How do enterprises use cryptocurrencies? What are the corresponding tax and security issues?

Original Title: The use of cryptocurrency in business: Why companies should consider using cryptocurrency

Author: Blockchain & Digital Assets at Deloitte

Compiled by: TaxDAO

An increasing number of companies worldwide are using Bitcoin and other digital assets for a range of investment, operational, and transactional purposes. As with any frontier area, there are both unknown dangers and powerful incentives. This article explores the questions and insights that businesses should consider when deciding whether and how to use digital assets.

Two Main Ways to Use Cryptocurrency

The first question to ask when considering the use of cryptocurrency in company operations is: Are we holding cryptocurrency on our balance sheet, or are we simply adopting payment methods that support cryptocurrency? To determine the path that is right for your business, consider how it aligns with business objectives. Think about potential benefits, drawbacks, costs, risks, system requirements, and more. As companies embark on their crypto journey, the following sections provide some broad considerations around the two different paths.

1. Enabling Payments: "Letting Go"

Some companies use cryptocurrency merely for the convenience of payments. One way to facilitate payments is to simply convert cryptocurrency into fiat currency to receive or make payments without actually touching it. In other words, the company is taking a "letting go" approach by using service providers to conduct transactions, thereby keeping the cryptocurrency itself off the books.

Third-party vendors will charge fees for this service, handling most of the technical issues on behalf of the company and managing some risks, compliance, and control issues. However, this does not mean that the company is necessarily absolved of all responsibility for risks, compliance, and internal control issues. Companies still need to consider whether their chosen service provider takes AML and KYC requirements seriously. Of course, they also need to comply with any restrictions set forth by the Office of Foreign Assets Control (OFAC), which manages and enforces economic and trade sanctions imposed by the U.S. government.

Considerations when working with third-party vendors:

• Companies largely rely on vendors, so careful due diligence on the vendor's resilience and responsiveness is necessary to meet the company's expectations.

• Consider the customer experience in accepting and issuing cryptocurrency payments, and how the vendor's actions or inactions might affect that experience.

• As part of due diligence, pay close attention to the vendor's internal controls, financial condition, operational security (e.g., cybersecurity that meets recognized standards), fraud detection programs, all fiat currency conversions, and the reliability and accuracy of all accounting and tax information provided by the vendor. This also includes matters related to creditworthiness and counterparty risk. Ideally, the vendor can provide some third-party assurances regarding these issues, such as Service Organization Control (SOC1 or SOC2) reports.

• Understand the vendor's pricing and whether the company faces risks of price fluctuations.

• Since the third party is an agent, ensuring that settlements actually occur remains the company's responsibility. The company cannot transfer all regulatory and compliance responsibilities to other providers.

• Global licensing and regulatory requirements are constantly changing. How does the payment vendor ensure that it obtains and maintains appropriate licensing and compliance in the jurisdictions where it operates?

• Does the payment vendor have the capability to provide technical support in a "follow the sun" model across all jurisdictions it serves?

• What are the potential implications of relying on third-party vendors for the company's transfer pricing planning?

• How will the use of third-party vendors affect the accounting treatment of foreign currency transactions?

  
  

These questions are not meant to deter the adoption of crypto payment vendors. Using them can be a quick and simple way to enter the crypto ecosystem. Therefore, the bottom line is to be mindful in choosing vendors and consider all potential implications of enabling crypto payments.

2. Initiating Payments: "Getting Hands-On"

Other companies currently using cryptocurrency in a "getting hands-on" manner utilize third-party custodians. If a company is ready to not just enable crypto payments but intends to further expand the adoption of cryptocurrency within its operational and financial functions, it may find that the number of benefits as well as technical issues to be addressed significantly increases.

To prepare, the finance department may consider the following preliminary questions:

• What is the purpose of the company adopting cryptocurrency? If the goals are unclear, it may lead to scope creep and difficulties in risk management.

• What measures have been taken to acquire the necessary knowledge to receive, monitor, and manage crypto payments?

• Should the company self-custody cryptocurrency or outsource it to a third party?

• What measures have been taken, or has there been consideration of investing in cryptocurrency as a new asset class?

• What adjustments does the finance department anticipate for central bank-issued digital currencies?

  
  

The finance department will inevitably be involved in these decisions and the changes required because:

• The traditional finance department is responsible for maintaining the company's financing relationships (e.g., banking groups, investment partners, third-party operating capital providers).

• The finance department will need to determine what type of banking and financial services the company will require as it positions itself within a broader and bolder digital ecosystem.

  
  

Companies can follow two paths when they begin to more broadly adopt cryptocurrency:

• Use third-party vendors or custodians to maintain custody of cryptocurrency on the blockchain and provide wallet management services to facilitate tracking and valuation of crypto assets.

• Integrate crypto technology into the company's own systems and manage its own private keys, determining whether licenses are needed to transfer cryptocurrency.

