Tokenization isn't a novel technology; but it certainly has newfound appreciation in recent times. Similar to how early enthusiasts experimented with NFTs tokenization has been part of the landscape for sometime now. But with evolving tech within this space, institutions are increasingly showing interest in tokens, and unexpected economic dynamics have encouraged their adoption.
This resurgence does, however, present some challenging questions, particularly regarding how companies should account for tokenized assets in their financial statements. Since the adaptability of this concept is still in its early stages, there is a limited amount of available information and established practices in this regard.
Before we share some thoughts on this, let's understand what does tokenization mean.
Tokenization of digital assets refers to the process of converting physical or intangible assets into digital tokens on a blockchain or DLT. These tokens represent ownership, rights, or a stakes in the underlying asset.
Almost any type of asset can be tokenized, including real estate, stocks, bonds, art, commodities, and more. Tokenization allows these assets to be divided into smaller, more easily tradable units.
This makes accounting for them a complex process. The specific accounting treatment can vary depending on factors such as the nature of the asset, the accounting standards applicable in the operational jurisdiction and whether the tokens represent ownership, utility, or some other rights. We've drawn from studies including the OECD's 2020 paper "The Tokenisation of Assets and Potential Implications for Financial Markets" to get guidelines on how they can be represented in financial statements.
1. Are they financial assets?
If the tokenized asset represents ownership in an a pre-existing real asset (e.g., stocks, bonds) or carries contractual cash flows (e.g., interest payments), it may be classified as a financial asset. In the same vein, if they represent owning a real assets that is not financial in nature (real estate, art work), they may be considered as non-financial assets.
2. UK FRS - Financial Instruments
In the UK, FRS 102 requires comprehensive disclosures related to financial assets, including information about their nature, risks, and fair value. Accounting standards do evolve overtime with the complexity of products in the market so a close read of it is required before deciding accounting treatment for the asset.
For companies that are multi-jurisdictional, its important to check requirements under host standards and tax rules.
3. Are tokenized assets derivatives?
They are not. While tokenised assets have a like to like value for an underlying asset with the ownership of the asset vesting with the token asset holder. Derivatives "derive" their value from an underlying with no ownership rights to the original asset itself. For eg, a tokenised version of gold will have the same value to the unit of gold it represents, whereas a derivative instrument based on the value or price of gold doesn't have the value of the asset (i.e. gold). Derivatives are used quite commonly as speculative instruments used for hedging purposes. The accounting for these greatly differ too.
4. HMRC Viewpoint
As of now, HMRC has not provided specific guidance pertaining to NFTs or tokenized assets in a general context. They do, however, offer guidelines related to cryptocurrencies.
In the event that NFTs are acquired and subsequently sold, with a demonstrable change in value from acquisition to sale, it's reasonable to assume that tax implications may arise. The specific tax treatment will depend on how these assets are classified in financial accounts. Potential taxation scenarios may include tax on profits (corporation tax) or capital gains tax
In summary, this field is relatively new, and the accounting treatment varies depending on factors like the asset's purpose and the nature of the underlying core asset. There isn't a universal solution that applies to all situations. If you'd like to brainstorm the handling of tokenized assets like NFTs, please don't hesitate to contact us through our dedicated contact page. We're here to assist you.
All pictures used in the article are from pexels.com and allowed for commercial use under a creative common license
The article is only for information purposes. Please do your own research or reach out to professionals for further guidance