Risk Framework for Digital Assets from the Regulatory & Tax Perspective

Transcript

super thank you very much and welcome uh to our session we're happy to be here um my name is Thomas slinder I'm a tax partner at mme and my colleague Andreas cloner is a legal partner and that's why we try to cover both topics Regulatory and tax um with regard to uh digital assets mme is a firm in the heart of crypto Valley so we have offices in T and in surk and we're around 130 uh people there but we are not only doing fintech so we are a certainly an

advisory firm in in a lot of different topics but around 20 25 lawyers tax experts compliance experts um of our team are PR dominantly working with uh DLT based projects and are doing uh nothing else than trying to solve Regulatory and tax issues and uh 10 years ago we had the privilege um to support ethereum foundation with the establishment of the foundation in Switzerland and we've organizing The Ether pre-sale and uh it really feels like centuries so 10 years went went by very fast on one hand but a lot of different things happened in the

meantime and um while supporting Banks exchanges and and financial intermediaries with uh implementation of digital Assets in their uh services and in their infrastructure um we had to deal with a lot of regulatory and tax questions and our learning actually just in general is you need to understand the technology T up front need to understand the te technology and then you can try to understand the legal the tax the comp compliance um consequences and implement the clear framework uh to manage the risks but the most important learning is do you need to work with brilliant

people and that's why now I hand over to Andreas uh to give you an introduction to our risk framework for digital assets okay okay good morning cany does that work yes it does good morning also from my end um glad to be here in in Geneva so when we talk about this Digital Risk Frameworks risk Frameworks for digital assets what are we actually talking about and who is that addressed to um mainly it is addressed to uh any kind of secondary Market participants but we have been using this framework a lot for banks and uh other similarly regulated um clients of ours which need to be know

need to be in a position that they know what kind of assets are they actually dealing with uh and this not only from a pure kind of regulatory perspective so is it a uh payment token is it an asset a security token is it a utility token but also from a more risk-based approach what kind of risk do I bring into my house into my bank for example if I start uh providing custody Services trading Services staking Services related to a particular assets and what kind of viit consequences do I face so what we came up with and the first version has been uh created already I think back in 27 I believe it was uh the then called BCP risk framework uh that we have published

it's an open- Source document version two which has been released in 2019 is currently on our website available so you can visit that anytime um and we're currently working on version three um uh together with Signum bank so the next release will be a joint release of and mme and in updating that framework but uh what we want to do today is guide you through the principles of the framework the framework itself constitutes of two elements one is the concept that's what we're going to look at uh in in the next 30 30 minutes roughly 35 minutes and the other piece is really a a large very heavy Excel file which then you as a

bank a risk officer of a bank or someone being responsible for the digital digital Asset Risk framework adoption would then fill out for each particular token we can't display that on a screen it's simply too large there loads of questions so we focus on the concept in this limited time we have today um and we look at a concept here the U what does it consists of uh it essentially consists of four elements key element one is token functionality and then we look based on the understanding on the token functionality on the different tokens um impact on the regulatory level on the tax level particular V and on the risk

assessment level um and I think that's also the way we want to kind of go through today with you uh that you understand what how this framework is built up on and the first exercise we do token functionality essentially is nothing else than what lawyers typically do when they move into a new matter that look at trying to understand what is everything about what is the functionality what is actually the facts related to that particular assets is it a counterparty right is it a native token um what kind of layer is it operated on what kind of uh more objective um features does it have and I need to understand all of these features

to be able to assess then the regulatory consequences the tax consquences and also the risk consequences so this is normally uh the exercise we start doing and that we would advise that also the exercise everybody else will be start to do and then once you have that and I think it doesn't you know looking at the limited time we have today it doesn't make sense to discuss too much on the facts because it's different for each token we move right into the different risk assessment and the first one will be the regulatory token qualification can you move one slide forward and when we look at regulatory token qualifications We have basically no us

