Opportunists

7.3 Taxpayer reactions to airdrops

7.3.2 Opportunists

Crypto asset airdrops could attract a similar strategy to dividend-farming in the stock market. Assume the following hypothetical example: A taxpayer purchases 1,000,000 XRP; transfers them to a custodial wallet for 10-15 minutes for the Snapshot; returns them to an exchange, and sells them. Notwithstanding the sale, however, the option to accept an

220 Strathmore Exploration supra note 141.

offer based on that temporary holding persists. The taxpayer has not secured an income stream, but has segregated an option which was embedded in XRP by the airdrop announcement at a cost equivalent to the bid-offer spread.

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The Tod and African Life cases were not concerned with the tax treatment of the dividend income but the sale of the base asset. They seemingly do not apply. Secondly, ceteris paribus, the capital lost through the bid-offer spread constitutes expenditure, not income, to obtain merely a right to exercise an option to receive an airdrop, not the airdrop itself.

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In cases where an option is exercised with the intention to sell the underlying asset, the courts have in the past considered the nature of the proceeds. In terms of the judgment in Matla Coal Ltd v CIR,

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being upheld in ITC 1427,

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the nature of the proceeds from the sale of an asset acquired through the exercise of an option is determined with reference to the taxpayer’s intention at the time of acquiring the option, not the time of exercising it.

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Per Stott,

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a taxpayer’s ‘ipse dixit’ is decisive in the absence of any contradicting facts. Each case would differ on facts, and one could only conjecture on what may tip the scales between capital and revenue.

Three possible contingences are considered below:

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Income stream: assets which generate no income tend to be revenue assets. However, FLR is able to be used to generate income in two ways. First, as described in chapter 7.2 by the use of FLR in the FTSO voting mechanism, or alternatively through utilising it to collateralise SMART contracts created on the Mainnet, for which a fee is paid by the users.

221 Typically, an embedded option is inseparable from the host asset, and cannot be traded independently. Here the option can be separated as it vests based on a non-persistent holding at a specific time. However, it has in common that the option may not be traded.

222 Note that the option is exercised effectively by updating one’s XRP Ledger address metadata, indicating acceptance of the offer to acquire the asset at a stipulated price, in casu for no consideration.

223 Matla Coal Limited v CIR (22/85) [1986] ZASCA 120.

224 ITC 1427 50 SATC 25.

225 Cf SAM v COT (1980 (2) SA 75 (ZR)) 42 SATC 1.

226 Stott supra note 76.

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Holding period: the segregated embedded option is not tradeable as a stand-alone instrument, and can only be exercised through delivery of the underlying. Notwithstanding this, a forward sale may be entered into with a third party. If this were the case on or before the acquisition of the embedded option, the intention would likely be a trading intention. The principle of ‘best advantage’ per Stott is predicated on the asset having been held, and does not seem to provide any persuasive value other than in cases where a forward sale is entered into after acquisition.

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Commercial nature: if the taxpayer generally trades in financial instruments, it would represent an objective fact counting against their ‘ipse dixit’ of capital intent. While this is not conclusive, much would rest on actions taken after acquisition.

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Assuming that a taxpayer would as a matter of course argue a capital intention, the following is proposed.

The financial return on capital represents an opportunity which no investor would likely refuse, given the potentially massive income stream and the relatively low level of capital required, ie the option premium.

Thus, the argument of acquisition being to enable a lucrative income- generating capital asset is highly persuasive; that an income stream so vastly outmatches the capital should not mar what is a capital intention.

With respect to a taxpayer’s business, the matter would necessarily turn on whether traditional buying and selling of assets is sufficiently distinct from concentrated participation in the airdrop. A comparison may be drawn with reference to control. A trader has control over what to buy, what to sell and when; this equates to his actual ongoing purpose. The element of happenstance inherent in airdrops may distinguishes the two activities insofar as it could not reasonably be said that the actual purpose of the taxpayer is to trade on a hope. Further, as was raised in Stott, that an individual undertakes a single transaction should not equate to them conducting a profitable trade – there must be some level of continuity.

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227 Ibid.

228 Haupt op cit note 87.

229 Stott supra note 76.

This raises the point, however, that given the proliferation of XRP-related airdrops,

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what was before just a spes comes closer to being a reasonable expectation. A taxpayer who continually seeks airdrops may begin to exhibit this quality of continuity. Nevertheless, it is a question of fact.

Ultimately in isolated cases a taxpayer’s claim that their intention towards the option rests on acquiring an income producing asset is more persuasive. If they subsequently decide to exercise the option with a view to selling the underlying at a profit, while it could be argued this signifies a change of intention the case law does not place any emphasis on the taxpayer’s intention at the time of sale.

A taxpayer may have a mixed intention in acquiring the option. The taxpayer presumably has a revenue intention unless a dominant capital intention is demonstrated. Per the case law,

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it is submitted that the

‘absolving dominant purpose’ would need to be determined with reference to how long the taxpayer held the asset in an income- generating arrangement, and how the proceeds from an eventual sale compare to the income generated. If the greater profitability was derived through the sale, it could be that the income generation was incidental, and vice versa. Further, if income does not rise commensurately with asset price, it may be inferred that a taxpayer is employing a similar decision-making framework as Nussbaum;