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Security And Utility Tokens
It is hard to figure out whether an initial point offering is a token. Moreover, then, is it a utility token, or a security token? From discussions with companies involved, it is hard to conclude that their initial coin offering is a utility.
Practically spoken, another approach is possible. If it is the intention to raise money by selling tokens from an initial coin offering, and if it is the expectation of the buyers of the tokens that it will increase value over time, then at the end of the day, we have an investment in a security of one or another kind.
If you are selling tokens to people who believe the tokens will increase in value as you build up your business, then it’s a security, no doubt about it. The only way for it not to be a security would be if you refuse to sell it to any US investors at all, or by doing it through a security compliant offering.
Although a lot more can be written about this, and more will follow, but from our point of view – and this is the point of view of the Securities and Exchange Commission – these are securities, and it seems that state securities regulators feel even stronger about this than the SEC does.
Getting The Initial Coin Offering Right
So, having said the above, rule number one is never to issue securities without organizing yourself into a limited liability company.
This way, you limit your liability in the same way a corporation would. If you approach this as a group of “guys” loosely organized, you will no doubt be treated as a general partnership. This could be catastrophic. It will make each of you responsible for the losses any one of you might incur. Hence, it is our view that you organize as a company, either as a corporation or an LLC, compliant to laws of whichever state you incorporate under, in respect of issuing the securities.
State Laws And SEC Jurisdictions
Essentially, a securities token is a bundle of rights and privileges in the venture that is funded with the proceeds of the initial coin offering, so these rights must be recorded. It is not wise to record it in a smart contract. Most ERC20 arrangements cannot accommodate all the rights you need in there.
What is needed is a contract that makes it clear what rights the coin holders will have, especially concerning any equity that might come into existence. This is required, especially of some money comes in, or some profit sharing is to take place. Again, if you are going to appear to be a security, in so far as voting or profit sharing is concerned, you need to take care of the corporate requirements. If you are registered in Delaware, comply with the laws of the state in respect of how the securities are created, where you write them down, and how everything is recorded.
At the moment, jurisdiction is becoming an exciting issue. Yes, it is possible to set up in the Cayman Islands and sell from the Cayman’s, and you might even be able to do seasteading and issue the securities from some platform in the middle of the ocean, but as soon as you set foot on US territory, the SEC takes jurisdiction.
So if you are using any form of communication across the state, albeit radio, television, internet or telephone, the SEC has jurisdiction over you. You will not escape jurisdiction that easily.
Also, as soon as you make offers in any specific state, or even if you are just located in the state and you are making offers from there to out of state parties, the state will immediately have jurisdiction over your offering.
You will have to take heed of the Securities Act. It regulates all offers and sales of securities, and in terms of the act, the offer or transaction must be registered under the Securities Act in accordance with the act.
Without splitting hairs, the term “offer” under the act is very broadly defined. In terms of the act you are even making an offer if you mention on a radio show that you are considering a token offer.
Even if you begin slowly by giving away the tokens for free, it will be considered as an offer if anyone is remunerating you for your benevolence. Also, if you are subtly promoting on Twitter for some form of remuneration, it will be deemed an “offer.” Under the Securities Act, there is no such thing free & complimentary. It is always an offer.
From payment processors to money transmitters to crypto currencies and offshore banking, Fintech companies and its U.S. owners face a long list of tax filing requirements that get more complicated if the U.S. Fintech also owns foreign companies or a foreign company owns a U.S. Fintech.
If you a US citizen, Resident or Expat and an authorized signature in a Fintech foreign bank account with a balance that exceeds $10,000 at any time of the year, you are obligated to file Foreign Bank and Financial Accounts Report (FBAR).
Foreign Accounts Filing
- FBAR (Foreign Bank Account Report)
- FATCA (Foreign Account Tax Compliance Act)
- You must file if you are a citizen or US resident.
- You have a financial interest in or signature authority over an account belonging to the Fintech in a foreign country.
- That account is a Foreign Financial Account.
- The aggregate value of the account(s) exceeds $10,000 at any time during the calendar year.
- FBAR deadline to file is April 15. There is an automatic extension for October 15.
The Form 8938 was introduced as part of the Foreign Account Tax Compliance Act, which is referred to as FATCA. And similar to FBAR, FATCA’s purpose is to target tax noncompliance by U.S. taxpayers with foreign accounts and assets.
- FATCA focuses on reporting by U.S. taxpayers about certain specific foreign financial assets, which includes foreign financial accounts and other offshore assets, for example stock that a U.S. Fintech owns in a foreign company.
- FATCA also focuses on reporting by foreign financial institutions about financial accounts held by U.S. taxpayers or foreign entities in which a U.S. taxpayer holds a substantial ownership interest or is an authorized signature.
- The filing of FATCA is in addition to the FBAR filing.
If the total value of the foreign asset is at or below $50,000 at the end of the tax year, there is no reporting requirement for that year, unless the total value is more than $75,000 at any time during the year. This is different from FBAR that starts at $10,000.
- Specified foreign financial assets are defined as foreign financial accounts plus any stock or security issued by a person other than by a U.S person, any financial instrument or contract held for investment by a non-U.S. person, and any interest in a foreign Fintech or regular foreign entity.
- Essentially that means you have to report any foreign stocks or mutual funds not held inside a financial account, plus any interest in a PFICs — and PFICs are Passive Foreign Investment Companies — any interest in a foreign partnership, and a foreign corporation.
Foreign Company Ownership Filing
The Trump tax reform created an additional layer of tax reporting for U.S. Fintechs owning foreign companies:
- Repatriation tax.
- Taxation of global intangible low-taxed income (GILTI).
- Foreign derived intangible income (FDII).
- Dividends received deduction (DRD).
- Base Erosion and Anti Abuse Tax.
Multiple State Tax Filing
U.S. Fintech companies face another challenge for example, if holding multiple state money transmitter licenses or if owning income producing offices in multiple states. Multiple state tax planning is critical as every state requires registration for doing business and some states such as California charge a nominal income tax to LLCs even if they are sole-member ones.
In general, there are some taxes that a Fintech with multiple state operations will need to consider:
- State Income Tax
- Sales Tax
- Payroll Tax
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