What are block rewards?
In most proof-of-work and proof-of-stake blockchains, the reward a validator gets for successfully validating a block consists of two components:
- A coinbase reward (nowadays often called “block reward”, which I personally find a misleading term), which is a predefined number of newly created tokens to incentivize the miners
- The transaction fees of all transactions mined it that block
How were Block Rewards taxed in Switzerland in the past?
In the VAT guidance from 2019 of the Swiss VAT authorities stated, that block rewards are not subject to VAT, but only if a block does not contain any transactions. The reason behind this treatment is that block rewards are generated by the blockchain itself and not by a counterparty that could be deemed as the recipient of the validation services. As soon as a block contained at least one transaction, both the block rewards and the transaction fees would be taxable. In such case a Swiss validator/miner would have to declare VAT on the fees received, to the extent the end-user initiating the transaction was a Swiss resident. Since the validator cannot identify the end-user, the VAT authorities would typically agree to a tax ruling stating that only 1-5% of the revenue from mining/staking was deemed a Swiss sourced income subject to Swiss VAT.
What does the court decision change?
The court decision A-5638/2022 of 29 August 2023 states that block rewards should not be subject to Swiss VAT irrespective of whether or not a block contained transactions. This leads to a significantly lower VAT burden for the validator.
Numaric Example:
- A validator generates CHF 100 million in staking rewards
- 50% of the rewards come from transaction fees and 50% from block rewards,
- the validator has obtained a tax ruling that 1% of its rewards are deemed Swiss sourced income.
In the old system, the validator would declare a taxable income of CHF 1m (1% of CHF 100m) and pay VAT of CHF 77k (7.7% of CHF 1m). After the court decision the 50% block rewards would not be relevant for VAT and the validator would declare an income of CHF 0.5m (1% of 50% of CHF 100m) and pay VAT of CHF 38.5k (7.7% of CHF 0.5m).
What happens with not sufficiently decentralised blockchains?
The court decision stated that the rule of not taxing block rewards only applies to completely decentralised blockchains and left it up to the tax authorities to determine the tax treatment of blockchains that do not meet those requirements. As mentioned in earlier articles, the VAT authorities have not yet issued clear criteria as per when a blockchain is “sufficiently decentralised”. However, in my view, if a blockchain was developed and promoted by a centralised entity (e.g. a foundation) and it cannot be demonstrated that this entity given up control over the blockchain, the tax authorities could consider the block reward a compensation for a taxable service provided to the entity developing the blockchain. If that entity is domiciled in Switzerland, all block rewards would be subject to Swiss VAT. If that entity is abroad, all block rewards would be exempt.
What about delegated staking?
The court decision only addresses validators/miners who validate transactions and receive the rewards directly from the blockchain. In case of delegated proof-of-stake, a delegator is providing a service to the validator (even if he collects the rewards directly from a smart contract and not from the validator). Hence the counterparty of the delegator is the validator and not the blockchain, so the rewards are always taxable (if the validator is located in Switzerland), even if the earnings contain block rewards.
How should validators and miners deal with the new court decisions?
Miners and validators should assess whether they can split their revenue into block rewards and transaction fees. If they can, and if the administrative burden of doing so does not outweigh the benefits, they should calculate the correct figures and claim back the overpaid VAT for the past. If they cannot calculate the exact split into block rewards and transaction fees, they should consult their tax advisor whether they can apply for a lump-sum approach to reduce their tax burden.