 Hello, welcome to this CUBE Conversation. I'm John Furrier here in our Palo Alto studios. I'm John Kelsey LeMaster, who's tax partner at Goodwin. This is the CUBE signal. Kelsey, thanks for coming in. Thanks for having me, glad to be here. It's a tax partner. Obviously a lot of things going on. Apple bringing back cash into the United States. Big news, $380 billion tax reform for under President Trump. Seems to be spurring Nasdaq hitting an all-time high. Business is booming. Kind of a good tailwind for business. But really the hot topic that I want to drill down with you in this segment is have a conversation about the ICOs. Cryptocurrency, it's insane. It's super exciting. If you're under the age of 30, and if you're not actually so excited to get into this unregulated, uncontrolled, well, you could some say controlled market. It's just people going crazy. A lot of opportunities, a lot of fraud, a lot of action around building businesses around it. So you're in the middle of it. What's going on? Tell us. Give us a take on the ICO. How many ICOs are you guys doing right? What's the, what's Goodwin's number up to now? What's the, how many ICOs are you guys doing? Yes, the number we talk about a lot within the firm is about 40 active ICOs. That's probably not precise, but it's more or less that number. Every day we talk with existing clients or new clients that want to go through an ICO process. And we advise them the best that we can. There's securities laws issues, which people are aware of. That's not really my expertise. But in the tax world- Well, Gran Fonda, we'll have him in, he's coming in next, but we've had contracts with him. The securities issues and this, but there's huge tax consequences. Yeah, so there are a lot of tax consequences that are unusual and things that people don't expect when they're raising money, what they view as raising money through an ICO process. Because typically when you raise money from a venture capitalist or from investors, people who will buy securities in your company for cash or property, that's usually tax-free to the company. And that's, I mean, that's been traditional law for many, many years. The problem is in an ICO, what you're selling usually is a digital asset of some sort, a token, which often is a right to obtain some service on a platform that may or may not exist yet. And the tax characterization of raising capital for that kind of asset or property or service is probably does not qualify for the exception that normally qualifies when you sell stock or securities. So it's basically taxable revenue to companies. So let's drill into this, have that conversation about tax. So a lot of people I talk to, entrepreneurs or newbies, either new entrepreneurs or seasoned entrepreneurs, even the seasoned entrepreneurs look at the tax consequences and go on, wow, this is crazy. I don't understand it. And it seems like the tax providers, you guys are one of them, there's a bunch of other firms out there that can help at different price points all across the board. They're learning, their training wheels are on too. So people are learning, running, tripping, falling. It seems to be that from my perspective, and it's a real, real rapid accelerated pace. It's almost like the dot-com bubble, but fast forward. It feels like with an entire new infrastructure of corporate governance. I mean, this is pretty crazy. So the tax is a big one. And the dollar signs could add up big time if you're a company and you need tax advice because there's so many scenarios. What is the current state of that market with tax providers, the tax consequences? Is it as Thorny and Harry and how are you guys unpacking it? I think you're exactly right that a lot of us are learning together about the technology, about the business terms, the deals, those are evolving. The tax law is what it is. It has really not caught up to any of this. The IRS issued a notice in 2014 that tells you how cryptocurrencies like Bitcoin and Ether and Dash and some of those others are taxed to individual investors. But that's it. That's all we've heard from the IRS. So a lot of us as practitioners are trying to figure out how to apply traditional tax law principles to this brand new technological device or way of raising capital. And in some instances, the answers are clear and in others, they're not. There are a lot of square peg round hole problems that I think a lot of us are trying to work through. And as you said, we're doing it at a very rapid pace, real time. Clients are not really waiting for us to figure out every nuance of tax law and how it's going to apply. They're just doing their ICOs. And so there are a lot of situations where companies will do an ICO and raise, maybe this hasn't happened lately as much, but at least last summer, companies would raise hundreds of millions of dollars in an ICO without really getting any significant tax advice. And the basic rules in this area, as I mentioned, if you raise capital by issuing tokens, it's probably taxable revenue. So if you start up as a normal corporation where you're going to build a platform, spend some money to build it, and all of a sudden you raise $200 million. Well, if you can't spend all of that money in a year, you're going to pay tax. And last year, the corporate tax rate was 35% federally. Now that's been reduced on tax reform, but say you raised $200 million last year and you effectively couldn't spend much more than a