Ben, big thanks for this high quality analysis. Regarding “Eisner v. Macomber* , 252 U.S. 189 (1920)”, interesting, but probably that won’t apply because it’s a pro rata distribution of new stock, which means everyone’s financial position stays the same (vs voting rewards, which are received only by those staking in governance).
The article you have referenced is correct in the sense that it is not yet fully clear that the IRS have abandoned plans to tax staking rewards as income when they are received, rather than when they are sold. FWIW, I had expected the IRS to push ahead with trying to tax staking rewards as income on receipt, despite the contrary case law. This was one of the reasons why maturity works as it does, although I think the design could have been made stronger, hence this proposal. The signs are good that they may back off, but I agree, perhaps we shouldn’t celebrate too soon. I will update the post with a link to that post you shared.
Whatever the IRS does, it remains the case that the taxation of staking rewards around the world is completely new territory, and it’s not clear how the penny will fall. There will be very few deterministic answers. How the penny falls will depend on many things that are hard to predict, including sentiment for/against crypto in government, the outcome of court cases, and many other things. However, it is also true that most democracies have fairly rigid legal systems, and the decision will not fall to bureaucrats entirely - unless new legislation is passed, every decision they make is open to challenge on the basis of contradictory, accepted case law. That is why in my analysis and proposal I look at pre-existing accepted case law.
I would caution against the idea of slavishly following the advice from anyone who gives themselves the title “professor”, “assistant professor” (as per Emin Gün Sirer, but he often forgets the first bit, lol). There is broad disagreement between professors on subjects, demonstrating that they cannot be oracles of truth, and I can tell you having spent a lot of time looking at applied crypto and distributed computing proposals over the years that most of them are not up to much. I would also caution you against blindly following the advice of lawyers. Since 2013 I have been in contact with many leading law firms providing advice to those operating in crypto, and listened to them at conferences, and so on. What I can tell you in review, is that the vast majority of advice that these leading lawyers provided was clearly wrong, as I suspected at the time, and many crypto entrepreneurs listening too carefully to what they said were placed at an enormous advantage. Most people in domains outside crypto do not fully understand the nuances.
Ergo… there is no substitute for doing your own research and brain power. Paying experts is often how you end up in deep water. As people working on the design of the Internet Computer, which work we try to push onto the network via proposals, we must never abrogate our responsibilities to individuals with one or another job titles, or outside agencies. Fwiw though, we do have substantial constant contact with tax advisors, tax lawyers and stakers dealing with tax challenges in different jurisdictions. We might be wrong, because there is no deterministic answer, but we are not making these proposals in an uninformed way.
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Note, however, that it would be pro rata if everyone staked for the same amount and voted on the same number of proposals. Some people (by their own choice) decide not to do that, though. By failing to stake and vote, their share just goes to those who do vote. Does that matter? I don’t know, but it certainly makes the argument colorable.
The concept underlying Eisner also raises a separate point. Eisner recognizes that when additional stock in a company is created and given to shareholders, it dilutes the value of existing shares because the only thing that has changed is the number of shares in existence. The same should be true here because ICP represents the right to vote on proposals in the NNS. Have I “clearly realized” an “undeniable ascension to wealth” if I stake ICP in a dissolving 1 year neuron and make just under 6% in rewards when the voting power of my existing ICP has gone down about 9% due to voting rewards inflation?
To be clear, I don’t know whether a court would agree with my argument that Eisner applies. But I personally think it’s fairly convincing.
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Every tax jurisdiction will make its own decision regarding the taxation of staking rewards, and maturity. However, around the world, the taxation of income, and capital gains, mostly follows common principles. We do not believe that staking rewards should be taxed as income when they are received, only when they are sold, for the reasons given, but also believe that many tax authorities will try to tax them as income on receipt. For that reason, the design ensures that maturity is not fully realized wealth over which the neuron owner has full dominion. The design was sympathetic to the shape of global tax regulation, with the aim of protecting neuron holders.
