“What gets us into trouble is not what we don’t know. It’s what we know for sure that just ain’t so.”
― Mark Twain
Under current taxation regimes, cryptocurrencies are treated as property by the IRS, which implies a host of existing rules and regulations regarding the reporting and taxation of property transactions. This reporting and tax collection can be manually burdensome and is rarely automated given the current state of the technology. The IRS has recently started increased enforcement actions on cryptocurrency transactions. Blockchain and cryptocurrency enthusiasts have sought to apply some of the underlying technology and concepts in a variety of other ways to avoid these burdens. One proposed use is in customer loyalty programs.
Customer loyalty programs can provide differentiation and sustain competitive advantages, particularly where the switching costs are low[1]. Customer loyalty programs have a long history with applications in the 1700s and 1800s with tokens and stamps that could be used by the customer for discounts on future purchases with the same supplier. Perhaps the modern stereotype is the frequent flyer mile. Originally acquired and used solely for air travel, these can now be acquired without using air transport and exchanged for a variety of other goods and services. While typically not fungible beyond the partner ecosystem, customer loyalty tokens (e.g. frequent flyer miles) are sometimes seen as alternative currencies by both the creators and users. The analogy with cryptocurrency schemes as an alternative currency seems obvious.
Most consumers don’t think about taxation of their frequent flyer miles; and, most would typically assume that they are not taxable. This, unfortunately, ain’t always so. The IRS has issued limited guidance on the taxation of frequent flyer miles with IRS announcement 2002-18 stating they would not pursue a tax enforcement program on frequent flyer miles – and not that these were not taxable. This relief does not apply to travel or other promotional benefits that are converted to cash, to compensation that is paid in the form of travel or other promotional benefits, or in other circumstances where these benefits are used for tax avoidance purposes. And there are a couple of court cases[2] where the value asserted in a frequent flyer miles transaction has exceeded de minimus limits and resulted in the issuance of 1099-MISC income statements with tax impacts. There are many variants in customer loyalty programs and opinions on the practicality of heir taxability[3]. Unexpected tax enforcement against consumers of loyalty program tokens would significantly impact the value of such programs. No consumer-facing company wants to give its customers promotional tokens that result in tax problems from unexpected liabilities or reporting concerns.
Considering the potential for increased tax enforcement against cryptocurrency transactions, proponents of blockchain-based customer loyalty programs should consider how closely their proposed loyalty programs match the original concept of discounts against future purchases with the same supplier vs fungible alternative currency.
For companies considering a blockchain-based loyalty program there are additional considerations. FINCEN has recently issued guidance involving convertible virtual currencies. While this guidance seems directed to virtual currency exchanges, it is not clear that businesses exchanging virtual currencies for goods and services are exempt. If applicable, then the business would need to comply with state money transmission regulations. This gives companies considering blockchain-based loyalty programs added incentives for restricting the program to match the original concept of discounts against future purchases with the same supplier vs fungible alternative currency.
Blockchain-based customer loyalty programs are not impossible; however, due diligence needs to be undertaken with the applicable regulations, to ensure the loyalty program is designed appropriately.
[1] A. Nastasiou, M. Vandenbosch, “Competing with loyalty: How to design successful customer loyalty reward programs”, Business Horizons Vol 62, Is 2. March-April 2019 pp 2017-214.
[2] See e.g., Shankar v Commissioner 143 T.C. No 5 (2014), Hirsch v Citibank (S.D.N.Y) Case 1:12-cv-01124-DAB-JLC (2016)
[3] J. A. Mankin, J.J. Jewell, “Frequent Flyer Miles as company scrip: implications on taxation” Business Studies Journal, Vol 7, No. 1, 2015