  
  

Currently, many companies that actually use cryptocurrency tend to favor third-party custodians. Given this trend, this article will explore this path in more detail.

The second approach, self-custody, is more complex and requires deeper expertise. Moreover, if a company follows this route, it may bear greater responsibility for the work supporting its transactions. That is to say, much of what follows may also apply to self-custodied companies.

2.1 Wallets and Tracking

Cryptocurrency is stored and managed in digital wallets. An appropriate wallet structure is foundational to successfully implementing cryptocurrency financial functions. Many entities adopt a multi-layered structure where "hot wallets" are used for operational accounts, as opposed to "cold wallets." "Cold wallets" are typically used for assets that do not need to be accessed for long periods. For entities with high transaction volumes, tracking the details of these transactions can become a significant challenge.

Tracking typically requires detailed records of the date and time of purchasing cryptocurrency, its value, and allocations, among other things. In many cases, entities choose to convert to stablecoins (such as USDC, GUSD, PAX, etc.) to reduce uncertainty associated with traditional crypto asset price volatility. Once the exchange is completed, cryptocurrency becomes easier to use for traditional banking and financial transactions.

2.2 Additional Perspectives from the Finance Department

While cold wallets are applied for long-term storage, the importance of hot wallets has several other reasons. They can also help predict the various uses for which cryptocurrency will be placed or stored. In addition to supporting immediate operational goals, hot wallets also assist in:

• Quick payments;

• Transfers using cryptocurrency;

• Short-term savings and investments that approach money market yields.

  
  

For the finance function, most importantly, hot wallets provide the appropriate clarity and visibility to help the finance department continuously determine or adjust cryptocurrency allocations.

2.3 AML and KYC

AML and KYC regulations impact users of the crypto network, especially if they accept large payments from foreign clients. Companies need to be aware of their obligations to avoid inadvertently facilitating money laundering activities through foreign vendors or suppliers in complex international supply chains. Additionally, since all companies must comply with rules and regulations set forth by OFAC, they must be able to identify (or have a trusted third party identify) the source of any cryptocurrency they accept or ultimately pay. Companies should be vigilant regarding sanctioned and restricted Bitcoin and other crypto addresses.

2.4 Second Layer Protocol Risks

One area of innovation that companies should pay attention to is "second layer protocols." In short, these are applications built on top of blockchain systems. They aim to make cryptocurrency transactions faster and cheaper. These second layer protocols are rapidly maturing and may soon compete with traditional payment systems. Moreover, they may become more efficient and popular than the traditional payment systems currently in use.

2.5 Tax and Accounting Considerations

• Using cryptocurrency as a medium of exchange in a manner similar to fiat currency presents unique accounting challenges. Cryptocurrency is often considered an intangible asset. It is likely to require adjustments or additional disclosures to the income statement, cash flow statement, and other financial documents.

• For tax purposes, using cryptocurrency for receipts or payments may be viewed as a barter transaction (a non-monetary exchange of goods, services, or non-financial assets between two counterparties).

• The volatility of cryptocurrency prices throughout the transaction lifecycle plays a significant role in determining the value of digital assets, both for accounting and tax purposes.

  
  

2.5.1 Tax Treatment of Cryptocurrency Payments

For tax purposes, the value of cryptocurrency is determined when the payment becomes fixed and ascertainable. This may relate to the time the cryptocurrency is received rather than when the contract is signed. For tax purposes, similar to typical barter transactions, companies must determine the easily ascertainable fair market value at the time they receive the asset. This value is typically obtained using a blockchain explorer or value aggregator. Here are some important considerations to weigh:

• Companies must record the time and value of cryptocurrency when it is received or when the company has dominion and control over it. This information can enable the company to establish and track the tax basis of the cryptocurrency. Thus, once used or exchanged for another cryptocurrency or fiat currency, this information can be referenced.

• It is crucial to follow a systematic and reasonable approach to establish and track the basis and maintain detailed and appropriate documentation (especially when facing scrutiny from the IRS, state, or international tax authorities).

• When a company receives cryptocurrency payments, it must carefully track it to calculate any applicable sales tax, indirect tax, value-added tax, goods and services tax, etc. Currently, most government agencies only accept fiat currency payments. Therefore, companies must maintain reliable documentation and appropriate processes. This can help ensure that the amounts of cryptocurrency collected for indirect taxes can be remitted in fiat currency to the appropriate authorities.

  
  

2.5.2 Tax Treatment of Cryptocurrency Expenditures

When a company uses cryptocurrency for expenditures, the transaction typically has two aspects: (1) the gain or loss on the cryptocurrency used (the value of which is likely to have changed); (2) the expense or payment itself. The value of cryptocurrency at the time of the transaction may determine the so-called "easily ascertainable fair market value" of this barter transaction. And, as with income, it is also important to retain appropriate documentation regarding how the value was determined. The difference here compared to payments to vendors using fiat currency is that cryptocurrency triggers gains or losses on the underlying asset used in the transaction. Therefore, companies must create appropriate wallet structures to isolate cryptocurrency so that it can be confirmed which units of these assets are actually used.

