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Showing posts from September, 2017

1. So you want to do an ICO

Disclaimer

The number of token offerings through ICOs or otherwise that have crossed my desk in the last 12 months has exploded.  Many of those transactions have been put together with such speed that corporate structure and tax treatment are an afterthought with expensive consequences.  Even now, most of the focus seems to be on the securities law treatment of Tokens.  The following is a brief outline of some issues that are worth considering -- primarily in order to avoid adverse tax issues for founders, issuers and investors.  Following posts will discuss different structures mentioned below in greater detail.

Before we get to actual structures, however, it's important to understand what kinds of adverse things can happen to you.  Many people think that selling Tokens should be taxed the same way as a stock sale is taxed -- but there is a specific Internal Revenue Code section that provides stock sales are tax free -- and it doesn't apply to Token sales.

TAXATION OF TOKENS

2. Structural Alternatives (Outline)

Disclaimer

There are at least three basic structures for Crypto Companies, which will be discussed in separate posts:

A.     International Structure  (very hard to make work)
In order to have any reasonable argument that this structure work, you have to assume: Existing network development is extremely limited (e.g., pre White Paper); andSale of Tokens will be part of an operating business where the Sponsor provides software or services to users.OpCo forms a wholly owned foreign subsidiary ("ForCo")OpCo and ForCo enter into a "Cost Sharing Agreement" pursuant to which each will fund a portion of the development costs of the Network, based on the projected share of income from foreign sources and domestic sources.  OpCo funds a portion of its share of those costs by contributing all the foreign rights to the Network to ForCoEach of OpCo and ForCo sell Tokens or SAFTS to raise money to fund the expenses of developing the network and operating the system  (Read …

2(A). Potential International Structures (No Longer Viable)

Disclaimer
NOTE, THE 2017 TAX ACT VIRTUALLY ELIMINATED ANY BENEFIT FROM THIS STRUCTURE.  IT'S INCLUDED HERE SIMPLY FOR HISTORY
Potential International Structure
Many Crypto companies would like to avoid taxation altogether by selling their tokens through a foreign corporation.If the original technologist is neither a US citizen nor a US resident, this should be relatively easy to do.A foreign corporation that does not do business in the US should not be subject to US tax on the sale of Tokens or the operation of a business (although it may still be subject to US securities law rules on the sale of tokens or other interests).
Where the original technologist is a US Person or a US corporation, however, it is much more difficult and often impossible.
US tax law makes it very hard to transfer intellectual property to a foreign corporation.There is no reason why intellectual property exists in any specific location – and the US does not want taxpayers to deduct all the costs of develo…

2(B) Ordinary Corporate Structure

Disclaimer

Ordinary Corporate Structure
By the time most Crypto businesses start thinking about their ICO, they have already caused all the related IP to be owned by a corporation.In this case, a plain vanilla ICO causes enormous leakage to the IRS (regardless of whether it's in the form of a straight token sale or a SAFT).  The leakage principally results from the fact that the corporation has a huge slug of income in one year, and won't spend that money for several years.  Under US tax rules, a corporation can take losses from one year and use them to obtain refunds of taxes paid in the previous two years, but taxes paid three or more years ago are lost forever.  

If you assume for example, that the corporation plans to raise $100 million through the ICO and spend $20 million each year thereafter for 5 years, the corporation will come up ~$16 million short -- $16 million that your shareholders might have hoped to receive as a dividend.That’s because losses from years 4 and …

2(C) LLC Holding Company Structure

Disclaimer 

Where the initial intellectual property underlying a novel Block Chain is owned by individuals (or possibly by a corporation with significant current year losses where the IP is in its infancy), the best solution may be to set up an LLC as a holding company.

Outline of Structure:
Step 1. Form LLC Holding Company Founders form NewLLC, a Delaware LLCFounders contribute all IP, business plan, etc. to NewLLCNewLLC issues Common Units to founders, advisors and people who will contribute to the development of IP.

Participants can stop here until the financing if they want to minimize current expenses and develop the IP to a point where they can attract investors.  In that event, NewLLC would sign "Confidentiality and Inventions Assignment Agreements" ("CIAAs") with all contributors and wait on Step 2 until it's ready to introduce investors.  (Note, if the Participants hope to layer in the participation of a foreign subsidiary (see  2(A) Potential Internati…

Sheltering ICO Gain

Disclaimer 

[To Come]

For example, if the company described above took $35 mm in the first year and invested it in a a qualifying equipment lease, it might have results along the line of a net $5 mm tax loss in year 1, ~$6.5 mm loss in year 2, ~$4.5 mm in year 3, followed by $21 mm of income in year 4.A transaction like this effectively shifts $21 mm of loss into years where a refund can be claimed ($8.4 mm worth), and the money has to be invested somewhere.(Yes, of course, leases are higher risk than Treasury Notes, but maybe that risk is manageable.)

How Does A SAFT Work

Disclaimer

Simple Agreement for Future Tokens

A SAFT is an offshoot of another structure known as a SAFE -- Simple Agreement for Future Equity.   For what it's worth, I'm not much of a fan of SAFEs.

IN GENERAL

In any case, a SAFT is generally issued before a network goes live when it would be impossible to sell actual Tokens (because the blockchain is not live and no one could be assigned a private key).  In its simplest form, an investor buys a SAFT for a fixed price and the SAFT provides that on the date the network goes live ("Network Launch Date"), the Investor will receive a fixed number of Tokens.  Sometimes, where the total number of Tokens in the Network is not predetermined at the time the SAFT is issued, the SAFT will provide that the holder will get a number of Tokens calculated as a percentage of the total number of Tokens in the Network on the Network Launch Date (i.e., the maximum number of Tokens including all unmined and unassigned Tokens).

VARIATIONS

LLC Holding Company Term Sheet

Disclaimer


This document is not an offer to sell securities, nor is it a solicitation of an offer to buy such securities.No offer to buy securities can be accepted and no part of the purchase price can be received until definitive documents have been delivered, and any such offer may be withdrawn or revoked by either side, without obligation or commitment of any kind at any time prior to notice of its acceptance given after delivery of such documents.An indication of interest set forth below will involve no obligation or commitment of any kind.
[Coin Name], LLC (“CNLLC”), a newly formed limited liability company which owns all the technology related to the new virtual currency network related to [Coin Name] is in the process of exploring the level of investor interest in an equity financing (“Units”).If you believe that you would like to hear more about an opportunity to purchase Units, please fill in your name below, and indicate the level at which you might like to participate.
Prior t…