At Toku, we’ve seen that as token-based compensation transcends geographical boundaries, organizations must navigate a complex web of jurisdiction-specific regulations that govern the use of tokens for compensation purposes. We are highlighting several jurisdictions that we receive many questions about and provide some key points to consider.
Token-based compensation refers to the practice of rewarding individuals with tokens (cryptocurrencies or tokens issued on blockchain platforms) instead of traditional equity or cash-based incentives. Token-based compensation builds on the structure of equity-based compensation, but its evolution is driven by separate regulatory developments, technological advancements, and changes in industry practices.
Worldwide Compliance and Reporting Requirements for Token Grants
Nearly all jurisdictions have common issues that need to be investigated on a case by case basis for the administration and distribution of token grants, especially for compensation purposes such as:. The details of this investigation include:
- Registering and complying with relevant securities laws, if a token is considered a security;
- Meeting tax obligations, including income tax withholding, reporting, and record-keeping;
- Aligning token compensation with deferred compensation, fringe benefit, bonus and gratuity regulations locally;
- Adhering to labor laws, such as minimum wage, overtime pay, and worker classification requirements even when compensating in tokens
- Implementing AML/KYC compliance measures, as needed.
Notable Jurisdiction Regulations for Token Compensation
At Toku, we've received many similar questions on the highest priority jurisdictions for our clients. Below, we will highlight some important regulations for some of the most common jurisdictions.
When providing tokens as a form of compensation in the United States, a key consideration is whether the structure will fall within the requirements of Section 409A or 83(b) of the US tax code. Section 409A regulates deferred compensation, i.e. income that may be paid in a year following the year in which the right to payment arises, while 83(b) relates to the transfers of property, including tokens.
409A has specific rules and requirements for plans that involve deferred income, and failure to comply with 409A can result in significant penalties, including taxes on deferred compensation and immediate taxation of deferred amounts. However, almost all RTAs and RTUs remain exempt from 409A, but token options in most cases will not.
Property subject to 83(b) is generally not taxable until it becomes vested, no longer subject to a "substantial risk of forfeiture." However, a service provider can elect to include the fair market value of the property in the year it is first transferred by filing an 83(b) form. Tokens awarded up front, such as with RTAs, fall under Section 83(b), and the service provider can make an election to include the token's fair market value in their income for the year of transfer.
On the other hand, conditional token grants, like RTUs and Token Options, may be subject to Section 409A, but many RTU plans avoid it by relying on the short-term deferral exemption. They must be settled within 2.5 months of the company's fiscal year-end.
All crypto assets are considered commodities by the Canada Revenue Agency (CRA). Despite the Canadian Securities Administrators recent guidance about the application of securities legislation and regulatory requirements to crypto assets, in most instances there should be no securities law restrictions applicable to the offer of restricted tokens due to available exemptions from the prospectus requirements even when considered restricted securities. Tokens must be delivered within 3 years of the end of the applicable service year in order to avoid immediate taxation under the salary deferral rules under the Canadian Income Tax Act (R.S.C., 1985, c. 1 (5th Supp.)).
As of June 19, 2023, the UK's upper house of parliament has approved laws related to crypto and stablecoins. The legislation, known as the Financial Services and Markets Act, aims to bring cryptocurrencies and stablecoins under regulatory oversight. With this approval, cryptocurrencies will be officially recognized as a form of payment under existing laws.
At the national level, Germany does not have specific laws governing cryptocurrencies; however, digital assets are subject to existing financial regulations. Cryptocurrencies are treated as private money and are subject to capital gains tax when used for transactions or exchanged for fiat currency. Additionally, German financial regulators, such as BaFin, have issued guidelines for companies operating in the cryptocurrency space to ensure compliance with anti-money laundering (AML) and know-your-customer (KYC) requirements. On an EU level, new regulations have been proposed to enhance transparency and address risks related to cryptocurrencies and digital assets, including regulations concerning stablecoins and potential restrictions on certain tokens related to securities and investments.
The Swiss Financial Market Supervisory Authority (FINMA) regulates digital assets, including token compensation, and has established clear guidelines for token classification. Switzerland is known for its supportive environment for blockchain innovation and has attracted many digital asset companies. Tax treatment of token compensation in Switzerland is based on the token's classification, and organizations must comply with Swiss tax and employment laws.