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Form 1042-S ruminations on crypto lending and dividend-paying tokens

Nelson Suit
Nelson Suit
Tax Compliance Officer

In a prior blog, dated 30 March 2021, titled “What about Form 1042-S tax reporting for crypto transactions?”, we asked whether U.S. tax information reporting on Form 1042-S might be triggered by certain crypto transactions outside of crypto trading. We considered staking rewards in that context, and, in this blog, we want to turn to a couple of other crypto-related payments that may also raise similar tax reporting concerns. 


  1. In addition to staking, crypto lending and dividend-paying tokens are two other crypto-related transaction types that may raise issues for U.S. cross-border tax withholding and Form 1042-S reporting.
  2. Whether payment of rewards to the lender in a crypto lending transaction or a dividend-paying token triggers Form 1042-S reporting depends on how the payment is characterised and the source rules that may be applied.
  3. It remains unclear how such crypto transactions will be characterised and how associated payments will be sourced, but, as crypto transactions evolve beyond mere trading, conversations regarding tax information reporting should begin to consider potential Form 1042-S impacts.

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1. Crypto lending

In addition to staking rewards, another area where potential FDAP payments could trigger Form 1042-S reporting is in the emerging area of crypto lending where the lender is a non-U.S. person.

Crypto platforms have evolved that allow an investor to ‘deposit’ cryptocurrencies on the platform and earn ‘interest’ on the deposit.

This may be accomplished in at least a couple of ways.

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a. Centralised lending

One is centralised lending, where an institution, much like a bank, takes the deposit of the crypto assets and lends those assets to borrowers and provides the ‘depositor’ with ‘interest’ on the account. The ‘interest’ may be paid in the form of the original crypto deposited or perhaps in a token issued by the lending institution itself.

Could such ‘interest’ paid by the lending institution be treated as U.S. sourced FDAP subject to cross-border tax withholding and Form 1042-S reporting?

Remember that Form 1042-S and associated tax withholding generally only apply to income that is treated as derived from U.S. sources under disparate tax rules.

Whether such withholding and Form 1042-S reporting is triggered depends again on the classification of the so-called ‘interest’ rewards. Since the IRS has not classified convertible virtual currencies as currency but as property, the return may not be treated as interest per se. Interest generally refers to amounts paid for borrowed money.

However, the rewards could nevertheless be considered as something analogous to interest given the role of cryptocurrency in these financing frameworks. The argument may be stronger especially where lending is conducted using stablecoins, created with the intention to track the value of fiat.

If crypto lending rewards are sourced like interest, a U.S. lending institution that pays its depositors may be treated as paying U.S. source income. This could trigger withholding tax and Form 1042-S reporting where the customer is a non-U.S. person.

Alternatively, could lending cryptocurrency be seen as analogous to lending securities?

Specific tax rules cover the lending of securities, and so while cryptocurrencies are generally not securities per se, perhaps similar sourcing rules could apply by analogy.

In certain securities lending transactions, the lender is paid a borrow fee. Unfortunately, the tax classification and sourcing of borrow fees are not clear. In practice though, some withholding agents treat such fees as a type of U.S. source FDAP if paid by a U.S. borrower.

If a U.S. lending institution is treated as the borrower paying a borrow fee in the form of the crypto rewards, that payment may be subject to withholding tax and Form 1042-S reporting if paid to a non-U.S. customer.

Possibly, this could be ‘other income’ that may be eligible for treaty relief under certain income tax treaties. But, again, since virtual currencies are not securities and the treatment of borrow fees remains unclear, the answer for crypto is likely doubly unclear.

Finally, if a ‘depositor’ of cryptocurrency is given a new token in exchange and the issuer of the token rewards the depositor with additional units of the new token, there may yet be another potential trigger for withholding and Form 1042-S reporting.

The ‘deposit’ of the cryptocurrency in exchange for the issuer’s token may be seen as a taxable exchange. Additional units of the new token issued may be treated as simply other income, perhaps sourced to the residence of the payor.

If the payor is a U.S. institution and the payee a non-U.S. customer, this could result in such income again being subject to withholding and Form 1042-S reporting.

b. Decentralised lending

Decentralised lending creates more difficult classification issues.

In a decentralised lending platform, an investor may utilise a crypto lending platform to deposit the investor’s coins to the liquidity pool as part of the platform’s software protocol.

Borrowers can borrow crypto assets from the liquidity pool and pay the pool a return on the borrowing. The platform then allocates the return to the investors that have deposited assets to the liquidity pool.

Unlike centralised lending, it may be impossible to trace where a borrower is resident since the investor is providing assets to a global liquidity pool. Thus, it may be unclear who the payor is.

More, there may be no institutional intermediary that would be able to withhold or report on payments.

Could the global aspect of decentralised lending pools lead the IRS to decide to source such payments to the residence of the payee, thus avoiding cross-border withholding tax issues?

Payments on notional principal contracts, for example, follow such a payee-residence sourcing framework. In such case, Form 1042-S may not be an issue.

2. Dividend-paying tokens

Finally, though not yet as common, the marketplace has started to see ‘dividend-paying’ crypto tokens. Such tokens may provide holders a payment based on a portion of the profits earned by the issuer, though the owner may not have other rights with respect to the company.

Tax treatment of such dividend-paying tokens is not entirely clear.

If based on its terms the token would be treated as equity in the issuer, the sourcing of the ‘dividend’ would seem to depend on where the issuer is organised. If the issuer was organised in the U.S., this may result in a U.S. source dividend subject to both withholding tax and Form 1042-S reporting.

Even if the token is not treated as direct equity in the issuer, an issue may arise as to whether the token is a derivative that references the stock of the issuer.

If this is the case, it could potentially trigger the dividend equivalent payment withholding rules under section 871(m). This would also bring in Form 1042-S reporting.

Dividend-paying tokens may become more of a withholding and reporting issue as the use case of crypto tokens expands and more financial assets become tokenised.

As we have noted before, there are more questions than answers at this point. But as discussion of crypto transactions move beyond crypto trading to other more complex transaction such as staking, crypto lending and dividend-paying tokens, the tax discussion may also need to evolve.

Even as domestic tax information reporting (Form 1099 reporting) rules remain unclear, it may be time to begin thinking about potential cross-border withholding and Form 1042-S reporting questions that the evolving crypto ecosystem poses.

Refinitiv Maxit, the industry’s only end-to-end tax information reporting solution, allows firms to focus on their core business without the cost and distraction of managing multiple vendors and large operations teams