Corporates investing in crypto

Simply put, the accounting for digital assets will likely be determined by the specific attributes of the digital asset itself. What is it investing in? To date, under US GAAP, investments in certain digital assets, like bitcoin, were accounted for under the general guidance on indefinite-lived intangible assets.³ A challenge with this approach is that the traditional intangible asset model requires digital assets to be recorded at cost, subject to subsequent impairment in accordance with ASC 350. When the value of the asset decreased, companies using this model were required to write down its value on their books. However, if the value of the asset subsequently increased, even within the same day, companies could not write it back up as discussed in ASC 350-30-35-20. This model can make it difficult for companies to accurately reflect the return on investment (ROI) for digital assets held as investments.

The previous accounting model described above made it difficult for companies’ accounting functions to accurately reflect the economic value of their digital assets on their financial statements.

Recognizing these challenges, the Financial Accounting Standards Board (FASB), which sets GAAP in the United States, finalized amendments to the accounting standards for certain digital assets. The Accounting Standards Update (ASU) No. 2023-08, Accounting for and Disclosure of Crypto Assets, issued December 13, 2023, now requires investments in certain digital assets, such as bitcoin, to be measured at fair value. As discussed within the ASU, this change is designed to help bring more clarity and comparability to financial statements and more closely represent the economics of digital asset investments. While not effective until 2025 for calendar year-end companies, early adoption is permitted⁴ and is a route that many companies are choosing.

Historically, the required disclosures for intangible assets did not necessarily paint a clear picture of a company’s digital asset holdings. As such, companies often disclosed additional information to better reflect the economics of the digital asset holdings. However, the FASB’s new ASU provides a set of standardized disclosures to increase comparability of disclosures across companies to help alleviate this reporting challenge. Prior to adoption, companies should work to craft appropriate financial statement disclosures related to digital asset investments.

Like other assets measured at fair value, crypto assets within the scope of ASC 350-60 are subject to the disclosure requirements in ASC 820. Further, the ASU’s amendments require entities to provide certain additional disclosures about crypto asset holdings, such as details on significant holdings, contractual sale restrictions cost basis information, and a reconciliation over the period. For a complete overview of disclosure requirements, please refer to Deloitte’s December 15, 2023 Heads Up, FASB Issues Final Standard on Crypto Assets.

While the FASB’s new ASU is not effective until 2025, many companies have seen a benefit in early adopting the new ASU as it reduces the need for patchwork disclosures by allowing certain digital assets to be recorded at fair value, thereby providing a framework of disclosures through ASC 350-60-50 and ASC 820.⁵ Despite these improvements, the new model will likely bring its own set of challenges, such as identifying the principal market and dealing with markets that do not close.

These challenges will need to be addressed to help ensure the new ASU provides the intended clarity and comparability of information for financial statement users resulting in better representation of the economics of such holdings. For additional insight on some of the questions raised by companies that are early adopting, please refer to Deloitte’s Frequently Asked Questions About Implementation of the FASB’s New Crypto Assets Standard.

The rules governing tax treatment of digital assets and crypto do not depend on US GAAP accounting rules and frameworks. One key difference: Under current accounting rules applicable to most companies, digital assets and crypto are adjusted for fair value; but for tax purposes, such treatment is only available as a result of an election that dealers or traders of certain digital assets may make, whereby the tax function can mark up or down to fair value. For tax purposes, gain or loss is normally recognized only when a digital asset is used, sold or exchanged. In the United States, taxpayers may specifically identify units of digital assets used, sold, or disposed of in a transaction. If an adequate and timely identification of the asset used in the transaction is not made, the taxpayer is deemed to have disposed of the earliest acquired units of the asset.

So how does one specifically identify a fungible digital asset like bitcoin? While industry practices have varied over the years, in June 2024 the US Treasury in collaboration with the IRS published guidance addressing the application of specific identification to sales, dispositions, exchanges, and transfers of digital assets.

