As businesses invest funds in cryptocurrencies and sell assets like nonfungible tokens, they should be aware of the accounting and tax issues surrounding them, or risk running afoul of regulators.
With corporations like MicroStrategy and Tesla investing billions of dollars in cryptocurrencies, more companies are considering incorporating crypto into their business operations. The use of crypto presents opportunities and challenges for businesses, but as with any new frontier, there are some unknown dangers, along with enticing incentives. A new paper from Deloitte, Corporates Using Crypto, offers companies an overview of the types of questions and insights they should consider as they determine whether and how to use crypto, including issues related to corporate treasury, strategy, operations, risk, compliance, accounting and tax.
“We’re starting to see more and more corporates recognizing that as retail customers become more comfortable with holding cryptocurrencies, they are looking for other avenues to use that, rather than just investing in it,” said Tim Davis, a risk and financial advisory principal at Deloitte & Touche. “Retail-based companies don’t want to limit a customer that would prefer to pay in crypto by saying, ‘We’re only going to accept payment in regular [currency.]’ Some of that is making sure they’re providing the broadest possible outreach to how customers want to pay for the products and services.”
As the value of assets like Bitcoin and Dogecoin rise, customers aren’t likely to pay in those cryptocurrencies. But there are other forms of crypto known as stablecoin, which try to peg their value to some external reference like a national currency, and so are less subject to volatility.
“Obviously when you’re in a particular asset class like Bitcoin, the theory is that it will continue to rise in value,” said Davis. “It does not make sense for a customer to pay in an asset that’s going to increase in price. It just means you’re going to pay more for something than you would have otherwise. So while that dynamic is out there, with cryptocurrencies increasing in value, I think you will see more and more customers preferring to pay in some kind of stablecoin. There are many different varieties of them. Stablecoins are also becoming an important piece of the basket of currencies when we’re talking about how corporates can accept payments for that reason.”
Companies also want to get into the crypto trend to show customers they’re not falling behind their competitors. “They may decide to take it as a form of payment from their customer … simply because it sounds cool,” said Rob Massey, global tax and blockchain assets leader at Deloitte Tax. “They want to be viewed as progressive. Quickly what they find out is there are a number of customers out there who would like to pay in stablecoin or crypto. There may be vendors that want to be paid in crypto or stablecoin. And then that begins the journey of how commerce is evolving.”
Companies that want to get involved in the crypto world need to make sure they have the tax and accounting systems in place to handle it. “There’s a number of people that believe it’s not too far out anymore that we can actually start using smart contracts and programmable money to elevate commerce,” said Massey. “If you think it’s not too far out, then why not start to engage in using crypto as a method of payment now, just in terms of readiness.”
Crypto can be complicated from a tax perspective. “Whenever you’re using something that is not fiat, then you’re realizing a gain or a loss from a tax perspective every time you use it, because the value that it has when you use it is probably different than your basis, so that triggers a gain or loss,” said Massey. “That does bring some complexity. We’re not used to a world of barter transactions. That’s kind of what it is for tax, because you’re using property of some kind that’s moving in value for property and services. Every time you’re using it, you’re triggering a gain or loss. Think about going through all of your accounting cycles and making sure that you’re tracking it when you’re using it for payroll, for a vendor, or for a customer. Then it requires a different level of tracking and frankly hygiene throughout your systems to make sure you catch it.”
In some cases, companies may want to use a reputable intermediary to process the payments for them. “The first decision they’ve really go to make is do they actually want to be accepting crypto themselves and holding it, or do they want to engage the services of an intermediary, who will essentially be cashing out the crypto for them, taking a fee and paying them in fiat,” said Davis. “Both of them are options, and there are service providers to provide that type of service. Obviously if you’re utilizing a third party, then you want to do some due diligence, that this company has got the controls to be doing it effectively because you have some customer relationship risk that you’re ceding to this third party, but you also have some compliance risk as well. If you’re accepting money in crypto, you at least have a responsibility to the Office of Foreign Access Control to make sure that you’re not accepting from what would otherwise be on a sanctioned or restricted list. Even if you’re not a financial institution, if you’re accepting crypto for payment, you still have that responsibility at a minimum when it comes to accepting payment.”
Companies need to be careful that they’re not being tricked into a money laundering scheme by accepting crypto payments. “It’s certainly a risk I think all companies need to be concerned with, but it’s typically businesses where there’s an inflow and outflow that represent a much greater risk for money laundering,” said Davis. “A casino, as an example, might be one where it provides the money launderer the opportunity to launder the money and get the proceeds back. If you were buying a car, it’s a little more difficult because you probably have to then go sell the car to get the proceeds laundered, and I think it’s unlikely that most launderers would go to all that effort. It’s not impossible, but they are likely to choose easier ways to do it.”
He noted that the Department of Justice issued a cryptocurrency enforcement framework last year to indicate which kinds of businesses might be prone to such activity. “In that document, it laid out those businesses that it believes are at high risk when it comes to crypto transactions and the likelihood that there’s money laundering going on,” said Davis. “You’d probably want to pay attention to those types of entities and have some sort of risk-based decisioning on how and when you’d accept money from those kinds of entities and, if so, what additional checks and balances you might want to put in place.”
