Blockchain/Distributed Ledger Technology and Cryptocurrencies - New Zealand's Regulatory Response

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Blockchain/Distributed Ledger Technology and Cryptocurrencies - New Zealand's Regulatory Response

By Chris Linton*

 

Introduction

Governments, regulators, international business and finance hubs, and global organisations continue to monitor, in some cases regulate, and in some cases compete for, blockchain/distributor ledger technology businesses, the initial coin offering (“ICO”)/token generation event (“TGE”) fund raising market, and crypto currency services and exchange businesses.  All are focused on supporting and growing these innovative technologies and, in parallel, maintaining the stability of financial markets, protecting consumer interests, and the country's reputation.

In New Zealand, the position is no different. This article explores the current (and evolving) regulatory landscape in New Zealand as it affects blockchain business, ICOs/TGEs and crypto currencies services and products.

New Zealand’s three key regulators

New Zealand has three principal regulators for this sector - the Financial Markets Authority (responsible for New Zealand's financial markets), the Reserve Bank (the central bank and prudential regulator for banking and insurance), and the Inland Revenue Department.  All have key roles to play, and from a seemingly standing start six months ago, are becoming increasingly active. 

1. Financial Markets Authority (“FMA”). 

The FMA is responsible for the following financial markets legislation:  the Financial Markets Conduct Act 2013, the Financial Service Providers (Registration and Disputes) Act 2008, and the Financial Advisers Act 2008.

The extent to which an ICO/TGE is regulated (and disclosure obligations triggered) depends on whether a “financial product” is being offered to retail investors in New Zealand (i.e. a regulated offer is being made). Whether a token offered in an ICO/TGE is a financial product, and if yes, what type of product, will depend on the token’s characteristics and economic substance.

The Financial Market Conducts Act 2013 (“FMCA”) applies to the offer of financial products for issue or sale.  Financial products are defined as:

  • Debt securities;
  • Equity securities;
  • Managed investment products; or
  • Derivatives.

The FMA also has the ability at any time to designate any other offering as a financial product.

To date, the FMA has issued one guidance note, in relation to ICOs and cryptocurrencies (October 2017 and updated in May 2018) and in the last week, outlined the fair dealing implications for this sector. Given the four categories of financial products (equity securities, debt securities, managed investment schemes, and derivatives), it’s easy to see why prospective ICOs are angling to issue (and be classified as) “utility” tokens.  This mirrors the focus globally on utility tokens, driven in part by the United States’ (and other countries’) securities laws, and also the evolving (and increasingly sophisticated)  business models and token economics. The FMA has indicated recently that it is planning to release guidance on utility tokens very soon, to provide some clarity/certainty.

Crypto-related activities, if they constitute  a “financial service”, are also regulated. Key crypto-related activities that will be financial services include exchanges, wallets, deposits, and broking.

2. The Reserve Bank of New Zealand (“RBNZ”)

The Reserve Bank is New Zealand's central bank responsible for stability of the financial system and currency.  It is also the prudential regulator of banks, non-bank deposit takers and insurance companies. 

RBNZ’s public commentary to date has been limited.  In July 2017, RBNZ confirmed that it believed its regulatory settings were appropriate, and no fintech sandbox was required. That was followed, in November 2017, by RBNZ publishing “Crypto-currencies – An Introduction to not-so-funny-moneys” as part of its Analytical Note Series (background papers prepared by RBNZ staff – and not necessarily representing the views of RBNZ). The paper’s purpose was to introduce “the distributed ledger technology of crypto-currencies”.  RBNZ has largely been silent, publicly, since then.

3. Inland Revenue Department (“IRD”)

Until very recently, the IRD had said very little publicly – other than confirm that the tax treatment of crypto currencies was part of its 2018 work plan, and making limited comments about the commodity/asset nature of those currencies. 

