The Swiss Federal Administrative Court's case (29.8.2023, A-5638/2022) revolves around the qualification and remuneration of validation/verification activities from a VAT perspective in a dispute between a Swiss validator and the Swiss Federal Tax Administration.
The Swiss Federal Administrative Court (SFAC) ruled, that a taxpayer providing validation/verification activities in blockchain networks is carrying out two independent services. One is the taxable transaction processing (=service), for which the taxpayer collected a transaction fee (=remuneration). The other transaction is the non-taxable "remaining" validation/verification activities provided to the blockchain network (=insufficiently identifiable recipient and not a service in a VAT sense), for which the taxpayer received block rewards (=non-remuneration).
Unfortunately, the question whether decentralized blockchain networks existed prior to handing over the network access to the community and are regarded as service recipient, must still be clarified by the Swiss Federal Tax Administration (SFTA). A court decision to this effect will certainly follow in the future.
The outcome of this case provides an initial framework for the VAT qualification of validation/verification activities and serves as guidance for validators and protocol companies alike.
The validator's activities on the Polkadot and Kusama blockchains resulted in both block rewards and transaction fees and included, among other things, operating software and network nodes as well as producing, validating and finalizing new blocks on the respective blockchain network and validating transactions commissioned by senders or incorporating such transactions from a transaction pool into new blocks on the relay chain (“transaction processing”).
Overview of SFTA's guidelines and their position in the case
The SFTA's practice information from 17 June 2019 (VAT information, 04 – “Subject to VAT”, sec. 2.7) provided initial guidance on the VAT qualification of transactions related to blockchain and distributed ledger technology, and were an important source of information for businesses and advisors at that time. However, as this new technology is developing rapidly, it seems that over time more and more questions remained unanswered resulting in legal uncertainty.
According to these guidelines, if the validator’s activities are solely compensated by block rewards generated automatically by the network, it does not constitute a supply but is rather qualified as a non-remuneration (Art. 18 Swiss VAT Act). If, however, the validator receives a transaction fee, the validation or verification activity qualifies as electronic service which is taxable when the service recipient is established in Switzerland (recipient-location principle, Art. 8 para. 1 Swiss VAT Act).
The SFTA argued in this case that the validator's activities should be treated as taxable electronic services, where the remuneration is based on the block reward and the transaction fee.
Key decision of the SFAC
The court focused on two questions:
- Who is the recipient of the validation/verification activity?
- Should the activities be considered as individual supplies under the Swiss VAT law?
Recipient of the activity
The SFAC examined the activities in the respective blockchain networks performed by the validator for a block reward and a transaction fee and concluded that whoever effectively benefits from the validation or verification activities is the service recipient.
It was clear to the court that the transaction processing itself is addressed to the sender of the transaction and effectively serves him. As the sender of a transaction can be sufficiently identified, the transaction processing qualifies as a taxable supply of services. There are accepted methodologies to determine the VAT due for senders that are identifiable but cannot be localized.
The remaining validation/verification activities of the validator are primarily aimed at the operation or the basic functionality of the blockchain and thus do not serve any specific sender, particularly since these activities are carried out irrespective of whether the block produced contains transactions or not. All network participants benefit from the update of the blockchain or the production of new blocks.
Since Polkadot (as of 20 July 2020) and Kusama (as of 4 December 2019) are a decentralized blockchain network, given that the protocol company does not have sole power of disposal over the blockchain anymore, the validation or verification activities effectively serve the blockchain network as such. Consequently, there is no identifiable service recipient and no service relationship in a VAT sense. The block reward received in this case qualifies as a non-remuneration (Art. 18 Swiss VAT Act).
Furthermore, the SFAC rejected the SFTA’s position that validation activities always qualify as a combination of supplies, because these supplies are provided by the validator to different service recipients (sender and decentralized blockchain network). Thus, the transaction processing and the remaining validation/verification activities of the validator are to be treated independently for VAT purposes.