ECIL, it could also benefit from ECIL in the case where the consideration of the offering reflects an obligation to provide a said product. In any event, there can be various and sundry cases regarding revenues and expenditures of the offering company, including R&D, thus applicability of ECIL to each case should be carefully examined.

VAT considerations
In most cases, events related to token offerings classified as utility tokens – whether issued directly by an Israeli company or if it undertakes the obligations of the offering entity towards the token owners in parallel with receiving the consideration of the offering – incur VAT liabilities.
In this context it would be necessary to determine whether the company’s obligation to the token holders is a service or a product; if the consideration is received in regular (“fiat”) currency or virtual coins such as Bitcoin or Ethereum; what the residency status of the coin holder is at the time of service or product consumption; etc. These are all factors in the timing and quantification of tax events.

In the past two years our office has been actively involved in cryptocurrency issues and have accumulated a wealth of knowledge and experience in the area. We advise crypto investors, including conducting voluntary disclosure procedures, and we advise and support entities involved in token offerings (ICOs).

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