Tax Journal

VAT and intangibles: VAT in a blockchain world

Date: 
14 February 2018
SPEED READ

The supply of intellectual property falls within the general VAT rules for the place of supply of services. The CJEU’s view in Hedqvist (Case C-264/14) is that transactions in cryptocurrency are exempt for VAT purposes; this does not mean that transactions paid for in cryptocurrencies are exempt from VAT, however. Blockchain is the electronic database which registers cryptocurrency transactions; and it is designed to operate without the control of a central authority. Although bitcoin is known for its anonymity, there is no intrinsic reason why a blockchain cannot hold information about the owners of assets, making it possible to trace back through transactions. Tax authorities have appeared enthusiastic about adopting blockchain for administrative purposes; it has even been proposed as a mechanism for a post-Brexit customs system. With blockchain also being adopted as the basis for private currency through an increasing number of ‘initial coin offerings’, as businesses seek crowd-funding, a number of cases have raised the question of whether such use of the technology amounts to prepayment or vouchers for VAT purposes.

Anne Fairpo (Temple Tax Chambers) examines VAT in a blockchain world.

Intangibles – in general terms – have had a reasonably stable VAT treatment for a while: the grant of any rights in respect of intellectual property, and the transfer or assignment of any intellectual property, is regarded as a supply of services for VAT purposes (being a supply of something other than goods). As such, VAT at the applicable rate must be charged by a VAT registered licensor on royalties and similar licence payments. For transactions within the UK, that will be 20%.
 
The supply of intellectual property falls within the general rules for the place of supply of services, so VAT will be determined by where the recipient belongs for VAT purposes unless the supply is not to a relevant business person. A supply of intellectual property to a business in another member state can therefore be zero-rated as an export; the recipient will be required to effectively self-assess for VAT under the reverse charge provisions.
 
Where a UK business receives such a supply from outside the UK, it will, of course, similarly be required to self-assess for UK VAT under the reverse charge provisions. This means that any business that sources its web or email hosting outside the UK, uses a Dropbox account or pays for any form of software as a service from a non-UK provider needs to account for that transaction under the reverse charge.
 
It should be noted that ‘use and enjoyment’ provisions may apply to change the place of supply of services in certain circumstances. The UK has relatively limited use and enjoyment provisions (primarily in connection with telecoms and broadcasting, where the EU has set out the provisions). Other member states have made more extensive provisions, however, which may result in a change in the place of supply; although this could affect any supply of services, it is in connection with intellectual property and similar intangible services that use and enjoyment are most often applied.
 
Supplies of intellectual property to a consumer will be subject to UK VAT; it should be noted, though, that it would be unusual to supply intellectual property to a consumer. The more usual transaction is a supply of digitised goods – a book or a CD, for example. The licence agreement for such supplies is usually very restricted, so that it is not usually regarded properly as a supply of intellectual property, as the user obtains only the minimum rights needed to use the digitised goods.
 
The VAT rules relating to electronically supplied services and similar digital services supplied to consumers (i.e. non-business customers) are increasingly focused on the place where the consumer is based. This has, of course, been the case within the EU for three years now, with the mini one-stop shop (MOSS) scheme to simplify matters. However, some businesses have not quite realised that the EU is not the only country with such a system. Australia requires foreign businesses to collect and account for goods and services tax (GST) on digital supplies to consumers (albeit with a $75,000 threshold); South Africa and others do the same – and some have a zero threshold for compliance (as does the EU).
 
For UK businesses, it should be noted that the MOSS scheme currently operated by HMRC is an EU scheme and so will fall victim to Brexit. The non-EU scheme, for businesses in non-member states, requires registration in at least one EU state. Businesses operating under MOSS should start making plans, if they have not already done so, for continued compliance in a post-Brexit regime.
 