being here in Switzerland and many of our clients also being in Switzerland and being subject to Swiss law of course the Swiss perspective is the most important one uh to look at but next to that there are other crossborder um considerations that need to be made which we're not going to dive into too much today but depending on the market you uh t Target as as a service provider out of Switzerland for example you may be subject to M so you need to understand what other Mika rules applicable for particular digital assets you may be targeting other markets possibly the US market so the secse kind of practice comes into play so all of these consideration need to made on top

if you only look at a Swiss considerations to be made um you can move on we all know I I think I presume most of us know the the FMA Ico guidelines and just to recap on that a bit um these guidelines have been released in I think February 2018 that was so just shortly after the the big Ico hype ended that started 1617 so it was not the the guidelines who ended the Ico hype but uh simply the Beer Market but what was fma's kind of motivation to release that so FMA basically kind of watched the market

always was clear they did have some current rightfully had some legal concerns uh related to certain Market participants and those concerns related mainly to two elements one was AML regulations and the other one was kind of financial um product regulations security regulations and so they came up with this model of three token one token not being regulated one being subject to am regulations and one being subject to security regulations so if we go through that as a recap we have utility token token that represent some kind of a infrastructural access to a decentralized um technology uh typical example would be um Ease on ethereum so

you need ease to interact with the ethereum protocol in form of gas you need ease to be able to operate a node so you can stake that a classic iCal utility functions then we have payment token as the term says payment token serve as a mean of payment examples here will be Bitcoin a classical digital asset of for payments but also e another example and why e you may ask because I already said e was a utility yes indeed but e is a great example to demonstrate two things is at some point in time started to be used quite widely in a way as a

means of payment so I don't really know when that was and but at that time the qualification switch to a hybrid qualification so ease is now considered to be both a payment and uh utility token and that demonstrates basically that you can't only do your exercise once in the terms of qualification you need to redo it once in a while because token qualification can change over time and the third category are asset tokens so token that represent some kind of a revenue stream some form of a counterparty right a right to a dividend or similar um which then are being treated as Securities on the Swiss law

there are also some further tokens for example nonfunctional utility tokens so if you say I'm I'm releasing a utility token but the utility will be implemented at the later stage so after have built my stuff but the token is already out there until the functionality is there the token is treated as a security uh an additional exam example where a token could be a security is when you say I have a pure governance token like a dow token Dow governance style and my token controls onchain the governance of a treasury so in if in theory the governance participants could jointly decide to pay out the treasury to

themselves then this indirect monetary benefit that you can allocate through the governance to yourself would also qualifies a security so just to kind of give you a bit an overview on these types of regulatory consequences when you look at the token when you do that as part of the digital Asset Risk framework and now if you're a bank and you kind of do this exercise on a regular level when do you do that obviously before you start dealing with that token that's clear but do you can you only do it once not really as I said token qualification can change over time as we seen in the

example with ethereum with e so you need to redo that once in a while how often that depends a bit on the risk framework of the token of the total risk score a particular asset has and on your risk appetite as a institution but that's definitely like the key takeaway you can't only do that once and you can't you need to do that on a regular basis and how do you actually do that can you simply rely on a memo a client provides like a mme legal opinion which is of course very valuable no but um that isn't and even the FMA ruling is that sufficient um my response would be no you need to have your own assessment of

course it's very helpful to have a legal opinion it's very helpful even more to have a fim on non-action letter or ruling confirm confirming certain regulatory status of a token but all those opinions that kind of um they're only valid at the time they were issued so you need to do redo the exercise and we would advise that you have a certain kind of automated system internally where you can ask some questions on the facts and then it spills out the results say hey High likelihood of utility High likelihood of payment token and you work with that um and what you do I said at the beginning we have this very large Excel file that you kind of fill in all the