On 28 March 2018, the IRD provided welcome clarity on the income tax implications of crypto currencies:

  • Cryptocurrency is property, not currency (so foreign currency gain/loss provisions do not apply).
  • Cryptocurrency received as payment for goods or services is business income, which is taxable. It is seen as a barter transaction and the tax payer will need to calculate the value of the cryptocurrency in New Zealand dollars (“NZD”) at the time it is received.
  • Payments in cryptocurrency, if not converted into NZD straight away by a cryptocurrency merchant processor, will need to be converted to the NZD equivalent on the relevant date. Conversion rates used must be from a reputable exchange with a reasonable trading volume.
  • The sale of cryptocurrencies may trigger a capital or revenue gain, depending on the tax payer’s purpose in acquiring the cryptocurrency. Cryptocurrency is considered property for income tax purposes. Accordingly, if cryptocurrency is acquired for the purpose of disposal (selling or exchanging it), the proceeds from sale are taxable. The IRD’s view is that bitcoin and similar cryptocurrencies generally don’t produce an income stream or provide any benefits, except on sale or exchange – suggesting that cryptocurrencies are generally acquired for the purpose of sale or exchange. The IRD also noted that for income tax purposes, cryptocurrencies have similar characteristics to gold bullion.
  • Good record keeping of cryptocurrency transactions is critical. Standard seven year record keeping requirements apply in New Zealand. If using mobile and desktop wallets and exchanges, a taxpayer needs to have access to his or her transaction history (deposits, transactions and withdrawals) and to be able to export this in a commonly used file format like CSV. A tax payer also needs to retain bank statements and cryptocurrency wallet addresses for verification.
  • The tax treatment of crypto currencies issued in an ICO/TGE will depend on the features, and distribution, of the crypto currency.  The IRD has suggested prospective ICOs/TGE issuers wanting certainty of the tax implication seek a binding ruling from the IRD. For those contemplating ICOs in New Zealand, that lack of clarity (while understandable) is unhelpful.

The IRD has yet to comment publicly on the GST (Goods and Services Tax) treatment of crypto currencies. However, it has confirmed privately that it expects to release guidance on this within the next few months.


Implications for New Zealand’s growing market

New Zealand’s key regulators believe that the current regulatory settings are appropriate, that no regulatory sandbox is required to enable this new sector to innovate and thrive, and no other changes are required to address the rapid growth in the use of blockchain/distributed ledger technology, ICO/TGE fund raising and cryptocurrencies. They are, however, “closely monitoring developments” - a wait and see approach, and have encouraged market participants to “come and talk to us” early in the process.

 

Our own experience of engaging with the regulators (both advising clients and at a personal level, as part of a government crypto-currency/ICO regulatory working group) has been positive and collaborative – intent is key.

 

That level of openness and engagement is heartening. It does mean, however, that: 

  • For ICOs/TGEs, the income tax implications are uncertain (absent a binding ruling from the IRD). Similarly, the regulatory outcome can be uncertain – at least for utility tokens, and other new token classes. Globally, both for regulatory and token economics reasons, an issuer may structure and classify its token as a utility. In New Zealand, however, the FMA is yet to issue guidance on the status of utility tokens under the financial markets regulatory regime (although such guidance appears to be imminent). As the FMA retains the right to designate a token (however named) as a financial product, the practical consequence has been that prospective ICO/TGE issuers have looked to structure their ICO/TGE offshore, where the regulatory outcome and tax implications are more certain. That will change over time, as New Zealand’s ICO/TGE market, and more generally, the global regulatory landscape in this space, develops further. 
  • For cryptocurrency related services and products (i.e. exchanges, wallet providers, and brokers), the financial markets  implications are much clearer – most will be financial services, and a licensing, fair dealing and registration on a public dispute resolution scheme will apply. 
  • For blockchain/distributed ledger technology businesses generally, New Zealand is not advocating blockchain/DLT-specific legislation (unlike some other jurisdictions, such asGibraltar and Malta, for example).  

Conclusion

New Zealand, compared to other jurisdictions, is a relatively late adopter of blockchain/distributed ledger technology and its ICO/TGE funding and cryptocurrency markets are in their infancy. The current regulatory response in part reflects that.

However, as has been the experience in more mature ICO/TGE and crypto  markets offshore, and barring any major global economic shocks (volatility seems a constant), it is likely that those markets will continue to grow strongly in New Zealand in 2018 – and any 2018 uptick in the value of crypto will fuel that growth.

 


 

* Chris Linton is a Partner in the Corporate and Technology Practice groups in the Auckland office of Duncan Cotterill (New Zealand). Chris can be contacted at chris.linton@duncancotterill.com.

photo
Auckland,
Thursday, May 31, 2018
Information Technology / Computer Law, Finance & Banking