Bitcoin and other cryptocurrencies are back in the news and the general verdict is that they are here to stay. Consequently, the demand and interest in incentivizing employees with tokens has increased as well. What are the employer tax compliance obligations when it comes to token-based compensation, and what penalties can be expected in the event of non-compliance in Switzerland?
Favorable regulatory environment
As an early sign of Switzerland’s positive attitude toward cryptocurrency and the underlying blockchain technology, the Swiss federal council published the legal framework for distributed ledger technology and blockchain in Switzerland in December 2018. The Swiss Financial Market Supervisory Authority (FINMA) followed by publishing their guidelines in February 2020, which classify tokens as an asset and differentiates between utility and payment tokens to be applicable under the financial market law.
Further guidelines for enquiries regarding the regulatory framework of ICOs (initial coin offerings) and token characteristics can be found on the FINMA website.
The equivalent to classic restricted stock (RS) in the world of blockchain and cryptocurrencies are restricted tokens (RT).
Once granted by an employer, the recipient is eligible to acquire the company tokens immediately, which makes the recipient the legal owner of the tokens, with all legal entitlements (e.g. including voting and dividend rights, in the case of payments tokens). Despite being the legal owner of the tokens, restricted tokens are usually subject to specific conditions like performance targets or milestones between the grant and vest dates, commonly referred to as the “vesting period”. Should the recipient not meet these restrictions or terminate employment in advance of the vesting date, such tokens can be reclaimed by the employer, based on the ICO plan.
Like stock awards, the taxable event of RT is usually at grant and the taxable value is determined by the number of tokens issued, multiplied by the fair market value (FMV) of the tokens at the taxable event. Similar to other equity-based compensation, the discounted rate based on the period of restriction (blocking discount) also applies to RT.
The taxable event has a potential impact to the employer’s obligation with respect of the token-based award, as there may be a payroll tax reporting and withholding requirement. This depends on several variables, such as, the recipient’s tax residency status, which may expose companies to tax compliance risks and penalties and interest, if disregarded. In any case, social security withholdings will be due at this time.
Restricted Token Units
Restricted token units (RTU) resemble restricted stock units (RSU) in the way they are treated.
At grant the employer promises to issue the recipient a certain number of tokens in the future, which are tied to specific requirements that must be met during the vesting period. A crucial difference to RT is the ownership characteristic of the RTUs, as the recipient only becomes the legal owner at vest, which is also the taxable event.
Failure to meet the requirements during the vesting period typically, depending on the leaver circumstances, lead to the loss of unvested tokens granted, similar to RT. Like restricted stock awards, the taxable value is determined by the number of tokens issued, multiplied by the FMV of the tokens at the taxable event (vest), which are subject to ordinary income tax and social security contributions.
As the vesting period typically extends over a longer period (e.g. 3-4 years), various tax compliance risks can occur between the grant and vest date, particularly where the recipient has worked in multiple tax jurisdictions. Multi-country payroll reporting and withholding compliance is the most common and complex challenge for multinational corporations delivering token awards. Depending on the relevant tax legislation, employers may be required to apply withholding and remit taxes in more than one jurisdiction with respect to a single award. Individuals, on the other hand, can suffer from double taxation in multi-country situations, which can cause frustration, impact cashflow and diminish employee satisfaction. In order to mitigate such risks, responsible employers typically seek expert advice to determine the correct rules in each jurisdiction.
For Swiss tax purposes, any profits made on the sale of RT/ RTU after the restrictions are lifted are considered as tax-free capital gain and not subject to income tax or social security contributions.
Traditional stock options are akin to token options (TO), which grant the recipient the right to purchase a pre-determined number of tokens at a certain price, at a specified future point in time.
Similar to RT and RTUs, token options are tied to certain requirements, which need to be met during the vesting period. Once vested, the recipient becomes the legal owner of the TO, and then decides when he/ she wants to exercise the token options at the agreed strike price. Depending on the tax jurisdictions involved, TO will likely be treated as non-qualified stock options from a taxation perspective.
As with traditional stock options, the taxable value is determined by the difference between the strike price and the FMV at vesting multiplied with the number of tokens exercised, which would be subject to income and social taxes in Switzerland. Additional tax compliance complexities come into play compared to restricted token units, as the sourcing period can differ per jurisdiction. For instance, some countries consider the taxation period to be between grant and vest of the tokens, whereas other countries consider grant to exercise as the taxation period. Such considerations are key for sourcing correctly in multi-country taxation scenarios.