However, there can be no guarantees. For this reason, we are proposing further hardening to increase the likelihood that a) increases in neuron maturity are NOT treated as ordinary income that is immediately taxable, b) neuron owners can stake their maturity, rather than merging it, which currently causes new ICP to be produced, which has a higher likelihood of being seen as income, c) neuron owners can choose whether to export stake vs use maturity to produce ICP, which provides them with some additional tax planning power over when they wish to pay capital gains vs income tax.
Final point: we think the design will actually be simpler to use in many ways, despite the complexity of its rationale. For example, ICP will now be directly disbursed rather than exported in a newly spawned neuron, etc.
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I want to reiterate: tax planning is not tax avoidance. Governments and tax authorities encourage people to carefully plan for how their business systems play with the frameworks provided, so that they can succeed. We are applying the same approach here with a decentralized protocol.
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Agreed on many of your points. I agree that tokens on the ICP ledger should not be messed with under anything other than the most extreme existential circumstances. That’s why there are implemented on their own traditional “immutable blockchain” (which is hosted on the Internet Computer blockchain, a kind of blockchain within a blockchain…)
Maturity is a different thing though in my view. It is an attribute of a neuron, within a self-updating governance system. Just like the Internet Computer blockchain must evolve, so must the Network Nervous System itself. That’s not to say we should start randomly removing maturity, but it’s not the same as ICP on the ledger.
Note that this mutability of maturity is one of the key reasons the maturity is not income, and this point is also very, very important to a lot of people. This proposal, by changing how maturity is treated, provides a demonstration of this point. FTR I have a lot of maturity, and very much care about it. This isn’t about taking people’s maturity away.
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Thanks for your thoughts. Taxation is not the only reason for this proposal, but it is an important part of it.
Worth noting that taxation has implications regarding how democratic the system is. For example, I know of many people living in crypto friendly/low tax jurisdictions like Puerto Rico, Portugal and Monaco who have been compounding away by merging their maturity without a care in the world (and thus creating new ICP on the ledger, which has a higher chance of being seen as income around the world). Meanwhile, I also know of people, myself included, who have not merged their maturity because they were scared it would create an income tax liability that would force additional sales.
As much as anything, this is an effort to put more people around the world on a level footing with those in crypto friendly/low tax jurisdictions. The key to the proposed changes here, is that we will allow people to stake maturity rather then merging it
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Hey Dominic, thank you for taking time to take part to the conversation. Could you please answer to this (below) ?
Regards
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This is great that you say there is a possibility the plan may not work as intended and at the end, there is a possibility that all the maturity may be taxable.
My point is that IRS don’t care about the wording or the form. You can name it dividends, rewards, interest. IRS are taxing all income. If a company are sending you a car because you have invested in it, the value of the car is an income and is taxable. This is my point. Everything can be an income.
If IRS ever accept that IC may pay maturity to investors without any taxes and these investors can accumulate wealth over decades with no taxes, IC would be the only one entities that can do this. All investors will want be in IC and the price of ICP would have no limit. I would love it.
All companies would change their dividends system for a Maturity system. So easy to do if this can avoid taxes.
I don’t care for myself. I am on the safe side. I don’t care for the handful of people on this thread because they have all information to make their own decision. But I care for small investors, not here, who have a blind confidence in you and have some chances ( many TMO) to have to pay huge tax bills later on and cannot afford to take that chance. What will be their solution if they are accumulating that income for years, have everything lock for 8 years, and the maturity become an official taxable income.
Now, IRS say all form of crypto rewards are taxable until proven otherwise. I act accordingly and will change (and claim back) if they ever loose their stance. This is not what people want to hear or read but is a much, much safer approach.
I knew from the beginning this proposal was proposed due to those 26 millions ICP not minted yet to avoid tax, and those ICP (still in maturity form) would want the voring and the rewards. It should have been stated clearly from the beginning though.
I truly hope the maturity tricks would work but, due to my age (at least a decade more then you Dominic) and experience with international business (in 22 countries with US as part at 95%), it is too much of a dream for me.
EDIT: Dominic, you have a huge influence on many people. Please be careful with that influence. This is a huge social responsibility.
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The proposals do not limit anyone from playing it safe and deciding for themselves that their maturity = taxable event.
