Tokenization – A brief introduction
While some banks are talking about entering this space soon, other banks already jumped into the digital assets space by releasing their own tokenization platforms or advertising job positions such as “Head of Blockchain Tokenization Consulting”. More and more start-ups are emerging that are dedicated to this new technology. The topic is red-hot!
In a nutshell, tokenization is the name for a process to digitalize assets using the distributed ledger technology such as blockchain. In theory, almost any asset can be tokenized. This is still very abstract – the key take-away for financial market purposes is that a blockchain theoretically enables trading in several forms of assets that are otherwise very difficult to trade.
Currently very popular are so-called NFTs (Non-Fungible Tokens). The most prominent use cases of NFTs represent assets such as real estate, art or virtual collectables (e.g. bored apes). Another form of assets that can be tokenized are fungible assets. These include cryptocurrencies, commodities and financial instruments, among other things.
In our view, there is great potential on the financial market for the tokenization of commodities. While for some commodities such as gold the market is rather liquid, other commodities are almost exclusively traded by larger corporates via bilateral agreements. Tokenization could eliminate the entry barriers and open market access to smaller participants.
This blog focuses on the Swiss VAT consequences of trading such a tokenized commodity.
Example case – coffee beans
An entity (“buyer”) intends to buy a tokenized commodity (“token”) via an electronic platform operated by a Swiss entity (“Swiss platform”) from another entity (“seller”). The token represents the right of its holder to purchase a certain commodity at an agreed price. The token relates to – for instance – 1 kilo of coffee beans. The result of exercising the token is the physical purchase of 1 kilo of coffee beans. The token can be traded in a simple and secure way on the Swiss platform – in return, the platform may charge access/membership/transfer fees.
From a Swiss VAT perspective, the implications and risks for each participant in the different transactions arising from trading and executing the token need to be assessed.
Swiss VAT – thoughts and questions
Trading the token via a Swiss platform
The practice and guidelines around tokens and VAT are still very new (and incomplete) from a Swiss VAT perspective. Every token must be analyzed and classified on a case-by-case basis, as even minor differences in the characteristics of the token can lead to a different VAT treatment. This is demonstrated very well by the following test case.
In the present case – the token could be classified as a payment token, i.e. it could be used as a means of payment to purchase coffee beans. On the other hand, the token has close similarities to a “call option”. Call options are financial contracts that give the buyer the right to buy an asset at an agreed price. If a token gives the entitlement to derivative rights or the like, it could also be categorized as an asset token based on the practice of the Swiss Federal Tax Administration (“FTA”). The effective qualification depends on multiple criteria, for example, if the price for the commodity must be paid separately or not. Another question is if the token is secured by any guarantee or collateral. Depending on the characteristics of the token, it is even possible that the token is so unique that the general approach to distinguishing between the 3 main types of tokens (i.e. payment token, utility token, asset token) for tax purposes makes no sense at all and another solution must be found. The current practice is rather vague in this regard and therefore, a separate assessment of each token with the FTA may be necessary. Besides this, it must be evaluated whether the provision of any electronic service is involved in the transaction.
Depending on the perspective of the involved parties (Swiss/foreign seller or buyer) the following topics/questions should be considered when analyzing the Swiss VAT consequences:
- Qualification as payment token: generally irrelevant from a VAT perspective
- Qualification as asset token: generally Swiss VAT-exempt-without-credit transaction in the field of money and capital – however, maybe an exception applies (for example if a derivative right is linked to a physical delivery of a commodity – does the delivery effectively take place or was the token bought for speculative purposes and if yes, where does the delivery take place?)
- Token sold to a foreign buyer: a foreign VAT liability could be triggered for the seller
- Qualification as an electronic service: selling the token to a Swiss buyer could result in a taxable supply in Switzerland and may trigger a Swiss VAT registration (ruling recommended) – particularly relevant for foreign sellers
- Qualification as an electronic service: depending on the characteristics of the token, the purchase from a foreign seller could lead to the liability of the Swiss buyer to account for Swiss reverse charge VAT
In the example case described above, under consideration of their specific transaction, the sale of the token was considered as Swiss VAT-exempt-with-credit as the place of supply was abroad. It was recommended to file a ruling with the FTA if the token would be sold to Swiss recipients, as it cannot be ruled out that the transfer/sale of the token qualified as an electronic service and as such might trigger a taxable supply / VAT registration in Switzerland. The FTA’s current practice requires a case-by-case assessment. The electronic service can only be excluded for sure if the token qualifies as a payment token.
Selling/purchasing the physical commodity when exercising the token
The transaction qualifies as physical supply of goods. Based on this, the VAT treatment depends in general on the place of supply. It must be evaluated as to whether the traded commodities are traded in or through Switzerland in order to determine the applicable Swiss VAT treatment.
Paying fees to the Swiss platform
It must be evaluated if the services provided by the Swiss platform qualify as electronic services for Swiss VAT purposes. In the case of an electronic service, the recipient’s domicile is decisive for the Swiss VAT treatment.
Tokenization of assets is an exciting and innovative development that opens a lot of new opportunities for the financial market. The example analyzed above is intended to illustrate the various Swiss VAT issues that might arise with tokenization – but there are many more. Given the relative novelty of tokenization and its treatment by the authorities, it can be helpful to consult an experienced and knowledgeable third party to support your token trading activities. In this fast-developing area, external tax and also regulatory expertise (which is not part of this blog) will also help you extract value from your business while remaining compliant with tax laws, financial market laws, licensing requirements and reporting duties.