By maintaining segregated portions and wallets (each with its own tracking basis), companies can accurately determine which digital assets they are using and how much gain or loss is triggered in the transaction. It is also important to determine the nature of the gains or losses triggered when using cryptocurrency. For tax purposes, using cryptocurrency for receipts or payments may be viewed as a barter transaction.

2.5.3 Payroll

Using cryptocurrency for payroll requires careful consideration of several factors:

• Appropriate processes are needed to track withholding tax processes.

• Most tax authorities do not accept cryptocurrency, and companies need to remit fiat currency to pay withholding taxes, which may require additional exchange transactions before remittance.

• Cryptocurrency does not generate traditional bank statements. Therefore, regulations need to be established to capture and disclose all relevant transaction details. Companies need to provide this information to the IRS, state, or foreign tax authorities.

• Public companies have additional considerations for executives compensated in cryptocurrency (e.g., proxy statements).

  
  

2.5.4 Financial Statement Disclosures

For many companies, using cryptocurrency in business is a new area. For many of the reasons mentioned above, it may impact the company's financial performance. Companies that practically use cryptocurrency should carefully consider the following questions:

• Are the applicable accounting principles for the transactions disclosed as required?

• Are the required disclosures sufficient and appropriate? Do they clearly depict the company's strategy for using cryptocurrency to users of the financial statements? Can readers of the financial statements understand how cryptocurrency is used in the business?

• How does the use of cryptocurrency affect the company's cash flow and operations?

• What are the relevant risks to the company's business? This includes the impact that cryptocurrency may have had or may have on the company's current and future financial performance, as well as the related risks the company may face due to the use of crypto assets in its business.

• Do the company's financial statement disclosures clearly depict the strategy the company employs in using cryptocurrency for users of the financial statements?

  
  

2.6 Integrating Finance and Operations

Finance and operations often serve as the cornerstone for the daily use and management of cryptocurrency within an organization. When considering the types of payments the company makes, the customers, vendors, and suppliers it frequently interacts with, the scale of transactions, and the demand for speed, a payment network using cryptocurrency may be the solution for finance and operations.

Consider this example: A manufacturer relies on components from different countries. It may contract with third parties to manufacture certain components, assemble them at another location, and mix the use of company and third-party distribution channels globally. Once the manufacturer establishes the network and invites third parties to join, the cost of transactional business becomes very reasonable. In this process, participants (depending on the networks they are part of) can benefit from:

• Linking payments to the delivery of goods, thereby reducing credit risk in transactions.

• Reducing Days Sales Outstanding (DSO), thereby supporting improved margins and working capital.

• Ensuring real-time payment delivery to enhance transparency in forecasting and reporting.

  
  

2.7 Selecting and Evaluating Vendors or Custodial Partners

Like investing in cryptocurrency, the use of cryptocurrency requires appropriate due diligence on third-party vendors and custodians. Understanding the broad issues begins with the potential various risks associated with cryptocurrency itself. For companies, it is essential to understand how specific digital assets operate, their terms and conditions, and the potential impacts of the asset's market vulnerabilities and volatility.

3. Defining the Company's Development Path and Creating a Roadmap

As with any technological change or upgrade, it is essential to develop an implementation plan. Some view cryptocurrency as a key part of financial evolution. When a company chooses to engage with cryptocurrency, it triggers changes across the organization and in ways of thinking. The implementation plan should include, but not be limited to, the following types of questions:

• What is the overall strategy?

• What are the short-term and long-term goals?

• What internal and external partners does the company need to involve? Can leaders find effective supporters throughout the enterprise and all relevant departments?

• Do the decisions and actions the company takes now provide flexibility and scalability for future work?

• How does the company integrate the security needs of operating within the digital asset ecosystem with its existing security and network operations?

• How does the company introduce cryptocurrency? Does it start with just payments, a letting-go approach? Or does it intend to get hands-on?

• What additional resources does the company need beyond what it currently has? What new expertise might it require?

• What would the implementation roadmap look like?

• How will the company assess progress during the implementation process? Does the company have the necessary processes to monitor transaction execution and vendor performance?

• What does the end state look like?

  
  

This can be a complex undertaking. That is why some companies choose to pilot the use of cryptocurrency before making a more robust rollout, just as they would pilot new technologies. One type of pilot is based within the finance department, as the finance department is typically responsible for the internal financing of the company and its departments and subsidiaries. The pilot could start with purchasing some cryptocurrency, then the finance department would use it for a few peripheral payments and track the payment, receipt, and revaluation processes of the cryptocurrency.