Tax and audit considerations for Facebook’s Libra currency
INSIGHT ARTICLE |
Facebook recently released details of their upcoming Libra blockchain and Libra currency slated to go live in the first half of 2020. Libra will be backed by a selection of government securities and government issued currencies. The Libra chain will be secured by an initial group of 28 node operators, including Visa, MasterCard, PayPal, Uber and Coinbase, with plans to expand to 100 geographically dispersed nodes. With over a billion Facebook users and participation from major payment processors and Fortune 500 companies, the Libra coin has the potential to drive real adoption of blockchain technology.
Libra’s tax implications for individuals
While Libra is designed to have an intrinsic value as a way to reduce volatility in its price, the price will still fluctuate. Lacking additional guidance from the IRS, Libra will be taxed as a form of property. Gain or loss should be calculated every time there is a transaction. The gain or loss is the price at the time of a transaction over the acquisition price. An individual’s holding period will determine whether it is short-term or long-term capital gain—meaning, if used to purchase goods, one would have to not only pay any applicable sales tax, but also possibly calculate and pay capital gains tax as well.
A second token, named the Libra investment token, represents a security and will collect the interest earned on the collateral backing Libra. If an accredited individual holds this token, they will possibly need to recognize interest income periodically. In about five years, Libra intends to switch to a Proof of Stake consensus algorithm. As a result, any holder of Libra currency will essentially be able to place it into a smart contract to verify transactions on the network. Doing so will periodically earn them additional Libra. The holder may have to recognize royalty or interest income in this earned Libra.
Business tax concerns for Libra
Despite Libra’s design to decrease volatility, any currency that is traded on a market will see price fluctuations. Since Libra will be taxed as a form of property, businesses that accept Libra will have to calculate a gain or loss at the time they transfer the coin into fiat currency. This could add new exchange risk to business transactions. The gain or loss a business must recognize is equal to the price of Libra when acquired less the price when it is used or sold. In the case of cross-border payments, this means businesses will need to calculate any capital gains tax in addition to any applicable value-added tax. Whether a gain or loss is short-term or long term will be determined by the holding period. Businesses that sell the Libra back into their local fiat could find that they have more to pay come tax season.
Audit considerations for organizations accepting and/or holding Libra currency
When considering the audit of a company involved with the use of the Libra blockchain and holding the Libra currency, the first area of focus is on the data reliability of the Libra blockchain. Before an auditor can gain comfort over assertions of the Libra currency on a company’s financials, the auditor must first be comfortable that the Libra blockchain is operating effectively and as intended. This comfort may be obtained through internal procedures or, in the future, a SOC report focused on the blockchain platform. The next area of focus should be the assertions, specifically procedures to prove control of a Libra wallet’s private key to ensure existence and completeness. A comprehensive valuation policy with considerations for minor volatility with the Libra coin to ensure proper valuation should also be documented, as well as detailed consideration of the functionalities and risks of the Libra currency to ensure proper presentation and disclosure.
Companies that accept Libra will be leveraging on/off ramps for conversion of fiat to the Libra currency, or vice versa. This creates further considerations for obtaining SOC reports related to these conversion providers. Additionally, it is important that companies using the Libra blockchain ensure that proper internal controls are in place around wallet management, transaction authorization and execution, and their use of smart contracts. Adequate segregation of duties, tamper-proof storage and authorization methods, and reviewing smart contract code audits should be an integral part of a company’s review of how they are using the Libra blockchain and currency. Guidance will be needed from the FASB and IASB as well as clarity from the SEC on custody and compliance for auditing purposes should adoption be widespread.
Additional business impacts of Libra
Companies should also consider that Facebook might give discounts on fees for using Libra. Libra gives businesses an alternative to traditional payment processors. Since Facebook is one of the founders of Libra, they will most likely encourage businesses to accept it in order to spur adoption. Another benefit businesses can expect to experience is interoperability between Libra Association member products. Using Libra would allow businesses to seamlessly move money between their PayPal, Facebook and MasterCard accounts at almost no cost, providing the potential to change the way we transact online.
As Libra was announced, regulatory agencies around the world quickly began to comment on how to address this new cryptocurrency. A blockchain is built on the strength of its members, as with bitcoin's approximately 11,000 members participating in the network every day. With Libra, the strength of the network is in its founding members, all significant business entities around the world. Regulators can already anticipate the quick adoption of Libra, which bitcoin is still trying to achieve after 10 years. While many regulatory agencies are gradually addressing cryptocurrencies, Libra may push regulators to act fast and answer tough questions like these. Is Libra a security? Is it a currency? On financial statements, do we record it as an intangible? How do we meet our Know Your Customer and Anti-Money Laundering procedures around Libra? Companies wishing to accept Libra need to consider these questions as well.
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