couple of million dollars, you could have a tax bill at the end of the year of $70, $80 million, which nobody was expecting. And so companies are trying to structure around and avoid those types of- It's hard to spend $200 million in one year. You really got to go crazy, go on a boondoggle. But this is an important point, so let's get down to that. So the cash proceeds coming in, I'll see the utility token, that's taxed right out of the gate. Yeah, there are some areas of uncertainty there and there are positions. I mean, people, there are alternative ways of viewing that, probably the right way of viewing money coming in. We say money, but usually it's ether or Bitcoin. So you take the fair value of what comes in and it's $200 million, that's in a utility token context, that's probably going to be viewed as revenue for future services, because by having the tokens, the individual holders will be allowed to participate in your platform and get your services. So services income, that's taxable. Now you may be able to defer some of it for up to one or maybe two years, it depends, but you're going to have to recognize all of it for tax purposes within two to three years max. And people have talked about, well, can I just wait and see what happens and not pay any tax on this income? And there are some sort of doctrines that you might look to, once called the open transaction doctrine, where if you don't really know what's going to happen, in a lot of these cases, the ICO proceeds have to be given back if the platform never gets built. So people have talked about, well, can I use what's called open transaction and wait and see, and if I build the platform, then I'll take the income in, in that year, in the future, but not now. Personally, I think that's a losing argument, and I would, my view is the IRS, when they start, once they start looking into this, they're going to really view this as all just services income, and you might have one or two years to spread it out, but you're going to have to pay tax on it. It sounds like there's a mix and a confluence between accounting and finance and tax law, because you got timing issues, that's revenue recognition, you mentioned services, with tax practice, you know, practitioner view. What is the line? Where's the absolute out of bounds in ICO tax policy? If you can lay, I know there's a gray area that people are working through and might have a position and lean towards a certain direction based on what they're doing, so I can get that, but where should someone look and saying, that might not be in the know and the taxing? Don't do this. This is one of the things that they shouldn't be doing. Obviously fraud, you know that, that's, but what about- You don't want to do tax fraud, for sure. I would say in general, it's going to be risky to take a position that if you raise a bunch of money in a utility token ICO, if you take the position that that's not revenue and you somehow view it under the Open Transaction Doctrine, for example, I think that's a risky position. Why? I wouldn't, just because I think that it's inconsistent with the law and the Open Transaction Doctrine space, normally when you receive money, and it's basically yours, you have a claim of right over it, that's taxable income to you, even if you might have to somehow give it back in the future. So I think that's, that would be a risky position to take. Another thing that we've heard about a lot of companies doing is for a while everybody wanted to set up a foundation in Switzerland. I'll set up a foundation in Switzerland, they'll issue the tokens. It's all tax free because it's a foundation. I think there's trying to remember, there's an ICO company that recently got in trouble for this because they were trying to take the funds out of Switzerland and use them for personal use. But anytime I hear someone talk about setting up a foreign foundation, my antenna go up, and I think that- You think that's a red flag? I think that's a major red flag. Most of these companies that are doing ICOs probably don't really have the kind of purpose or business that really fits with a foundation. I mean foundations are tax exempt, charitable type entities, right? So like the Ethereum foundation, I can see that, that to me sounds like a foundation, right? It's not there to profit- It's not a business hiding as a foundation. Exactly. And so that's a great way to put it. I think there for a while, people thought that I could hide my business in a Swiss foundation and never pay tax. And I think that's a major way- Okay, let's talk about the Cayman Islands, Switzerland. There's places to domicile or locate your business for tax reasons. And some people, there's playbooks out there on what to do and it evolves. It's moving trained for sure. But what problem are we solving with the tax? Can you just elaborate on what is the core problem to be worked on with respect to taxing, the tax consequences in the ICO crypto market? Right, so from the company's perspective, the core problem is what I was mentioning where when you raise all this money through an ICO, the most likely treatment of that, if you raise it into a US corporation, is that it's just taxable income. And maybe some of it's taxable this year and the rest is taxable next year, but it's going to be taxable to that corporation pretty quickly. And corporations don't want to pay tax. I mean, that's an age-old problem. So what people are doing and