information and it then it prints out their score and this is just for you kind of so you can imagine how that could possibly look like you have a couple of questions related to token then you can answer these and you come out with a result here ethereum hyrid token utility payment as we said before so important key takeway ways on the regulatory qualification element and then I head it over to to viit which is a bit more complex than the regulatory side um you know know your tokens so really kind of understand the functionalities of a particular assets qualify it before you start activities and re-qualify or check the

qualification you have done on a regular basis Thomas excellent so now you've done this uh anal is everyone is happy you checked all the boxes okay maybe I need to fulfill AML but I'm out of Securities Law so let's go to market and then hopefully someone says but let's have a short look at taxes as well just to be sure that we don't any run into any risk why taxes it's it's just relevant from a financial perspective and uh I think if you do it wrong it can kill your business so and the special Focus is on vit because vit is on your turnover so it's a turnover

tax and uh it really can eat up all your all your margin uh and uh and and if if you set it up in an inefficient uh way maybe just the short ref Fisher for the ones that are not vat or tax advisers and they don't have all the details um that's the Swiss vat system so it looks quite complicated and it is so there are three different rates the own rate R is 88.1% uh usually applicable to Services um but there are also special rates and reduced rates for very specific um Services then you have three or four actually four different treatments of

transactions so you have taxable transactions that are subject to vat you have exempt transactions that are potentially subject to V but because it's as an example an export it's then exempt under the law then you have exempt transactions like Financial Services where you're not subject to vit but on the other hand you have a disadvantage that you cannot credit any VI that is charged to you um that is the exemption without credit and then there are out of scope transactions that are not subject to Vi at all like dividends or donations as an example because there you don't have a supply or services or a supply of goods and which transactions

are subject to V I already said it it's the supply of goods and supply of services uh and the definition there is that the supply of goods is granting the ability to economically dispose of an object in its own name so if I sell you this microphone that is a supply of goods and if you pay something for it then it would be subject to V and then the supply of services is actually every Supply that is not the supply of goods so it's aun Bish so it's it's a kind of a negative definition so everything you do and someone pays you for it might substantially or might be a service qualified as a service so that's IP uh

that there's licensing of rights that is actually if you promise not to do something and someone pays you that's also a service so it's a very broad definition and certainly also tokens Can Be services and the question is if you issue tokens if you trade with tokens it's always the question is it kind of out of this supply of service definition or is it in because if it's in then potentially 88.1% must be charged if you sell it to Swiss recipients and uh I said the margin maybe is gone if you need to charge 8.1 or the business is killed because no one wants to buy uh if they need to pay uh 88.1% in addition so

that was the short refresher on the vit system now if we look at tokens um there are also um Publications by the federal tax authorities about token qualification about the V treatment and we see here the same categories utility token payment token asset token so everyone is kind of relaxed and say ah now finma said it's a the utility so I know how to treat it from a v perspective not true so we have the same titles or categories but different definitions because again V doesn't care whether it's subject to AML or whether

it's subject to a Securities Law they care whether it's a supply of service or not and if yes to whom you render it and what is the remuneration for it and what is the location of the recipient so totally different Viewpoint so we need to do the same analysis again from a tax point of view so we have here on the left side we have also these three categories payment token utility token asset token payment token as such are out of scope of V so means of payment if I sell you a means of payment it's no service implemented in this in the in the means of payment right so it's just an

exchange exchange uh of means of payment is out of scope then utility tokens under the definition of v authorities are a supply of services so they are either taxable or exempt because these are Financial uh financial services that are re uh rendered so this category is in in theory taxable and then you have the asset tokens these are really the Securities um that are per definition exempt uh supplies um but there you need to be careful there might not be subject to V but we have stem duties in Switzerland

we have witholding tax in Switzerland so witholding tax applies to interest and dividend stem Duty applies to incor kind of contributions into Equity or trading of Securities so these tokens might be subject to other turnover taxes maybe not V but maybe St JY so I think where you see there then the fmar categories I think where we have the same kind of qualification is certainly if it's really a means of payment so then it's from a finma perspective subject to AML and on from a v perspective is no Supply so we don't have V on such transactions on the other hand I think also for the Securities so

