A company that wanted to launch a business in Illinois through an ICO sought sales tax advice on issuing utility tokens in the ICO. The Department of Revenue advised, in a nonbinding letter to the company, that utility tokens were intangible property not subject to sales tax.
Utility Tokens: Ownership in Mining Hardware Business
In its request for guidance, the company explained that the model for its initial coin offering (ICO). It then asked whether it should apply for an Illinois business license to collect sales tax on its ICO.
To raise funds to start the business, it would sell utility tokens, or smart contracts. Each token or smart contract would represent an ownership interest in the hardware used to mine cryptocurrency. The tokens would not be listed on a cryptocurrency exchange, and the holder of the token would have the right to sell their hardware at any time.
Under the company’s business model, the company would own, manage and operate hardware used to mine cryptocurrency. Owners of utility tokens would also own part of the mining hardware and would receive payments from the company based on the number of utility tokens they owned.
Hardware Used to Mine Cryptocurrency
The company described the mining hardware it would use as a product. It described the sale of utility tokens as a resale of goods under sales tax law.
It stated that the token represented a smart contract that would be owned as a portion of the mining hardware.
Utility Tokens, Smart Contracts: Intangible Property
Illinois does not have any tax law or guidance on:
- utility tokens or smart contracts; or
- transactions involving any of the three types of property.
However, department regulations make clear that sales tax does not apply to sales of:
- shares of stocks;
- evidences of interest in property; or
- corporate or other franchises and evidences of debt.
These ownership and debt instruments are intangible property, and intangible personal property is not subject to sales tax.
In its response to the company, the department said:
Sales of the tokens described in your letter are sales of intangible personal property. Since the Illinois sales tax laws are triggered upon the transfer of tangible personal property, no sales tax liability attaches to the sale of those tokens.
Dearth of Guidance on Cryptocurrency and ICOs
The Illinois Department of Financial and Professional Regulation is the only government agency that has addressed cryptocurrency before the Department of Revenue issued this information letter.
Guidance from the Illinois Department of Financial and Professional Regulation (IDFPR) states that the exchange of cryptocurrency for money directly between two parties is a sale of goods. In addition, the guidance notes that the exchange of cryptocurrency between a merchant and an individual for goods does not involve money, i.e., legal tender. It also refers to smart contracts that are issued for non-monetary purposes as not being legal tender.
Neither the company nor the Department of Revenue refer to this guidance, and this guidance doesn’t apply to state sales taxes. However, the IDFPR does not recharacterize a sale of goods because digital currency is used in the transaction. Arguably, it implicitly recognizes that a sale of goods is a retail transaction.
ICOs Raises Funds, They Don’t Sell Products
The Department of Revenue advised that utility tokens are intangible property under existing rules.
However, Illinois sales tax does not apply to the sale of shares in a company in an IPO. It would follow that sales also tax does not apply to sales of utility tokens in an ICO.
The utility tokens may represent ownership in the company’s equipment, as described by the company, and not the company itself. However, utility tokens represent ownership interests, and sales of ownership interests are not retail sales subject to tax under Illinois tax rules.
It is important to remember that the letter issued by the Illinois Department of Revenue is not a statement of the Department’s position, as well as being nonbinding.
By Lisa Lopata, J.D.