Your guide to accounting for crypto-assets in Estonia

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accounting for crypto-assets in Estonia

TABLE of CONTENTS

  1. Understanding the role of blockchain technology and accounting for crypto-assets in Estonia
    1. Accounting for crypto-assets in Estonia: Recording practices for blockchain technology based instruments
    2. Categorizing and Valuing BTB instruments when accounting for crypto-assets in Estonia
      1. Holding a cryptocurrency and buying and selling it for financial gain; or cryptocurrency “mining”
      2. The selling or buying of services or goods for cryptocurrency
      3. Provision of cryptocurrency exchange service and wallet service to customers 
      4. Issuing, holding and trading of tokens
  2. Summing it all up
  3. Methods of payment of share capital for your Estonian private limited company

Understanding the role of blockchain technology and accounting for crypto-assets in Estonia

Crypto-assets, including cryptocurrencies, represent a fast-growing new asset class that has drawn the attention of entrepreneurs and investors alike. But, working with these new digital assets is not without its challenges. Businesses and investors that deal with crypto-assets must understand the blockchain technology underlying these assets and the accounting principles which govern their use. The following summary, prepared by Incorporate in Estonia‘s expert staff, will help you understand the regulations governing accounting for crypto-assets in Estonia.

Accounting for crypto-assets in Estonia: Recording practices for blockchain technology based instruments

Businesses engaging in financial transactions using blockchain technology based (BTB) instruments or crypto-assets in Estonia must properly account for those transactions. To facilitate proper accounting practices, the Estonian Accounting Standards Board developed a set of guidelines for BTB instruments based on Estonia’s financial reporting standards.

These standards define various subtypes of crypto-assets and how those assets may be bought, sold, or mined. The guidelines also regulate the use of crypto assets as currencies for the buying and selling of goods or services, the provision of cryptocurrency exchange or wallet services, and the issuance of crypto coins and tokens. The process of properly accounting for BTB instruments in Estonia begins with their classification.

In general, crypto-assets can be classified as follows:

  1. Cryptocurrency – These are coins represented in a digital form that is based on blockchain technology. The means of exchange for these coins is separate from central banks. The coins have no fixed direct value. Their value is based on demand and supply, and are valid merely because the transaction parties accept them as an alternative to lawful payment instruments. They must have a price expressed in traditional money at any given time. In addition, it must be possible to buy and sell them with conventional currencies in environments designed for that purpose (e.g., cryptocurrency exchanges).
  1. Asset-backed token – These are a blockchain technology based digital marker that grants the holder ownership of a physical asset (e.g., gold). The value is based on the value of the underlying asset.
  1. Utility token – This token grants the users access to products or services (e.g., use of a platform), but not ownership of the granting company or its assets. Although utility tokens can be traded, they are not means of exchange like cryptocurrency. The value of a utility token is based on the demand for the issuer’s product or service, and they are not transferable for use on other platforms. In application, these tokens are comparable to gift cards or vouchers.
  1. Security token – This instrument is similar to a traditional security where money is invested in a company with the hope of gaining a profit. Holders of security tokens may be given rights related to the underlying legal entity such as the right to receive money or other financial assets or a chance to have a say in the company’s decisions. The value of a security token will depend on the company’s success as the security token’s owner may participate in the distribution of profits or assets. The Securities Market Act governs issuances and uses of security tokens.

Categorizing and Valuing BTB instruments when accounting for crypto-assets in Estonia

How a crypto-asset is categorized for accounting purposes depends on the facts and circumstances surrounding the use of that asset by the business. These facts will determine whether an Estonian business records a particular BTB instrument as an asset, liability, contingent asset, expense, or earnings. It is up to the business’s management team to provide adequate information so that the accountant can correctly categorize the instrument.

In the following sections, we describe some of the most common uses and recording methods for businesses using crypto-assets.

Holding a cryptocurrency and buying and selling it for financial gain; or cryptocurrency “mining”

Estonia’s Income Tax Act defines a virtual currency, such as cryptocurrency, as an asset. However, according to international financial accounting standards, cryptocurrencies are not regarded as cash or currency. Thus, when accounting for crypto-assets in Estonia, cryptocurrencies are not recorded as money.

If a company actively trades tokens, buying and holding them for quick resale, they can be recorded as stocks. However, if the company’s aim is to hold the tokens for a long period for value growth, carrying them on the books at fair market value, they should be treated as financial assets.

The value of crypto-assets being treated as financial instruments should be recorded in euros using the FIFO or weighted average method at the current exchange rate as of the balance sheet date. 

Locating conversions rates for cryptocurrencies

When cryptocurrency transactions are made at market conditions, recalculation of the cryptocurrency into euros and vice versa must be done at the rate of the environment in which the transactions were made or where the cryptocurrencies are being held. If the transaction is not made at market conditions, the applicable average exchange rate can be found at TradingView.com’s Cryptocurrency Market page.