if you have a share a bond a fund share that is tokenized um or certain contractual re rewards we would uh treat it from a regulatory perspective as a security and uh the same from a we perspective where we then have potentially withholding tax or stem Duty issues but everything in between kind of this utility tokens might be everything from a vat perspective so you said ether as a native token uh um was a utility changed into a payment token now from a mere V perspective we would ask is there really a defined service implemented in an

ether so yes I can access but it's not a defined service from a defined counterparty in a defined location so we a lot of of of the requirements from a definition point of view fall out so this utility would not be a utility from a v perspective it would stay a payment token the same for vouchers of values so if you have a voucher for 10 Franks to go to uh migro to to buy something that's not if you sell the voucher it's not yet a service because you don't know yet for what you will uh uh redeem it so what will really be the underlying uh Supply it's it's

just a voucher of value they're treated the same as payment tokens however as soon as it's a voucher of Supply where actually in the voucher or in the token it's already defined I will get one hour of tax advice from Thomas Linder resident in suich then selling this voucher is already a taxable service it's a prepayment of service so small differences can have uh big uh consequences certainly the same if you have taxable supply of goods of services rights implemented and as said you there you need to still do then the distinction is it really taxable or are we in the exempt uh area um like

Financial Services real estate and and some other transactions and if if I may add on that Thomas uh I think I mentioned the beginning you know the framework is designed for financial institutions yes it is as a whole but this question on you know are we moving in the field of a regulatory utility and are we ta tax exempt on the viit level yes or no that goes far beyond financial institutions and we we we kind of need to do this exercise very often when we support clients who have a kind of want to operate a very scalable uh application based solution related to digital assets

which digital assets may be traded in in a centralized way but you don't want to have a necessity to to identify users because you can't because it's fully web three based because you want to keep it open because it's designed for entertainment purposes or you don't want to have uh people forcing into kind of a a selfhosted wallet Solutions because he then can address a different Market segment which non- crypto savy users so there you need to remain in this utility token surroundings from a regulatory level but of course uh also from a VI level because it otherwise could kill your business model so this part goes far beyond financial services and

financial institution uh um it really applies to the whole Market as such and and and it's very important that already in the in the when you when you kind of Define the token functionality that you think about this uh aspects um because Andreas always tries to squeeze everything in this utility token category right it's unreg so wo so let's let's go for it but then I I try to get away from the utility and and and uh qualified as a native token as a v voucher of value that we are rather in this payment token category uh in the green part there from a VI perspective and and this

combination is kind of usual so all the layer one tokens have some utility from a regulatory point of view but are treated as payment tokens from a v perspective now just what does this mean so if you are we have here a bank we have a broker here in Switzerland um that is just exchanging tokens buying selling buying selling um you have on one hand you have you buy from from Brokers or or private people in Switzerland or you have foreign um suppliers and then on the other hand you sell to your customers in Switzerland outside of Switzerland or through some Brokers now if the token qualification is a payment or asset token just in

general your activity will not be subject to V so neither the input so the purchase nor the sale um will be subject to V and that's just normal kind of that's what you know as a bank and then and as a as a broker you have Financial Services they are exempt you don't really care about uh the tax treatment however as soon as you change it and you have a utility token then the token might be subject to vat so uh either if you buy it from a broker in switzland he would need to charge you 8.1% on the purchase price or and that's also important if you import it from

outside of Switzerland so you acquire tokens from a foreign broker from a foreign individual you are subject to 8.1% acquisition tax so you already have a tax liability on your purchase and then if you sell it again if you sell it to Swiss parties you would need to charge 8.1 if you sell it to foreign parties that would then be an exempt transaction because it's outside of Switzerland but here in a worst case you have 88.1% um charges on your turnover and uh in a worse case you don't have or a very limited Credit Opportunity um for on the input side so um this is really not

