The new DLT rules will come into force next October in Malta. If you’re a professional working in this space, potential issuers will contact you because they like the regulatory regime. But they will also ask you a few questions you’d better know how to answer. Such as: will the funds raised in an ICO be taxable?

To be able to answer this question, one first needs to determine the profits recognised in accordance with IFRS (the accounting standards adopted by the EU). After that, certain tax provisions may adjust your tax base – for example, an exemption might reduce your tax base.

Since, no specific tax rules exist in respect of ICOs, establishing the accounting treatment for the proceeds raised in an ICO will also determine the tax base of such an event.

The three possible accounting treatments for proceeds raised in an ICO are treating the proceeds as equity, liability or else as revenue.

The first option only applies if the issuer issues a security token and the second option shouldn’t apply because an issuer isn’t committed to redeem the tokens at any point in time. The third option is tricky as IFRS 15 stipulates when and how to recognise revenue. At a high level, revenue should be recognised: if there is a contract with the customer; if the contract stipulates a performance obligation (in other words, the supplier is committed to provide a service/ good to the customer); and revenue is recognised when (or as) the performance obligation is satisfied. This is a condensed version of the five-step approach IFRS 15 sets out.

The issuer’s performance obligation is to build the platform

So let’s go through each of these three steps and identify if the proceeds received from the issue of utility tokens constitute revenue in the hands of the issuer.

First, is there a contract? If you like, the White Paper is a contract where the issuer is entering into a commitment with investors to build a platform as set out in the White Paper. I think it’s safe to say that the first condition is satisfied.

Second, what is the performance obligation? Utility tokens are sometimes compared to arcade tokens. The player exchanges fiat to arcade tokens and arcade games accept only such tokens. In a scenario where all the arcade games are provided by third parties, what is the performance obligation of the arcade (read issuer too)?

To my mind, the issuer’s performance obligation is to build the platform (or whatever else it committed to in the White Paper). So, in a scenario where the arcade operator issues one million tokens on a first come, first served basis for €1 million, the arcade provider builds an arcade, the tokens may not be redeemed and the arcade may not issue further tokens, and instead, players transfer the tokens to the suppliers of the arcade games each time they play and the suppliers then sell the tokens on an exchange in return for fiat (or other tokens).

Then, the €1 million raised on the sale of tokens should constitute revenue and the performance obligation of the arcade operators is the provision of an arcade.

Should an issuer recognise the proceeds raised in an ICO as revenue on the first day, and possibly also pay tax on it on the first day?Revenue recognition under IFRS 15 is based on transfer of control and control is defined as the ability to use and obtain substantially all of the remaining benefits associated with the asset.

 Also, IFRS 15 states that if control is not transferred immediately, revenue should be recognised over time as the performance obligation is satisfied. When is control transferred in the context of an ICO?

In principle, I believe that transfer of control occurs when the issuer builds and goes live with the platform.

Accordingly, the proceeds raised in an ICO should be recognised as revenue when the platform is made available (or using our analogy above, when the arcade opens its doors).

Now that we determined the accounting treatment (and consequently the tax treatment) of the proceeds raised in an ICO, an issuer will also want to consider its deductible expenses for tax purposes. After all, the building a platform on the blockchain is not a small endeavour. The net (if it’s a surplus) should be subject to tax.

Chris Grech is an accountant with a special interest in technology, financial markets and blockchain. He is the current CFO for SiGMA and the Malta Blockchain Summit.