In some instances, the value of a crypto-asset may be first calculated in USD before conversion into euros. In these cases, the USD-EUR quotation should be based on the exchange rates found at the European Central Bank website’s Euro foreign exchange reference page

Recording and valuing mining-related crypto-assets

Cryptocurrency mining is a process where actors known as “miners” complete transaction blocks from already verified transactions. Cryptocurrency miners use special hardware and software for mining, and new cryptocurrency units are formed in the system automatically. Mining is extremely resource intensive and miners receive new cryptocurrency units (e.g., Bitcoins) as compensation.

Earnings from cryptocurrency mining treated as investment earnings for tax purposes. The market price at the time the cryptocurrency is mined can be reckoned as the historical cost, which is revalued at its fair value as of the balance sheet’s date. Mining is a value added tax (VAT) exempt activity and its value is not included in taxable turnover totals. Because mining activities are VAT exempt, miners cannot get refunds for VAT paid on expenses, such as electrical costs, related to mining activities.

If a company leases its data capacity for mining activities instead of directly mining cryptocurrency, the transaction is treated as a service sale subject to the ordinary rules of VAT charging.

The selling or buying of services or goods for cryptocurrency

If a company buys or sells goods or services in exchange for cryptocurrency, then the cryptocurrency received or paid is calculated into euros at the exchange rate as of the transaction date. The VAT for these transactions is calculated in the same way as for FIAT currency transactions, based on the company’s VAT liability. Held cryptocurrencies are recorded at their fair value on the income statement.

However, as cryptocurrency is simply a payment for the provision of the service or receipt of the goods, the cryptocurrency itself is not subject to VAT in such transactions. Nonetheless, the crypto-assets gained from the transaction are recorded as financial assets, not as cash or FIAT currency.

Provision of cryptocurrency exchange service and wallet service to customers 

The profit a business gains from exchange rate differences when operating a cryptocurrency exchange or wallet service is not subject to VAT. Also, the exchange of virtual currency for FIAT currency is exempt from VAT and vice versa. By analogy, we surmise that the exchange of one virtual currency to another virtual currency is also not subject to VAT.

Similarly, by analogy, a wallet service could be treated as the administration of non-cash payment instruments and is also a tax-exempt turnover. Of course, this creates a situation in which the input VAT cannot be recovered either.

Issuing, holding and trading of tokens

Crypto-assets are sometimes used in a manner similar to asset and non-asset backed securities or vouchers. Issuing tokens for these purposes is referred to as an Initial Coin Offering (ICO). Despite this label, the word “coin” is often used to refer to crypto-assets used as currency, such as Bitcoin. Whereas, when used for fundraising, crypto-assets are more often called “tokens.”

Tokens, particularly those which are non-tradable in the active market are often referred to as high-risk tokens. Generally, an active market is one in which many traders participate, transactions are conducted at arm’s length, and transactions for the asset take place with sufficient frequency and volume such that market-set prices can be determined. Whether a token is high-risk and its potential for financial gain are important factors in determining how the tokens should be recorded when accounting for crypto-assets in Estonia.

Security and utility tokens

Security tokens grant the holder the right to some financial interest in a company, such as a  portion of future profits. Security tokens may be recorded as assets or contingent assets, depending on management’s assessment of their potential for gain.

If the company’s management estimates that there is a high probability that the organization will gain financially from ownership of the token, then it may be recorded as an asset. If management evaluates a token as having little chance of resulting in gain, then the token does not fit the definition of an asset and should be recorded as a contingent asset. Contingent assets are recorded as an expense at the time of purchase for accounting purposes.

A utility token is one that grants the holder the right to purchase a good or service usually at a discount from the token’s issuer. If a utility token fits the definition of an asset in the management’s estimation (the probability of financial gain is very high) and the acquirer intends to use the right related to the token, it can be recorded as a prepayment for stocks or tangible assets.

Taxation for utility tokens

Utility tokens, which essentially serve as a voucher, may be either single-purpose or multi-purpose. The tax rate for utility tokens tracks that of the promised good or service. For example, if the goods or services represented by the token is subject to a 20% VAT rate, the issuer of the voucher immediately generates a turnover with a 20% rate when the voucher is issued. If the buyer has an EU VAT number, the rate is 0%.

If the tax rate of the underlying good or service cannot be determined with certainty at the time of issuance, for example, if the goods and services may be taxed at both a 20% and a 9% rate, then the issuer generates a turnover when the token is redeemed for the goods or services.

Accounting for intangible and asset-backed tokens

If a token grants its holder a right to underlying assets such as raw material, intangible assets including licences or patents, works of art, real property, or other things of value, it is an asset-backed token. For accounting purposes, an asset-backed token’s value is calculated using the value of the underlying asset. Or, if the token grants a contractual right to receive money equivalent to the value of the underlying asset, it can be recorded as a financial asset.

