Some clients have sacrificed HEX tokens with the intention to receive PULSE tokens once they are released.
This article considers the tax position and the current application of the income tax legislation, draft IRD guidelines on DEFI protocols, and our understanding of sacrificing tokens for the Pulse Chain. This article may be updated when more information is available.
Richard Hart has created a new token called Pulse. We understand that:
- Investors could sacrifice tokens (such as HEX or USDC) to potentially receive PULSE tokens.
- The sacrificing period has finished
- There is no guarantee that investors will receive PULSE tokens
- PULSE is yet to launch (as of January 2023)
- When PULSE is launched, it will have no value
- After 48 hours, PULSE tokens will have a value
This situation creates some interesting tax situations, and we have outlined these below.
Sacrificing HEX/USDT tokens to potentially receive PULSE
In this situation, the investor is disposing of either HEX or USDT tokens as part of the sacrifice.
This is a disposal for tax purposes, and the profit is calculated as the difference between the sale value and the acquisition value. The acquisition value is the investor’s original purchase price (or weight average cost).
The sale value is the market value at the time of disposal. The tokens sacrificed had a value at the time, and this is reflected for tax purposes.
A question that may arise from being sold at market value is, “what am I receiving in exchange for the sacrifice?” Especially if it is taxed at market value.
To have disposal for no value is unlikely. This is because the although the words used are ‘sacrifice’, which means ‘something given up or lost’, the underlying transaction here is an exchange to receive PULSE when it is issued.
There are many other situations in tax legislation (or law) where an event is called something, but the underlying evidence is different. For example, if someone has an independent contractor’s agreement to perform professional services, they may still be classified as an employee (depending on the evidence and facts of what they actually do). Having a contract and being called a contractor may not be sufficient not to be an employee.
To claim disposal for no value, you would need a clear and compelling reason why you’ve given away the token for nothing without expecting to receive something in exchange. From a commercial (and common sense) perspective, giving something of value away for nothing (to an unknown wallet address) doesn’t make sense.
In exchange for the sacrifice, acquiring an intangible right to receive PULSE
In exchange for sacrificing the original token (HEX/USDC/USDT), the investor is acquiring an intangible right to receive a PULSE token when issued.
The intangible right has a value (the same value as the value of the tokens disposed of).
The intangible right represents the investor’s ability to receive the PULSE tokens in the future. It is an in-between state of still owning HEX/USDT and receiving the PULSE. It has value; the amount paid for it is the market value of the tokens sacrificed.
Based on the current timeline of events, we believe many investors are currently in this situation, owning an intangible right to receive PULSE.
Disposal of the intangible right to receive PULSE
As of January 2023, this step hasn’t occurred because PULSE tokens have not been issued. Below is what we expect to happen.
When the PULSE tokens are issued, the intangible right to receive them is disposed of, and PULSE is acquired. This is a taxable event because the intangible right is being disposed and the profit is calculated as the difference between the sale value and the acquisition value. The acquisition value is the acquisition value as the market value of the tokens sacrificed (from above). The sale value is more interesting. It will be the value of the PULSE when issued.
Richard Hart outlines that the price of PULSE, when issued, will be $0. If true, this would suggest that the intangible right is disposed of for no value, and a full deduction of the acquisition value can be claimed as a tax loss. However, in our opinion, it’s unlikely IRD or tax legislation will apply this way.
We have also read that PULSE is expected to have no price for the first 48 hours, and then it will have a price. From our understanding, there are no material changes occurring to the tokens or platform, or network in the first 48 hours. Therefore, we are suggesting there is a difference between the price and value for PULSE over the first 48 hours.
This concept of a difference between price and value may seem strange. However, IRD applies this principle in many other situations. For example, mum and dad buy a property for $500k, then in two years later sell the property to their child for $500k (the sale price). The property sale is documented via an agreement for sale and purchase (ASP), and a solicitor is involved in documenting the sale, transferring the title, releasing the mortgage etc. (like an ordinary property transaction). In this situation, the parents have brought and sold the property for the same value within the bright-line period; therefore, there is no profit. However, IRD requires the property to be sold at market value (say $750k). Therefore, although the property has been sold for $500k and documented through solicitors if the market value is $750k, IRD will apply the market value, resulting in a taxable $250k profit. There is a difference between price and value.
In our opinion, the value of PULSE is what was paid for it (regardless of the price when released). The value is the same as the value of the token sacrificed to acquire the intangible right. Therefore, the intangible right is disposed of for the same value as what it was acquired for (resulting in no taxable profit/loss), and PULSE’s acquisition value is the same as the disposal value of HEX/USDC on sacrifice.
PULSE will taxable on disposal (whenever the investor choses to sell the tokens).
Another example of price and value could be an ICO token. If an investor invests 10,000 USDC into an ICO token, it may not be known what the ICO token price will be on the issue. However, we calculate its cost value to be 10,000 USDC, the same value as what was paid to acquire the token. Only on disposal of the ICO (once issued) will trigger the taxable event on the ICO token.
Contact Tim Doyle for a call or meeting to discuss any cryptocurrency tax or accounting questions. Our office is in Cambridge, Waikato, or we can arrange a video conference call.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.