20 April 2021

Delegation of Tokens, Staking Rewards and VAT

  • Articles
  • Tax
  • Banking / Insurance
  • Blockchain / Digital Assets

For VAT purposes, the delegation of the "staking function" of tokens is in principle to be qualified as a taxable service of the token holder to the validator. A corresponding ruling request was positively confirmed by the FTA.

  • Fredrik Dekker

    Tax Advisor

  • Thomas Linder

    Tax Partner
Current blockchain protocols use - instead of the proof-of-work algorithm known from Bitcoin or Ethereum (also called ""mining"") - a proof-of-stake algorithm and thus allow token holders to participate in the consensus mechanism as validators and receive remuneration (staking rewards) for doing so.

Instead of participating in the network as a validator themselves, the protocols usually also allow token holders to delegate the corresponding ""staking function"" of the token (i.e., the technical ability to participate in the consensus mechanism) to other validators. In this way, the ""staking functions"" of the delegated tokens are available to the validator to increase his own stake and support him in being able to perform his own validation activity more successfully.

Validators who want to open themselves up for delegation can often create a special ""Staking Pool"" Smart Contract for this purpose. In the corresponding smart contract, the validator defines the compensation to the token holder for his delegation. The delegated tokens always remain under the control of the token holder, so that the validator - except for the use of the ""staking function"" for his own validation activity - has no possibility to otherwise dispose of the tokens or to use other functionalities. The distribution of the newly created tokens to the validator and delegator is automated according to the specifications in the smart contract.

The transfer of tokens to providers of custody services (so-called custody wallet providers), which either accept customer deposits in virtual currencies on their own wallets and maintain respective accounts or manage customers' third-party tokens on segregated wallets, and at the same time offer services in connection with staking, must be distinguished from the technical possibility of delegating the ""staking function"" described here.

 

Legal basis and published VAT practice

The following fundamentals are relevant to the topic described:

  • Pursuant to Art. 18 (1) of the VAT Act, domestic services that are provided for consideration and for which there is no tax exemption are subject to VAT.
  • Pursuant to Art. 21 (2) (19) of the VAT Act, various transactions in the field of monetary and capital transactions listed in the VAT Act are exempt from tax. These include, among others, the granting and brokering of loans as well as the management of loans by lenders (lit. a), transactions with deposits and payments (lit. c), transactions relating to currencies (lit. d), transactions with securities, uncertificated securities, or derivatives as well as with shares in companies and other entities (lit. e) or the offering of shares in collective investment schemes and their management (lit. f).
  • Subject to Art. 8 (2) VAT Act, the place of supply of services is deemed to be the place where the recipient of the service has the registered office of the economic activity or a permanent establishment for which the service is supplied or, in the absence of such a registered office or permanent establishment, the place of residence or usual stay (Art. 8 (1) VAT Act).
  • Cryptocoins/tokens are units of value that are generated decentrally via a predetermined mathematical process within a computer network on a blockchain. Cryptocoins/tokens can be provided with any functions. Basically, three main types can be distinguished: Payment coins/tokens, utility coins/tokens and investment coins/tokens (asset [backed] coins/tokens) (MI 04, section 2.7.3.1).
  • Transactions on a blockchain must be validated and verified by the network nodes of the respective blockchain network through a defined consensus mechanism in order to be executed. Each blockchain has its own consensus mechanism, which ensures that all participants agree on their data. Two widely used mechanisms are called Proof of Work (so-called mining) and Proof of Stake (so-called staking), although other methods or hybrids are also used. Compensation for such validation or verification activities carried out by means of software is usually provided in the form of a so-called block reward (newly created units of the corresponding cryptocoins/token) and/or a transaction fee (MI 04, section 2.7.3.5).
  • If the validation activity is compensated exclusively by means of new cryptocoins/tokens generated automatically by the network (so-called block reward), there is no party that expends an asset for the receipt of a service. Under these circumstances, there is no service relationship in the validation of transactions, which is why the block reward does not constitute a taxable remuneration (Art. 18 para. 2 VAT Act). If, on the other hand, the compensation for the validation of a block takes the form of a transaction fee, which is paid by the sender to the validator for a specific transaction via the network, there is in principle a taxable service relationship between the sender and the validator. The validation of a transaction for a service recipient in Switzerland is subject to tax as an electronic service at the standard rate (Art. 18 para. 1 VAT Act in conjunction with Art. 8 para. 1 VAT Act).
  • In ""pool staking"", the holders of staking cryptocoins/tokens can join a staking pool by delegating their stakes, for which they are usually compensated with a share of the transaction fee collected through staking. The staking pool operates the staking software. There are tax-relevant services between the staking pool and the individual participant. The place of these services is determined by Art. 8 (1) VAT Act (MI 04, para. 2.7.3.5).

 

VAT assessment

As explained above, in the case of delegation by smart contract, the token holder transfers its ""staking function"", i.e., the technical possibility to participate in the consensus mechanism, to a validator for use for its own validation activity. Accordingly, the delegation of the ""staking function"" is in principle to be qualified as a taxable service (Art. 3 lit. e No. 1 MWSTG) of the token holder to the validator. A tax exemption foreseen in the VAT Act for the present service is not apparent.

Since the tokens remain under the control and thus in the ""possession"" of the holder at all times in the case of a delegation of the ""staking function"", this is to be distinguished from the transfer to providers of custodial and administrative services, but also does not constitute a turnover in the field of money and capital transactions.

Regarding the place of supply, in the absence of a special rule, the principle of the place of the recipient applies (Art. 8 (1) VAT Act). The corresponding services are therefore only subject to Swiss VAT if the validator is domiciled in Switzerland as the recipient of the services.

A corresponding ruling request concerning a specific project was positively confirmed by the VAT Department of the Federal Tax Administration.

 

Summary

Since, in the case of delegation via smart contract, the token holder transfers its ""staking function"", i.e., the technical possibility to participate in the consensus mechanism, to a validator for use in its own validation activities, the delegation of such ""staking function"" is in principle to be qualified for VAT purposes as a taxable service provided by the token holder to the validator.

The delegation of the ""staking function"" must be distinguished from the transfer of tokens to providers of custody services (so-called custody wallet providers), which either accept customer deposits in virtual currencies on their own wallets and manage respective accounts or manage customers' third-party tokens on segregated wallets, and at the same time offer services in connection with staking. Depending on the design, these services might be VAT-taxable services (e.g., custodial services, Staking-as-a-Service, etc.) or VAT-exempt services in money and capital transactions (e.g., account management, interest, etc.) of the custody provider.

Finally, if a party acts as a validator itself, the validation activity qualifies as a taxable service for VAT purposes, provided that not only a block reward but also a transaction fee is collected. A block reward alone, on the other hand, does not constitute a taxable remuneration according to the practice of the tax authorities.

However, there are still many open questions regarding the VAT qualification of transactions in decentralized networks, such as whether, in the case of a validation activity, the individual sender of the validated transaction or the cybernetic system as a whole is considered the recipient of the service, which service relationships qualify as electronic services, or how a place of supply can be determined in a decentralized network.

We therefore recommend that you examine each situation in detail regarding the specific VAT consequences. We will be happy to assist you in this regard!

 
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