In light of questions raised by our US-based community members regarding the distribution of Spark, Flare Network has engaged independent tax counsel to provide its opinion on the tax implications of the staggered token release plan. Specifically, we asked the tax attorneys at Tjong & Hsia whether the staggered timing of the token release would create tax implications under US federal tax law for US recipients under the assumption that the value of Spark would, arguably, increase to something greater than $0 subsequent to the initial 15% planned release.
INITIALLY, PLEASE NOTE THAT THE BELOW EXCERPTS FROM THE RESULTANT TJONG & HSIA TAX MEMO DO NOT CONSITUTE LEGAL ADVICE TO MEMBERS OF THE FLARE NETWORK COMMUNITY. YOU SHOULD ALWAYS CONSULT WITH YOUR OWN TAX COUNSEL FOR PERSONAL TAX ADVICE.
That said, we quote the relevant parts of their analysis as follows:
THE DOMINION AND CONTROL DOCTRINE
The first part of Tjong & Hsia’s analysis reviews the “dominion and control doctrine” which basically says that property (in this case crypto tokens) is taxed to the recipient at the time that the recipient is deemed to be in dominion and control of that property. In other words, if dominion and control is of the initial 15% Spark distribution is deemed to exist on day zero, when Spark is arguably worth $0, then the income tax to the recipient for that 15% is $0. However, if dominion and control for the remaining 85% Spark distribution is deemed to exist only on the future dates when that Spark is released to the recipient, then the taxable income to the recipient would be the value of those distributions on the dates that they are distributed.
“Virtual currency is treated as property for federal income tax purposes1. The dominion and control doctrine applies to rights and property received, but not paid for, by a taxpayer, including unsolicited property such as free samples and security purchase rights. Air dropped coins are unsolicited property that may be claimed by a taxpayer if he has sufficient credentials.
These coins are not gifts. The property is, however, an economic gain that, if and when the taxpayer exercises dominion and control, will be realized income2. The long-standing position of the IRS has been that such rights and property are realized as income only if and when the taxpayer exercises dominion and control3 and when the courts have considered the issue, the decisions are consistent with the IRS's position4.
The proper time for determining the amount realized is at the time dominion and control is exercised with respect to the property by the taxpayer5. Free samples received by a taxpayer are unsolicited property, and included in income at fair market value if and when the taxpayer exercises dominion and control.”
1 Notice 2014-21
2Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955).
4Haverly v. United States, 513 F.2d 224, 226 (7th Cir. 1975) (“[I]ntent to exercise complete dominion over unsolicited samples is demonstrated by donating those samples to a charitable institution … .”); Holcombe v. Commissioner, 73 T.C. 104, 117–18 (1979).
5See GCM 36639 (Congressional Record donated). IRS News Release IR-2006-128 (Aug. 17, 2006) (example where acceptance of unsolicited property is often not simple).
DOMINION AND CONTROL DOCTRINE DOES NOT APPLY TO SPARK
If the dominion and control doctrine applied to our planned distribution schedule, then US recipients would arguably face a recurring tax bill on the 85% Spark they receive in future distributions. However, according to the Tjong & Hsia analysis, the dominion and control doctrine would not apply to the 85% distribution if the initial 15% distribution was seen as a “forward arrangement” for the subsequent 85%.
“[If the distribution arrangement] would be viewed as the recipient entering into a forward arrangement in which they are paying a certain [value] in exchange for the receipt in the future of the Tokens being distributed monthly […] the basis would be the allocable purchase price under the forward arrangement to each future receipt of 3% of the total Tokens and the “dominion and control” analysis of an airdrop would no longer be relevant."
According to the analysis, the method by which our community members claimed their initial 15% distribution of Spark would arguably constitute a forward arrangement for the remaining 85%:
“[T]here are a number of economic factors consistent with the treatment of the initial arrangement itself as a forward arrangement.”
“[I]t was “clearly documented that in order to "claim" your Spark, you needed to make a transaction on the XRP ledger (which by implication requires spending some XRP). The claim guarantees the claimant's rights to the FULL distribution in the future”. And while it doesn’t specify all the details of how the future distribution will work (100% upfront or in increments as currently planned), “it is still a "contract" guaranteeing future delivery of Spark to any XRP holder who pays the requisite transaction fee on the ledger.”
“[I]f respected, the subsequent distribution of the 85% would be treated as an acquisition by virtue of the forward contract entered into currently.”
Our commissioned tax analysis concludes that the method by which users claimed their Spark would constitute a forward arrangement such that the subsequent 85% distribution would be treated as having the same value as the initial 15% “day zero” distribution. That said, we again note that the analysis heavily emphasizes that cryptocurrency is a novel industry facing high levels of scrutiny and potential challenge by worldwide tax authorities. Therefore, we urge our community members to consult their own tax advisors and perform their own due diligence.