Accountants need to take note of price fluctuations in the crypto market, which can be different from how it works with regular currency. “There are instances where you’re dealing in something, if you’re going to contract in a digital asset, a cryptocurrency which is moving in value, what does that do? It really creates potentially a derivative, which is different,” said Massey.
The auction of a work of art in the form of a nonfungible token, or NFT, by the artist Beeple in March by Christie’s for $69 million raised awareness of the intersection of cryptocurrency and real currency. “Traditional crypto is one thing, and it’s continuing now with NFTs, which have a lot of popularity now,” said Massey. “What can nonfungible tokens do? We’re seeing them across a lot of different industries, in sports, media, and entertainment, even traditional financial services.”
Some companies are offering to pay their employees and directors in cryptocurrency, which could increase the use of NFTs. “Some of that is driven by the company just wanting to promote the asset class,” said Davis. “Some of it is coming from the individual who is saying, ‘If I had a choice, I’d rather be paid in crypto than in fiat.’ You’ve got online businesses that are increasingly looking at ways in which they could have their own tokens that are within their own ecosystem, and they might even have a rewards component. You’re creating some type of customer loyalty by rewarding them with some additional tokens. They can then exchange those tokens for other things in the environment. It might be a gaming platform or a social media platform, where you can create your own e-commerce environment on your own coin, and then possibly give the individual some ability to then cash out of the coin. It has this utility where you can actually do things like create customer loyalty with owning a token associated with that particular brand. It just has that additional benefit that fiat doesn’t have.”
Some NFT owners have found that they couldn’t even access the NFT once it was purchased, and the accounting for an NFT is likely to be complex. “I think the accounting treatment is going to be dictated based on the type of entity that holds it,” said Massey. “You’re going to get to a different answer for corporate versus an issuer versus an investment company, and then you also have considerations about what it is you’ve invested in. Not all NFTs are created equal, just like not all crypto is created equal. What it represents is going to bear weight in the accounting treatment as well as tax.”
NFTs might be treated like other collectibles. “It’s almost the next evolution of baseball cards,” said Davis. “You collected it because of your love of the game, not because you were hoping to make some profit on it in the future. … It’s not so much an investment vehicle. But you have to think through the platform that you’re going to use to provide it, make sure it’s going to be there for the customer when they need it, and you probably need some kind of backup option, so if it’s being kept on someone’s phone and the phone gets lost, they can come back to you, authenticate themselves, and get their copy back again. It’s still early days, and we’re just starting to see the emergence of some of these marketplaces and portals, but it’s signaling the start of a trend that we’re going to see much more of is this ability to own things and to have the creator of that, the artist or producer, put some rights and conditions over that.”
The use of NFTs is likely to raise accounting and tax issues, but Massey had some advice. “Think about, first of all, what is it that they’ve created or bought? Then what does it represent when it’s sold? Is it really a sale or a license? Sometimes the sale of an NFT is more akin to a perpetual license than it is an actual transfer of a copyrighted thing,” he said. “There’s questions in there that would impact both the tax and the accounting treatment. It’s also the sourcing. How do you source a transaction? There’s really interesting questions around indirect taxes, like the sales tax or the VAT around the world. There are things like information reporting, 1099s, so as we go down to these new concepts and increasingly marketplaces, where people can either issue or sell for the first time or resell, then it’s important for the accountants to step in. It’s all of our normal list of things we would consider, but it all starts with what is it that we’re transacting with? What is the property? What is the NFT and then what is the transaction? We tend to get involved in these really interesting conversations with innovative new models and take a step back. Here we are, the bean counters. Let’s figure out what it is.”
SEC and FASB standard-setting
The Securities and Exchange Commission is also keeping a close eye on the crypto market, although public companies still haven’t waded into too deeply yet.
“It’s still early days, and we as yet haven’t seen a lot of evidence of widespread use of digital assets, notwithstanding some fairly recent one-off significant transactions, but beyond that we haven’t seen widespread use of it,” said SEC chief accountant Paul Munter during Baruch College’s financial reporting conference last week. “There are some huge scoping issues here because not all digital assets are the same. A lot of times, people pose the question assuming we’re just talking about Bitcoin, but in reality the spectrum of digital assets is very broad and continues to evolve. If we were to think about a standard-setting solution, it has to start with a question of scope. What exactly do we mean by digital assets? What kinds of things are we contemplating? How would we scope it in a fashion that not only would be fit for purpose for the type of digital assets that exist now, but that may exist in the not too distant future? Beyond that, who are we talking about? Where in the digital asset space are we trying to develop guidance for? Is it the holders? Is it the miners? Is it the broker-dealer type entities, etc.?”
The chairman of the Financial Accounting Standards Board, Richard Jones, said at the same conference that FASB decided not to add a project on digital assets to its agenda this year. “When we looked at it, we didn’t see a lot of diversity in practice in the accounting for similar items,” he explained. “We also saw that there was an AICPA paper out there that I think does a great job of explaining particularly the intangible asset model and how it would be applied to digital assets that qualify as intangibles. Finally when we think about our agenda, it’s not just what would be a good accounting question to answer, but we also look at prevalence and to date we haven’t seen that broad prevalence. Certainly there are some big names that have some presence in this space, but we didn’t see that broad material presence that meant it should be at the top of our standard-setting agenda.”