are still doing is there are structures where you can set up a subsidiary in a foreign jurisdiction like Switzerland, Cayman Islands. This is not a foundation, this is a normal subsidiary. And if you get the intellectual property moved into that subsidiary in an appropriate way and there are rules around that, and then you have substance in that subsidiary where you have employees in that jurisdiction who are helping to develop the IP, then if you do everything right and then you sell the future services out of that subsidiary and you sell the ICO tokens out of that subsidiary, you may get some ability to defer US tax until you actually take money out of the subsidiary and repatriate it to the US. So that's what- It's a lot of work to set up a subsidiary. It's a lot of work to set up a subsidiary. And it's costly. Is it worth it? Yeah, so prior to the tax reform bill at the end of the last year, if you could do it all right, and there are a lot of issues with getting it right and complications and complexity, but if you could do all of that and there are a lot of companies that did, then yeah, I think there are good positions for deferring tax, which on $200 million ICO, that's deferring $80 million of tax until some indefinite period in the future. There's not many $200 million ICOs out there. Most of them are in the five to 20, 20 to 60 range million. So I think now that we're- Still a good chunk of change. Yeah, a good chunk of change. And so post tax reform, the tax rates last year were 35% corporate, federal income tax rate, now they're 21%. So there's been a huge reduction in corporate income tax rate in the US. So that I think coupled with the smaller size of the ICOs is going to drive fewer companies to want to set up these offshore structures because one, it's a smaller amount of tax liability that they're dealing with. And two, because you're raising less money, it's not too difficult to spend $5 million over two years. So pretend I'm doing an ICO, right? So I say, oh, I'm going to do an ICO. Well, I know that I could maybe fetch 20 million, might be the range, say I get lucky, just say I do 30. I say to myself, okay, can I spend $30 million in two years? Probably, yeah. But it's not so much spending money. I want to get your reaction to this. It's not just spending the money to get the tax offset. It's can I get to revenue? So can I hit the flywheel for critical mass in a revenue model, which now a new dynamic is 2018 seems to be the year of, we were looking for real deals, not vapor deals, white paper and raise money. Is that, how does that work? So if I say, hey, I know with 20 million in two years, I can get to catch flow positive, break even. What's the tax consequence on that? Is that a good deal to do? Yeah, so once you turn net profitable for tax purposes, you'll start paying tax in the U.S., right? And so if the idea is I'm going to raise $20 million in an ICO in January, 2018, and I'm going to spend $20 million between now and the end of 2019, you can probably, you have to model this out with your accountants, but you can probably match up the 20 million you receive this year with the 20 million of expense you spend in the next, you know, between now and the end of 2019. And once that zeroes out, then you probably won't pay too much tax on the 20 million you receive now. Then once you flip to net positive, right? So you've spent the 20, took the 20, now you're at zero and you start earning income. But that's a real business. That's a real business and that's going to be taxed like any other business. And now you're in a much lower U.S. tax rate and environment of 21% that, you know, that's probably a fair deal. This is the business model question that everyone's asking. Can I get, use the cash to build a business? This is now the conversation in the venture community. It's the conversation in the entrepreneurial circles. How to do it, not just go to the trough and take as much down as you can, which pretty much everyone will try to do, but that's up though, there's not many people doing that. I mean, Signal's got a big ICO coming. They're rooming in the billions, but are you advising clients to stay in the U.S. if they don't have to go to Cayman's? What's the current state of your research note, or tax note to clients? Yeah, so, and this, I mean, I think this you might have different views from different practitioners. My personal view is that if it's a relatively small amount that you're raising and you expect to be able to spend it down within that one to two year period, I tend to advise clients to keep it simple, stay in the U.S., because there are a lot of ways you can screw up a Cayman structure, a Swiss structure, and usually these companies are working incredibly hard to build their platform. It's also distracting. That's my point, exactly, is that the benefit is uncertain and it may not be much of a benefit at all, and it's probably much more important that you succeed with your business than for you to save what may or may not be a smaller, large amount of tax. So, you guys are learning on the fly, which is great. This is a market, it's a huge wave. Everyone's getting their surfboards and getting out there on this big wave, and it's super exciting. What are the practitioners circles? Your peers, and you guys, as you guys, huddle on this in the industry. What is the general rule of thumb that you guys are applying? I know Goodwin's a great firm. You guys have