For digital assets held in self-custody (ex. using an un-hosted wallet), the company must document in its books and records the particular units to be sold, disposed of, or transferred by reference to an identifier such as purchase date and time, purchase price, or other indicia that sufficiently identifies the assets. The company must maintain adequate records by location (e.g. wallet or address) in order to adequately identify a particular digital asset or tax lot, even if comingled with other fungible assets held in the same location. This identification must occur prior to the transaction and the digital assets must be transferred from the correct location.

For digital assets held in custody of a broker, exchange, or custodian, the requirements to specifically identify units are similar to those mentioned above. The company needs an inventory of their digital assets in their books and records which tracks the units or tax lots by account, including relevant tax lot identifiers such as acquisition dates and tax basis. When they decide to use, sell, or exchange an asset, they need to communicate to the broker prior to the transaction, the details of the asset or tax lot intended to be used. The communication needs to adequately identify the units by reference to an appropriate identifier (such as the date acquired) that the broker deems sufficiently specific to that particular asset.

The actual transaction flow (as relevant to a particular broker, account or wallet) must follow the specifics used in the identification. The rules are clear that for those which don't appropriately and timely identify the specific unit or tax lot, the transactions are deemed to happen on a FIFO basis.

While the new rules provide clarity, they are not without practical challenges. In the preamble to the rules, US Treasury commented on the requirement to identify the asset prior to the transaction and how these rules differ from those applicable to traditional securities where settlement may take a day or two compared to the near real time settlement of digital assets. Companies with high volumes of transactions may find it burdensome to provide the level of documentation and communication to satisfy the requirements of specific ID. These companies should consider putting in place standing instructions (ex. using those most recently acquired). Standing instructions are allowed for those who self-custody their assets as well as for those who use a broker. In conjunction with the regulations, the IRS published Revenue Procedure 2024-28 which allows taxpayers to re-attribute their unused digital basis as of January 1, 2025. They must satisfy the documentation requirements described in the Rev. Proc. and record the re-attribution in their books and records on by January 1, 2025, prior to any digital asset transactions in 2025, or before they file their 2025 tax return. For more details on these rules, see our Tax Alert.

From a tax standpoint, digital assets held for investment purposes are normally deemed capital assets. In corporate solutions, capital losses can be used only to offset capital gains. So, while a company may remeasure crypto assets at fair value with changes recognized in earnings for accounting purposes, tax does not follow that methodology (except in certain limited circumstances relating to an election to mark to market as a dealer or trader in digital assets). Rather, it's a matter of layering in a deferred tax asset, which may require a valuation allowance if there are no other sources of capital gains. So how does this play out in a set of financial statements? Members of a company's tax function should abide by the rules and framework of US GAAP first and then layer on the tax treatment in terms of deferred taxes.

Let's move now from the investment angle to consider the use of digital assets in business transactions, such as fund transfers, paying vendors, and as an accepted form of payment from customers. When used for such transactions, digital assets should be segregated into separate wallets to maintain a clear distinction between digital assets used in the operation of the business (ordinary assets) and digital assets held for investment (capital assets). Naturally, if digital assets are being used in place of fiat, such actions will generate a gain/loss recognition event for tax purposes under the umbrella of a barter transaction. That’s the case every time digital assets are used in a business transaction and the rules for basis tracking for ordinary assets to differ from those mentioned above for capital assets. This has a related impact on accounting as well, and the process can become complex on both fronts.

So far, we've applied a US-centric view to digital assets from both an accounting and tax perspective. Outside the United States, the treatment of digital assets varies substantially. Unlike the change in accounting for crypto assets under US GAAP described above, accounting under International Financial Reporting Standards (IFRS) does not have specific guidance for crypto assets. IFRS guidance views digital assets like bitcoin as general intangible assets similar to prior US GAAP accounting or in some cases as inventory carried at fair value less costs to sell. When a company uses digital assets like bitcoin to transfer funds across borders; say to a foreign subsidiary in Europe—it encounters complexities in other jurisdictions. The transfer process may involve a number of steps: converting fiat to a crypto, transferring the crypto, and then reconverting the crypto as a fiat. One of the benefits, of course, is that such a process avoids bank transfer fees. Yet the act of transferring funds may well have triggered an unrealized gain or loss. And since the subsidiary may not be subject to the same tax and accounting rules as the US parent company, there may be implications in the following areas:

• Gain recognition rules
• Cost basis tracking methods
• Indirect taxes, such as VAT
• Withholding taxes that may apply upon transfer

The bottom line is this: The tax and accounting rules surrounding digital assets are still evolving. This evolution is occurring simultaneously around the world but with inconsistent conclusions being reached across jurisdictions.