Blockchain and VAT

 
Turning to some more specific, recent, headlines that relate to intellectual property, the rise and (at the time of writing) the slide of bitcoin has brought cryptocurrencies to the headlines and, fairly inevitably, has led to questions and queries about the tax status of bitcoin. The questions aren’t entirely new: HMRC released it’s Brief on cryptocurrencies in 2014 (Revenue & Customs Brief 9/2014), prompted by a CJEU case on the VAT status of bitcoin transactions. (The first article I wrote on virtual currencies was in 1998, for this journal!) Every so often, the media cycles through bitcoin and tax.
 
From a VAT perspective, at the EU level at least, bitcoin (and cryptocurrency in general) isn’t causing too many waves. The CJEU’s view in Hedqvist (Case C-264/14) is that transactions in cryptocurrency are exempt for VAT purposes under article 135(1)(e) of the Principal VAT Directive. This exempts transactions ‘concerning currency, bank notes and coins used as legal tender’ from VAT. There was – and continues to be – a fair amount of debate as to whether cryptocurrencies are currency. (They’re definitely not legal tender, which has a surprisingly narrow definition.) The US, for example, takes the view that cryptocurrencies are property (IRS Notice 2014-21) and do not fall within the US tax rules that apply to foreign currency transactions. The CJEU sidestepped the point somewhat, concluding that cryptocurrency is a contractual means of payment and therefore within the scope of the exemption. It took the view that linguistic differences between member states meant that it was necessary to interpret the position ‘in the light of the context in which it is used and of the aims and scheme of the VAT Directive’.
 
In practice, this means that the services of a cryptocurrency exchange are exempt from VAT. It does not mean that transactions paid for in bitcoin are exempt from VAT. The usual rules continue to apply there. In the UK, for example, a business accepting bitcoin would be required to convert the transaction into sterling in order to account for VAT to HMRC. Over recent months, this has raised some practical problems, as there may be a significant difference in the value of bitcoin at the moment the transaction is initiated and the moment at which it is recorded on the blockchain, which can be hours later. Fiat currencies do not usually fluctuate with the vigour of bitcoin, so this hasn’t traditionally raised much of a problem. The market, it should be noted, may be resolving the problem in any case. A large payment processor, Stripe, recently announced that it will stop accepting and offering bitcoin as a payment mechanism because it considers that it is no longer accepted by vendors, due to the substantial fluctuations, and believes that most bitcoin owners are holding it as an investment rather than a payment mechanism.
 
The Hedqvist decision referred to bitcoin specifically (Mr Hedqvist, a Swede, was planning to set up a bitcoin exchange) but should apply to any cryptocurrency that is used as a method of payment. The exemption means that some questions raised by cryptocurrencies in general are sidestepped: the key question being, where does the transaction take place? The cryptocurrency is decentralised (see below) and exists everywhere that a copy of the blockchain for that cryptocurrency exists. Transactions are recorded on every copy of the blockchain, so a transfer from A to B will be recorded in A’s country, B’s country and every other country where there is a holder of the blockchain.
 
For VAT, the issues are slightly less complex than for other areas of tax. The place of supply is generally driven by the place of the supplier or the place of the purchaser; only a few very specific types of supply take place where they are performed, and none of those are intangible in the right way to be able to use blockchain. For direct tax, and territorial tax systems, it remains the case that cryptocurrencies raise some situs issues that have not yet been properly resolved.
 
Bitcoin, however, is only one manifestation of a form of intangible: blockchain.
 

A brief word about blockchain

 
Blockchain is an electronic database, a register of assets: that’s pretty much it, although it can be put to myriad uses. Where it gets interesting is that blockchain is designed to operate with no central authority, so that there need be no single authoritative entity controlling the register.
 
Transactions in the assets can be – and in the case of cryptocurrencies are – validated on the blockchain. Security exists both through the use of cryptography and due to the fact that, to alter one of the records in the blockchain, it is necessary to change every single copy of the blockchain to reflect that change. A non-validated change won’t be replicated through the blockchain copies; any change to an existing block will show up as tampering. The breaches of security on bitcoin that hit the headlines from time to time have been breaches of bitcoin exchanges, rather than the central blockchain.
 