done some great work. You're conservative, but yet aggressive, which is a good balance here. I think some firms just won't even touch an ICO, too risky for them, but you guys take a good line there. You're pushing the envelope. What's the rule of thumb in the practitioners circles? Where's the standards evolving? What's your reaction to that? So, I mean, this is probably not an all super helpful answer. I don't think there are standards. I mean, this is a space that barely existed eight months ago, and now we're doing 40 ICOs at a time. So, it's a very fast-paced evolving space. We just had tax reform, literally two weeks ago. So, I'm on an advisory group with the Ethereum Network Foundation, and it's a bunch of tax lawyers in New York and out here, and we talk every couple of weeks just to kind of figure out what we're doing. There are a lot of things we talk about, but I wouldn't say there are really any standards that have come up. There are other ways that people are implementing ICOs that didn't really exist six or eight months ago, which you'll probably talk about with Grant to some extent, but you could just go out and have your tokens ready and sell them, right? That's a token sale ICO. We have a lot of clients that want to raise the money before they have their tokens built. They just have the white paper, so they will sell SAFTS, right? Which are a simple agreement for future tokens, which you basically agree to, you'll give me your ether now, and I promise I will give you tokens in the future, right? And that's a SAFT. Now, there are versions on that where we see investors kind of hedging their bets, like, well, I don't really know if you're going to be successful with the platform, so what I really want to do is I'll give you money now, and I want an instrument that kind of gives me flexibility to either take tokens or equity. So you see these instruments, like one's called a SAF, right, it was a simple agreement for future equity, which you see in normal financings, but with a dash T on the end of it. So it's like- We're going to pipe, we're going to have SAFTS, we're going to have all this stuff going on. So there are all these acronyms coming up, and there are different versions, but some of those versions might give you better positions on bringing in the money now and waiting to figure out if it's going to be taxable. What have you learned? You've been got ICOs under your belt, you guys doing good work over there, relatively new. What's the big learnings that you've walked away with so far, and what's still in front of you? Yeah, I think what I've learned is just, for me personally, it's very interesting to see how these traditional tax concepts, which are simple in the abstract, really apply in very unexpected ways to an ICO. And the things we've been talking about on the company side is a big area there. I've also focused a lot on, you know, if you were an investor and you're participating in an ICO, odds are you're not paying cash. You're probably paying in Ether, Bitcoin. And if you've held those other cryptos for a long time, and say you bought Ether at $10, and you're trading it in now at $1,000 in an ICO, well, you probably also have gain, because you've just exchanged your Ether, so now you have $990 of gain for every Ether that you send in, and there are ways to try to manage that for the investors, but that's one area that's been a surprise for investors. I mean, it's something we've been aware of, but it's something I've kind of thought about and learned that in a lot of these situations, there are tax consequences not only for the company, but on the investor side. So on both sides of the table, there are tax consequences, and people are often surprised by that, and everybody's catching up. Kelsey, great to have you on. Take a minute to end the segment, just share a little bit of the work that Goodwin's doing. You guys have a tax practice, you're ahead of it over there. What's some of the work you've done? Do the plug-in. Yeah, so we, in this space, we are working with a lot of clients on ICOs. We're working with a lot of traditional venture funds that are dipping their toe in, and are reviewing ICOs that they may invest in. So we look at it with our investor hat and with our company hat. We've also helped clients that are thinking about doing tokenized funds, where they will raise capital into a venture fund, but they'll do it by issuing their own tokens. So those are very interesting structures in and of themselves. So we've really kind of embraced this space and worked really in just about every way that you see these companies taking shape. We've helped them and helped the investors. And of course you've got funds of funds going on now. I saw a couple of decks been circulating around funds of funds. You got token funds, funds of funds. This is like a new asset class. It's a whole new world. I mean, unregulated, uncontrollable control by probably a few people. I mean, pretty wild. Having fun? It is, it's been a blast. Kelsey, thanks for coming. Kelsey, the master partner at Goodwin on the tax side, a lot of work, I'm sure he's busy. It's complicated and they're learning and people are being successful in ICOs. And again, one of the big things is the tax consequences. Check out Goodwin. They got a great firm over there. Kelsey, thanks for spending the time coming on to you. I'm John Furrier. This is CUBE Conversations in Palo Alto. Thanks for watching.