The risks underlying digital assets, including crypto, vary considerably. Consequently, companies should conduct rigorous due diligence about how the given asset or coin operates and related market vulnerabilities, as well as terms and conditions. From a technical perspective, companies should understand the blockchain supporting each asset and how the associated governance system works, as this may have a direct bearing on the resilience of the coin system. This can also help to identify the types of events for which companies should be monitoring. For example, the computer code that enables the bitcoin network to process transactions is fundamentally different from the Ethereum code base. Further, as many blockchains enable extensibility in the form of smart contracts (e.g., ERC-20 tokens), mechanisms that allow for the taking of unilateral actions can have a negative impact on the holder of the assets. Other instances where assets can be lost include proof-of-stake blockchains, where assets can be “slashed” for violating network rules. That will result in a reduction of the amount of assets held in a given address. A full appreciation of the technical and business risks associated with each digital asset, and their dimensions, may warrant the assistance of third-party technical help and evaluation.

The recent collapse of a high-profile crypto exchange highlights the importance of conducting rigorous due diligence in terms of counterparty risk, how a given digital asset or coin operates, and related market vulnerabilities. A robust third-party risk management process would likely have identified the exchange’s lack of a service organization controls (SOC) report, apparent absence of insurance, receipt of cease-and-desist letters from the FDIC, and the fact that the entity parent was domiciled in a lower-regulation jurisdiction. Such indicators as these can inform the relative level of risk in engaging with a given entity. And in this instance, they would likely have resulted in corporates choosing alternative exchanges.

Custody raises a number of important questions. Will the company custody the asset itself, or will it rely on third-party vendors? Self-custody may provide easy access to the assets, but it also presents additional risk in terms of accidental loss, transaction authorization, and transaction monitoring and recording. Given the inherent complexity and risk associated with self-custody, more and more companies are resorting to third-party custodians. Then it’s a matter of evaluating the strengths and weaknesses of different custody processes and procedures. If the company chooses to rely on an exchange or custodian to store its digital assets, careful consideration of a large number of potential risk issues and questions is in order. Some of these include:

• How does the third-party exchange or custodian secure private key material?
• Can the company trust the accuracy of account statements furnished by the third-party vendor?
• What plans are in place in the event of a liquidation of the custodial services?
• How does the exchange handle market anomalies, such as flash crashes?
• What is the vendor’s hard-fork policy in supporting new digital assets?
• What occurs if private keys and passwords are lost or stolen?

A great way to start addressing these potential issues would be to obtain and review the SOC 1 and/or SOC 2 reports of any potential exchange or custodian.

Authorizing and executing transactions and transfers (such as the cross-border transfers to subsidiaries and/or loans made to related parties) may well create a host of risks. That’s why it is vital for companies to segregate duties in such a way that there is a clear chain of command and documentation regarding who has custody of the assets, the ability to authorize their usage, and responsibility for the recordkeeping of those assets. In the recent market events surrounding the collapse of certain digital asset platforms, it has come to light that there were issues in terms of segregation of duties around authorization of transactions, recordkeeping, and safeguarding of assets.⁶ Mature organizations likely have the necessary controls in place to prevent unauthorized transactions from being broadcast to the public blockchain. Further, it may be common for automated recordkeeping and monitoring to be performed to ensure that the business is not assuming risks beyond its designated risk appetite. There are also third-party tailored custodial solutions that employ, among other devices, automatic alerts that transactions were, in fact, authorized. Given that there is no FDIC insurance for digital asset holdings, it’s important that a company ensures its holdings are segregated from other participants rather than being part of a commingled account in an omnibus fashion and that the custodian carries adequate insurance. That can become very important if an exchange or custodian suddenly goes offline for a time or ultimately fails.