where you want uh to be and we had some cases layer one tokens as said I I just said before usually they're qualified as payment tokens um so we are here you can list it you can sell it to customers no one cares however then suddenly some project F the ruling with the federal tax authorities and the token was then qualified as a utility and that IM immediately destroys the business case of the bank to list the token and uh might harm uh the the project then also in in in its uh approach to the market and the liquidity uh in the market so um that's a very important discussion and

um especially secondary Market can have or can be hit quite quite hard with with such and you need may need to pay back viit for the past five years which can become very painful yes of on the total turnover that you've made so far even if you didn't make any profit right so it's not the profit tax so you can make losses but you pay viit um and then here certainly we do the same as as as our colleagues in the regulatory part we ask the questions so is it the link uh to ownership of an of an underlying object is a service um linked with the the token do

we you have rewards Etc and out of this uh questions we come then to a certain qualification um also here you can ask the federal tax authorities for their opinion um the risk is always that you don't like their opinion but but certainly gives you some legal certainty and the knowledge on the authority side is is already quite high and they know they generally know what they're doing um with one or covered out of practice it really depends to whom you're talking in the federal tax authorities and um finally the the ones that have been kind of exposed to the topic have been

certainly the German speaking uh people in authorities between because T was kind of the first uh location where where these topics came came up so we have some projects in the French speaking part that file rulings with the authorities and they get different answers than if I file it in German in the German speaking part and so we can also leverage on that and and kind of use it from a strategic point of view but just you need to be careful and you need to be really watching and who is kind of providing you with this opinion and if you don't like the outcome uh we can also try in another language yeah may as you remember we had

this kind of four parts the factual kind of understanding of the digital assets and the regulatory assessment the tax assessment which is important not only for the financial institutions but basically for everybody who kind of somehow uh has a certain activity related to assets uh the risk assessment part like the L part is focused more kind of of a you know suitability suitability test like Meed requirement adoption but for digital assets so kind of understanding uh factual and Technical and contractual risk related to certain digital Assets in in the framework that has been published now which you can as I said download from

our web page there are roughly 60 different categories and subcategories that you know you can move through as a risk officer to understand particular assets um as I said we going to publish very soon I think Q beginning q1 the the new version of that together a Signum but so just for you um a rough understanding no the last one uh no the the risk the yeah what kind of risk are we looking at it is you know the technology related risk do we really have sufficient decentralization and a node level uh what is the adoption of a certain protocol for example how long has it been in in the market how when

was it deployed how many user do does it have Etc then a certain counterparty risk that may be proper counterparties in terms of contractual particularly related to asset token but in a more decentralized way do we have dependencies on on particular individuals on the depend in particular companies is it really decentralized if we talk about defi setups for example do we understand that what kind of Market risks do we face and do we have any kind of sanction AML related policy risk so if you say okay we have some kind of a staking model for example you need to understand where the staking Revenue come from do they are they freshly minted token then obviously we have a

very low risk are these token which come from a certain kind of a liquidity pool or from third parties feeding into a pool then we have another risk framework to understand so these are the questions that we ask and then you come with a risk SC from it's a to e in this version it could be one to whatever um but basically understanding is that something of high risk of low risk um depending on on the risk factors and the risk rating we need to wrap up because time is up but the good thing is the key takeaways we've already covered a couple of times so what are these just to to wrap up again first thing know your

token understand before you do any activities related to a digital assets what is this digital assets on a functionality technical perspective and then based on that knowledge derive uh what kind of legal regulatory qualification does it have what kind of a VI tax treatment comes along with it and what is the risk weight of a particular asset and you need to build out a frame framework which kind of gives you process how to assess that and which also helps you to kind of keep in mind that you need to monitor those assets on a regular basis and uh redo the exercise once in a while I think that's from my end the key takeaway

anything to add Thomas no just don't forget about taxes and um we're still around certainly today just ask us question if you're interested and uh thank you thanks a lot