VAT practice of the Swiss Federal Tax Administration SFTA on validator activity
The validator in the case dealt with by the Federal Administrative Court provided services for the two well-known blockchain networks Polkadot and Kusama. In addition to his own stake, he also represented a large number of stakes of so-called “nominators” who delegated the representation of their stakes via the networks to him (so-called “nominated proof-of-stake” consensus mechanism). By the delegation of the nominators, the validator thus represents their stakes in the network and receives a commission on the nominators’ staking rewards in return. The treatment of the validator’s staking rewards, which consists of transaction fees for the validation of transactions in the networks on the one hand and so-called block rewards (i.e., newly created units of DOT and KSM tokens) for the operation of software, network nodes and validation of new blocks on the other, was disputed.
The SFTA has published its practice on the treatment of validation and verification of transactions via the blockchain in the area of VAT in VAT-Info-04. According to this, the compensation for validation or verification activities carried out by means of software usually takes the form of a so-called block reward (newly created units of the corresponding cryptocoins/tokens) and/or a transaction fee.
If this activity is compensated exclusively by new cryptocoins/tokens generated automatically by the network (so-called block reward), there is no counterparty, which is why the block reward represents a non-remuneration and is therefore not subject to VAT. However, if a transaction fee is added, which is paid by the sender to the validator for a specific transaction via the network, this is a taxable transaction between the sender of a transaction and the validator. This validation of a transaction for a customer in Switzerland is subject to VAT as an electronic service.
As in the present case the validator received block rewards as well as transaction fees, the SFTA was of the opinion that both the transaction fees and the block rewards were subject to VAT as compensation for the verification of transactions, although the transaction fees only accounted for about 0.01% in relation to the block rewards. After all, VAT is only due insofar as the senders of transactions were domiciled in Switzerland, which has to be determined by an estimation method due to the anonymity in the decentralised networks.
Reasoning of the Federal Administrative Court
In a first step, the Federal Administrative Court found that validators in the decentralised networks in question (Polkadot and Kusama) perform the following four validation or verification activities:
- Operation of software and network nodes.
- Validation of new blocks on the central blockchain (so-called “relay chain”).
- Validation of new blocks on blockchains running parallel to the relay chain (so-called “parachains”).
- Validation of transactions or inclusion of transactions in new blocks of the relay chain.
Compensation is made on the one hand through block rewards for the operation of software, network nodes and validation of new blocks on the other hand are compensated through a share of the transaction fees for the processing of transactions. While the SFTA took the view that all services only serve the senders of transactions and thus constitute taxable services, the Federal Administrative Court has confirmed that this can only apply with regard to transaction processing. The determination of a service recipient must be made according to economic, factual criteria, and is thus judged by whom a validation service effectively serves. Consequently, only transaction processing can be assigned to a service recipient, the sender of transactions. The other validation services, i.e., the operation of software, network nodes, and validation of new blocks, serve the blockchain networks as a whole and maintain the fundamental functionality of the networks, which is why these networks are to be considered service recipients. The Federal Administrative Court justifies this, among other things, as follows:
- Empty blocks are also produced in the aforementioned networks, and with regard to the payment of block rewards for the validation of new blocks, no distinction is made as to whether transactions are contained in a produced block or not.
- In the case of such empty blocks, the protocol company behind them cannot be regarded as the beneficiary, as they no longer have any power of disposal over these networks and these networks are to be regarded as decentralised. In the present case, authorisation modules for control and management were removed in 2020 and the protocol company does not have a voting majority.
- Even in the case of block rewards, which are paid out for blocks with transactions, the validation of these blocks is a service to the networks, as these services are provided regardless of whether transactions are made, and they enable the general functionality of the networks.
In a second step, the Federal Administrative Court examined whether the validation of individual transactions and the services for the operation of the network software and network nodes should be qualified as a single service or as main and ancillary services that should be treated the same for VAT purposes. However, in the absence of a single service recipient, this was denied by the court.
The Federal Administrative Court has therefore ruled that transaction processing (compensated with the transaction fees) and the operation of software and network nodes with the validation of new blocks are two services to be treated independently for VAT purposes and that the latter (in the absence of a sufficiently identifiable recipient) is a non-taxable and non-remuneration. Only the transaction fee from domestic senders is therefore subject to VAT.
Referral back to the SFTA for further clarification
The Federal Supreme Court thus partially upheld the appeal and referred the case back to the SFTA for further clarification of the exact point in time at which the networks were decentralised (in any case, however, at the latest when the aforementioned control modules were removed) and for recalculation of the VAT due.
At the time of writing, it is still unclear whether the Federal Administrative Court’s ruling is final or if it will be/has been appealed to the Federal Supreme Court.
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