In certain cases, the token itself may fit the definition of an intangible asset. If this is the case, such tokens are recorded and calculated like other prepayments.

Questions to be answered to make it easier for the ICO’s issuer to decide on the ICOs recording
  • Does the ICO token fit the definition of a financial liability?
  • Does the ICO token fit the definition of equity?
  • Is the ICO token a prepayment from a customer for goods and services?
  • Are none of the above true?

Summing it all up

When recording crypto-assets in financial reports, we recommend that you also memorialize the following information:

  • The policies followed by your management team when making categorization, value, risk, and other estimations
  • A description of the techniques used for setting the fair value of each crypto-asset
  • Any material events occurring after the balance sheet date such as changes in value, shifts in the ICO stage, or others
  • Descriptions of the risks that holding crypto-assets may pose, and any risk management measures your organization is taking
  • Which regulated market’s prices were used to record the virtual currencies on the balance sheet
  • The income statements in which profits and losses from fair value changes recorded.

All transactions should be recorded based on the exchange rate of the value date. Subsequent fluctuations in the market prices of cryptocurrency are then recorded on the income statement as income or expenses.

Crypto-assets in Estonia must be recorded in a manner that assures that

  • Their substance is understandable to the reader of the report
  • The accounting policy chosen is based on the economic substance of the instrument
  • The recording of the instrument is comparable to the recording of similar instruments in the reports.

Economic transactions should be accounted for based on the economic substance of the transactions, even if the substance is not in accordance with the legal form of the transactions.

Methods of payment of share capital for your Estonian private limited company

Establishing a private limited company in Estonia is simple and this business form is one of the most popular among entrepreneurs in Estonia. In Estonia, it is possible to establish a private limited company without paying the share capital. In this case, there remains a notation in Commercial Register that the private limited company was founded without making contributions. However, to reap the full benefits and liability protections of an Estonia private limited company, the share capital must be paid.

Before a company can pay dividends to shareholders or to increase or decrease the share capital value of a company, the Commercial Code of Estonia requires the contribution of the initial share capital (the minimum value of EUR 2,500).

Inputting the share capital also bolsters the company’s reputation. The share capital can be looked at as money held in reserve to help the company pay for unexpected outlays, and it also covers possible debts. In essence, the share capital is viewed as a warranty by the government and business partners.

Using non-monetary assets as payment of share capital

The payment of share capital may be monetary or non-monetary. In most instances, the share is paid for in money. In the case of a monetary contribution, the paying process is rather simple and clear. All that needs to be done is to transfer the contribution of share to the bank account of the company.

The situation of non-monetary contribution is more complex and versatile. The contribution of non-monetary shares gives business owners an opportunity to use assets owned by them to grow the company’s liquidity and also to fill the share capital payment requirement stated by law even if they do not have access to an Estonian bank account. It is very common for private liability companies to use existing material, machines, and appliances as non-monetary share capital contributions. Real estate may also be used for this purpose.

Cryptocurrency also may be used to pay the share capital of a newly formed enterprise in Estonia. Entrepreneurs can transfer ownership of Bitcoin or any other non-traditional currency from their private person to the newly founded company as a non-monetary contribution.

But, not every corporate service provider is prepared to help entrepreneurs fund their Estonian businesses using cryptocurrency. To our knowledge, Incorporate in Estonia is the only corporate service provider in Estonia that facilitates this capitalization method.

How to pay your share capital with cryptocurrency when establishing your business in Estonia

In order to pay share capital in cryptocurrency such as Bitcoin or other altcoins, a company must be incorporated in the notary’s office or online. Upon incorporation, the organization’s future management board member shall evaluate the monetary value of the cryptocurrency and present relevant proof to the Commercial Register. A screenshot of the daily exchange rate of the currency from a trusted cryptocurrency exchange website is sufficient to prove the value of cryptocurrency for share capital. In addition, a contract for the transfer of the cryptocurrency to the company must be presented.

If the value of the share capital is above EUR 25,000, the value of the contribution must also be verified by an auditor. The auditor’s report verifying the valuation of the cryptocurrency must be provided to the notary at the time of incorporation.

Incorporate in Estonia’s service fee for the incorporation of an Estonian company with non-monetary share capital is EUR 1,750 (excl. VAT, if applicable) or 2.5% of the initial targeted capital if the share capital is more than EUR 25,000. Please note that you will be required to pay an additional service fee if an auditor’s verification is required.

The use of crypto-assets to establish and build your company in Estonia offers you the opportunity to step into the future and achieve your goals. If you have any questions about how to manage your crypto-assets in Estonia or need help to make payment of share capital in Bitcoin or altcoins, please do not hesitate to contact us at advisory@incorporate.ee.

Disclaimer: This article provides general information, which may or may not be correct, complete or current at the time of reading. No recipients of content from this site should act on the basis of content of the article without seeking appropriate legal advice or other professional counseling.

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