Let’s let the proposals be enacted, vote on them one by one, allow people to exercise their freedom of choice, use them or not use them, see how it works in the end and go from there. No monetary cost to make the changes either.
Since maturity is compounded in a separate silo in the new plan, it can be disbursed as soon as the IRS comes to such a conclusion. If that happens a few years down the line, after a bunch of lawsuits and counter-lawsuits ending with a verdict in favour of the IRS, it could be a bloodbath, since all the compounded maturity from American investors will come to market at the same time. The possibility of this happening will overhang ICP price until the conclusion is reached.
I must have missed something then.
Do you mean the Stake maturity will be rewarded without any lock period? Same as an 8 years lock neurons now, but with no lockup and available at any time?
Staked maturity would share the same lockup period as the neuron itself. This is what permits it to count toward voting power and thus compound future rewards.
If that is the case, then what happens in the event that the IRS wins a judgement years down the line that all staked maturity is taxable and slaps people with a huge retrospective bill that they cannot pay by selling ICP because it is locked in?
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If that were to happen, you’d be in the same situation as anyone else who receives a huge asset without cash on hand to pay the tax obligation. This is why you have to use your own best judgment in addition to whatever you can learn from available experts: because there are real risks involved in getting it wrong for your locality.
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But isn’t that exactly what happened with seed investors? They used their best judgement knowing there were risks involved. Why are we making an exception for them?
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To my mind there is an inconsistency between the goals of compounding and delaying the receipt of funds as a taxable event. My position (and I confirmed it with a tax advisory firm for the UK) is:
- Increases in Maturity are not taxable. (It is an internal accounting variable. No ICP has been received and no benefit obtained.)
- When a neurone is spawned or maturity is staked. This is receipt of a benefit and is taxable.
This argument seems defendable in substance. Though I would prefer if the word “maturity” were replaced by a more neutral term such as “accumulated voting activity” without financial connotations.
I worry that the proposal actually makes the situation murkier and creates its own risk
- It tries to create a clever argument whereby re-invested (something) is not taxable because it is uncertain. I don’t see authorities buying this argument as it is clearly analogous to dividend reinvestment.
- It encourages re-investment and therefore makes the voting centralisation worse.
More straight forward ways to reduce tax liability related selling pressure and accumulated rewards would be to;
- Provide an easy way for people to automatically convert a proportion of their rewards to ICP or even cycles to cover tax rather than the whole amount.
- Reduce voting rewards so that total inflation is lowered. (Voting rewards are paid for via inflation and reduced capital gains in any case so are somewhat zero sum despite being taxable. I would therefore argue they should be the minimum required to incentivise participation and locking and any amount in excess of this is actually damaging.)
- Only pay rewards periodically. For example on a quarterly basis. This would reduce continuous selling pressure, Simplify tax accounting. And because the market would anticipate an increase in supply on these dates it is likely that the ICP price and therefore taxable gains would be lower on these dates.
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In my experience this is how RSUs work. They’re seen as income, so the platform facilitating the receipt of them performs a “sell to cover” transaction to pay for the taxes.
I’m not suggesting that the NNS would actually make a sale, but rather set aside the portion relating to tax as you suggested.
The problem with that approach is the dissolve delay. In 7 days that portion of ICP could be worth less than the tax liability.
That’s also a problem today but because it’s an “all or nothing” approach there would most likely enough to at least cover the tax.
in PR this is seen as ordinary income taxed at regular rates (not low thats for sure) unless they have a special tax decree which they have been approved for the tax exemption to cover staking revenues; it’s not easy and cheap. otoh practically anyone can set up a company in estonia where retained earnings aren’t taxed for about 500 euros.
but fine whatever do as you wish, whales will just manipulate the price up 5% for a month and then do a disbursal to get an extra 5% so that you can go around telling people they might not have to pay tax.
btw Dominic love how you slyly poop on the big accounting firms to avoid them doing any work and thus avoiding any chance of them pooing all over on this proposal
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Regardless of the implications, let’s please keep this conversation civil and stick to your arguments.
This is not Reddit, and hiding your non-constructive comments behind an anonymous username is not appreciated.
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