Disclaimer: the information contained in this blog post should not be construed, as legal, accounting, or tax advice or opinion provided to the reader by Andy Lee, CPA or IdentityMind Global. This material may not be applicable or suitable for the reader’s specific circumstances of needs. Therefore, the information should not be used as a substitute for consultation with professional legal, tax or other competent advisors. Please consult your advisors before taking any action based upon this information.
Many companies are considering conducting an initial coin offering (ICO). Some companies are even shopping around for a country to incorporate and launch their ICOs from. Switzerland, Japan, and Estonia are among some of most popular locations, as some of the local regulations, including the tax rates, can be more favorable. However, the question is, is it tax-favorable for a company to undertake its ICO in a foreign country? Maybe, but you need to know the rules.
Companies conducting ICOs often think of taxes as the second most important thing, right behind raising interest for their project. Subsequently, there is a scramble to understand the regulations of a myriad of different jurisdictions. However, it doesn’t matter where you go, under the U.S. tax system, any foreign corporation that’s more than 50% owned or controlled by a U.S. shareholder or a collective group of U.S. shareholders has U.S. tax obligations. Any such company is generally referred as a “controlled foreign corporation” (“CFC”). A CFC’s earnings are deferred from U.S. taxation until they are repatriated to the U.S. parent (i.e., as dividends). However, there are certain anti-deferral provisions where, if CFC generates certain types of income such as passive income, including capital gains from selling warrants, such income would be immediately taxable in the U.S. to the U.S. Parent, even when such income is still kept in the CFC and nothing has been repatriated yet. We generally refer to these anti-deferral provisions as “Subpart F.”
A CFC’s capital gains from selling warrants would likely be Subpart F income. What is a warrant? A warrant is “a derivative that confers the right, but not the obligation, to buy or sell a security, normally an equity – at a certain price before expiration.” Does that sound like token sales in an ICO? This is not legal advice and I will defer to your attorney or CPA to answer that question. However, if the answer is “yes”, then token sales are equivalent to sales of warrants in nature, and the CFC would need to recognize capital gains, which would be treated as Subpart F and taxable immediately to the U.S. Parent/ shareholders. Remember, the determination of whether a company has Subpart F should be made in accordance with the U.S. Internal Revenue Code, not the local regulations and regardless of how the local regulations view such money.
What if the foreign company that is launching the ICO or token sale is less than 50% owned by U.S. persons? Well, there is another anti-deferral provision under the Internal Revenue Code called “PFIC” income, which stands for “passive foreign investment company” income that could be relevant. Defined in Sections 1291 through 1297 of the U.S. income tax code. A passive foreign investment company (PFIC) is a foreign-based corporation that exhibits either one of two conditions:
- At least 75% of the corporation's gross income is "passive," income that is derived from investments rather than from the company's regular business operations.
- At least 50% of the company's assets are investments that produce income in the form of earned interest, dividends or capital gains.
Unfortunately, PFIC is very difficult to deal with and could have much worse U.S. tax impacts than the Subpart F income. You are likely going to want to avoid it.
Bottom line, if a company that’s at least partially owned by U.S. persons is thinking about ICO, it should think about the pertinent U.S. tax implications and plan ahead. Remember, you can’t do taxes in reverse, and finding an expert up-front can save you in the end.