The meaning of life, tax and the digital universe

Here is a five-minute round-up of the key takeaways.

Digital tokens have faced multiple trials, tribulations and fluctuations in value over the past year and beyond. But they’re here to stay and can’t be ignored.

One of the big attractions of digital token is their versatility: They come in different forms:

Payment token
Essentially the same as cash (think Bitcoin)

Utility token
A voucher that can be exchanged for goods and services (think present)

Security token
A token that gives rights over a business (think debt or equity)

Hybrid
A combination of the above

This versatility means that digital tokens can be used in multiple ways including payments, investments, traded securities, rewards and presents.

Struggling to keep up
But with the versatility of digital tokens comes difficult questions about how to account for them, tax them and vice-versa.

The challenges are compounded by the fact that most APAC jurisdictions (India is the notable exception) have no specific tax rules for digital assets. IFRS accounting makes no specific reference to them either. So, most jurisdictions have been forced to fall back on existing codes that may need to be adapted and even stretched to fit the idiosyncratic nature and application of digital assets.

Beyond the tax demands facing issuers and recipients, these complicated and uncertain tax and accounting treatments have important implications for how the tokens are valued and deployed in areas such as investment holdings and employee incentives.

Accounting treatment
If we start with accounting, the way the token is treated depends on how it’s being used.

As a general rule of thumb, IFRS treats digital tokens as an intangible asset if they are held as investments and as inventory if used for trading. They would be designated as financial instruments if they grant the holder a contractual right to receive cash or other financial assets (e.g., debt, equity or derivatives of such). One of the main challenges is that the distinction between tradeable asset and investment for appreciation is far from clearcut.

The accounting treatment isn’t just important for valuation and reporting purposes, it also has a significant bearing, though not binding influence, on whether and how the token is taxed.

Tax treatment
Largely, though not universally (e.g., India), tax codes for digital assets follow the rules for physical and intangible assets.

In line with accounting rules, the starting point for determining whether the token is liable for tax centres on its purpose. Further considerations include the source, timing of recognition and whether earnings are deemed to be capital gains or profit/revenue.

In Singapore and Hong Kong, capital gains are exempt from tax, but they would be taxable in India and Australia. In turn, Singapore and Hong Kong only tax profits generated locally, but India and Australia tax income from wherever in the world it is generated.

India stands out in having recently imposed a 30% tax on the transfer of what it terms virtual digital assets. It doesn’t matter whether the gain is treated as capital or revenue for accounting purposes. The tax applies either way. This tough line is attracting attention from other jurisdictions both regionally and worldwide.

Substance outweighs form. For example, if the asset is accounted for as inventory, it would be difficult to convince the authority that it’s a long-term investment rather than being used for trading.