Transactions are recorded in new blocks: a blockchain holds the entire history of all transactions on the blockchain. Once an asset is transferred from vendor to purchaser, for example, the validated transfer is a new block, with the previous ownership (and any ownership before that) maintained on the blockchain.
 
Bitcoin is known for its anonymity. It’s similar to physical cash, in the sense that it isn’t intrinsically feasible to identify the owner of any particular bitcoin asset; that’s a choice that was made when the cryptocurrency was launched. However, there is no technological reason why a blockchain-based cryptocurrency cannot contain identification of owners of the cryptocurrency. Bitcoin is not, in fact, absolutely anonymous. If you know a person’s bitcoin key, you can identify their transactions: the blockchain contains all transactions ever carried out in respect of any issued bitcoin, including the details of the keys involved in the transaction. By the way, this does mean that the blockchain can get fairly large: the bitcoin blockchain was approximately 149GB in December 2017 (per statista.com).
 
There is therefore no intrinsic reason why a blockchain cannot hold information about the owners of assets within its database. On such a blockchain, it would be possible to trace the ownership of assets back through transactions to the inception of the blockchain. This is one of the reasons why blockchain is being considered by (for example) HM Land Registry, and is also being considered by others to record and trace the ownership of assets such as ethical diamonds.
 

Back to VAT

 
The interesting aspect of blockchain for VAT (and maybe for tax in general) is that, in a fiat cryptocurrency, the technology could be used to ensure VAT is collected on every single transaction. This won’t work on bitcoin specifically – not without some other system being involved – because it’s not built to work that way.
 
Any transaction on the blockchain in a cryptocurrency involves the following:
 
  • a transfer initiated by the purchaser (the person transferring the currency) of X amount of the currency;
  • a direction to the system to return any change from the purchaser’s holding to the purchaser (otherwise the transaction could be a bit more expensive than anticipated); and
  • a fee for the blockchain participant that resolves the transaction (not strictly needed, but transactions with no fees tend not to get processed).
There’s no technological reason why that transaction couldn’t require another step: transfer a certain amount to the tax authority as payment on account of tax (VAT and direct tax) on the transaction, and require the tax authority’s confirmation of receipt before the transaction is validated. The blockchain would hold all that data: not only the transaction between purchaser and vendor, but also the record of taxes accounted for. Carousel fraud would become rather more difficult (at least, with that particular cryptocurrency). There are, inevitably, likely to be a few civil liberties questions involved, but it is a technically feasible arrangement – and something that is not practically feasible in the traditional banking system.
 
A very detailed proposal was put forward for a blockchain implementation of VAT in the United Arab Emirates, for example. It was not implemented, perhaps because it was a bit ahead of its time: being technically feasible isn’t the same thing as being practical to implement at a reasonable cost for participators, let alone the government.
 
Tax authorities, far from being bothered by blockchain, seem quite enthusiastic about it for administrative purposes – unsurprisingly. Blockchain has even been proposed as a mechanism for a post-Brexit customs system. Making tax digital may, in the next five to ten years, get very digital indeed. Watch this space…
 

Another current blockchain use: initial coin offerings

 
Moving back from the administrative uses of blockchain to its uses as a type of currency, it’s not just bitcoin grabbing headlines. Over the last year, there have been an increasing number of ‘initial coin offerings’ (ICOs) as businesses seek to raise money. ICOs are a form of crowd-funding: the usual arrangement is that the business, instead of offering equity participation through shares, sells its own ‘coins’ to purchasers and then uses the money to build the business or develop a new project. The ‘coins’ may be redeemable against future products or services from the fundraising business. The ‘coins’ are, of course, recorded on a blockchain, and are often purchased using a cryptocurrency such as bitcoin.
 
So far, so kickstarter.com, or any other form of funding by early purchase. The difference with these ‘coin’ offerings, though, is that they are usually tradeable. The original investor doesn’t have to wait until a service or product is developed to be able to benefit from the ‘coin’ acquired. The ‘coin’ may be able to be sold on an exchange (rather like a cryptocurrency, in that sense) in the interim.
Although similar to cryptocurrency, the ‘coins’ aren’t quite the same thing. Instead of being a method of payment, widely used, they can be redeemable for a particular product or service (although, being tradeable, there’s no particular reason why a vendor couldn’t accept a ‘coin’ if it chose to do so). The product or service might well be vapourware, and never appear, but there is at a least a theoretical link to something, unlike bitcoin or other cryptocurrencies.
 
It should be noted that some ‘coins’ carry other types of rights, such as the right to participate on an advisory panel – or, possibly, even equity rights. The issue of these types of ‘coin’ is unlikely to be regarded as being within the scope of VAT, as there is no service or goods being provided in exchange for the money provided.
 
But for those ‘coins’ which carry an entitlement to redemption for something in the future, therein lies the VAT question. What are these: prepayments, vouchers or something else? The question was raised in respect of cryptocurrencies generally at one point, although it was effectively agreed that, because they can be (theoretically) used anywhere, for anything, a cryptocurrency as such is not really equivalent to a voucher as there is no link to any predetermined service or goods. But ‘coins’ are, or can be, rather different – and so there is at least some prospect that one or more governments could wake up to the fact that they might possibly be vouchers for tax purposes.
 
Considering this issue, the recent case of Lunar Missions [2018] UKFTT 7 might offer some indicators of the VAT treatment of ‘coins’ which are redeemable for goods or services. Lunar Missions Ltd raised funding via Kickstarter for a project to send an unmanned landing module to the south pole of the moon in order undertake some scientific experiments. The rewards for those funding the project were all based on a time capsule to be buried on the moon, and included vouchers which could be used towards ‘digital memory space’ and/or physical space for a strand of hair in that time capsule. The rewards were freely transferable, so there was no requirement that the funder be the person to provide data to go into the digital memory space, or a strand of hair for the physical space.
 
The Lunar Mission case is particularly relevant here because the reward for funders was a voucher, in circumstances which are arguably equivalent to certain types of ‘coin’ in ICOs. The case is different to many other Kickstarter projects, as these tend to offer specific rewards (a gadget, a downloadable song, that sort of thing), rather than a voucher that can be used towards something at a future date.
 
The court held, as with Findmypast Ltd [2017] CSIH 59, that the transaction could not amount to a prepayment for VAT purposes, as there was considerable uncertainty as to what, if anything, would be provided to funders. For something to amount to a prepayment, there must be some degree of certainty as to what will be provided and that it will in fact be provided (VATA 1994 s 6(4)). The same principle will almost certainly apply in the case of most ‘coins’: there is no guarantee that the project being funded will succeed, let alone that it will deliver the type of service envisaged at the time of funding.
 
However, the court was able to conclude that what was offered was a face value voucher, because it was redeemable for space up to a specified value, and that it was a single purpose voucher, being redeemable for space in a time capsule. Even if the digital memory space option was chosen, that would still be held on physical storage, which would take up physical space in the capsule. VAT was therefore due on the issue of the voucher.
 
There is potentially a clear analogy with ‘coins’ that are redeemable for future services. It is unlikely that the possible range of services for which the ‘coin’ can be redeemed will vary so much that they are considered to be different types of supply (and, of course, there is current consultation on extending the definition of single purpose vouchers to cover vouchers which can be redeemed for a range of supplies which all have the same VAT treatment).
 
What may need to be carefully considered, however, is whether a specific ‘coin’ is a face value voucher in the first place; in particular, whether it carries a right to receive services to a value specified in or on it. If the ‘coin’ can be exchanged for defined services (such as a block of cloud storage space, where the funding is being used to develop cloud storage facilities), regardless of the value of those services at the time of redemption, it might not meet the conditions that are required for something to be a face value voucher. The point will depend, inevitably, on the terms on which the ‘coin’ is issued – if, instead, it is redeemable for cloud storage space (to continue the example) up to a defined value, it would seem likely to find itself in Lunar Mission territory.
 
As always, it comes back to the contractual terms. These might, one day soon, be encoded in a smart contract on a blockchain. And so it goes…
Issue: