New dawn, new reality

hmp-220.jpg

www.hmplaw.com

Since cryptocurrencies emerged as a hot global trend in recent years, there has been much more excitement and interest related to the area, particularly in Korea. The Korean government has made considerable effort to establish proper regulations covering various cryptocurrency-related matters by forming a Joint Task Force (JTF), comprising multiple related governmental authorities, and publishing press releases of its findings. However, the government has still not finalised any legislative solutions to define and institutionalise cryptocurrencies.

In light of the foregoing, the Korean government's regulations, based solely on either existing laws or authoritative interpretations, can be categorised into two groups: (i) regulations on initial coin offerings (ICOs); and (ii) regulations on the establishment and use of cryptocurrency exchanges.

In September 2017, when the cryptocurrency market was becoming overheated, the JTF suddenly announced that it would ban ICOs entirely. In its announcement, the JTF expressed a hard-line stance against all forms of ICOs, including those conducted by way of using cryptocurrency to allocate revenues from a given project or to grant certain rights or dividends of a given company (the security type ICO), or by way of issuing new a cryptocurrency on a relevant exchange's platform (the coin type ICO), regardless of the technology or terminology used.

Cases of improperly conducting ICOs or operating cryptocurrency exchanges are generally subject to criminal penalties

However, there have been no specific cases where companies seeking to launch ICOs or to establish cryptocurrency exchanges have been directly regulated by the Korean government. In this regard, governmental action on ICOs has taken the form of indirect regulation: imposing restrictions on the financial institutions (such as banks) used by ICO companies and thereby effectively preventing transactions.

With regard to regulations on cryptocurrency exchanges, the Korean government announced its anti-money laundering (AML) guidelines in January 2018. These guidelines were designed to strengthen identity verification and the reporting of suspicious transactions. In addition, the government also introduced a policy to regulate cryptocurrencies by introducing a real name cryptocurrency transaction system. However, in spite of these government measures, the Korean cryptocurrency frenzy intensified even more. In the end, in January 2018, the Ministry of Justice announced a drastic hard-line position, stating that there would be a 'complete shutdown of all cryptocurrency exchanges'. Then, in the evening of the same day, the Blue House (the presidential office) made another announcement modifying the government's stance, stating that the matter of cryptocurrency exchanges would be subject to development via discussions with the relevant government authorities. Nevertheless, this was not enough to prevent a dramatic fall in cryptocurrency prices immediately thereafter.

As the JTF's additional measures dragged on over the next several months, in April 2018 the Korean Blockchain Association (KBA) announced a self-regulatory proposal with which cryptocurrency exchanges should comply. The proposal provided detailed compliance obligations regarding the storage of cryptocurrencies, user protection and identity verification, internal controls, system security, and the like.

As shown above, since there are no direct regulations governing the establishment and operation of cryptocurrency exchanges, cryptocurrency transactions should be interpreted in terms of the existing laws indirectly relevant to cryptocurrency.

If any cryptocurrency issued through an ICO can be converted into a security, as defined under the Capital Markets Act (the Act), then such an ICO may be subject to the provisions on issuing securities under the Act. However, since the existing Act adopts the principle that securities are only securities if stipulated by law, an instrument should not be regarded as a security if it does not fall under one of the definitions of a security expressly listed in the Act. Moreover, it is difficult to find a case where Korean financial authorities have applied the Act directly to an ICO case.

Having said that, however, considering the various forms and types of cryptocurrency, the possibility cannot be excluded that some cryptocurrencies will eventually be regarded as securities sometime in the future, as there have already been several attempts to establish procedural regulations for ICOs, asserting that they constitute the issuance of securities under the Act.

Conducting a business for raising funds without permission, as defined in the Act on Regulation of Conducting Fund Raising Business without Permission, means any business that is conducted in order to raise funds from unspecified individuals (i) without first obtaining authorisation or permission, or filing a registration or report, under other statutes or their subordinate regulations, and (ii) while simultaneously executing a contract which promises a so-called investment-guarantee for such individuals. Therefore, so long as the foregoing does not apply to an ICO, then raising funds through an ICO generally may not constitute conducting a fund raising business without permission. However, if the investment is designed to guarantee compensation for any investment loss for the ICO participants during a given ICO, then this could possibly be deemed as conducting a fundraising business without permission (note that in Korea, some who have raised funds under the guise of ICOs have been punished for violating this specific Act).

In the past, exchanges registered their businesses as online distributors in order to trade in cryptocurrencies online. Under the Act on Consumer Protection in Electronic Commerce, an online distributor shall file report regular reports with the Korea Fair Trade Commission. However, because the commission stated in 2018 that cryptocurrency exchanges should not be regarded as online distributors, the major exchanges have now dropped that designation.

The Foreign Exchange Transactions Act applies to cases where a person provides services for converting cryptocurrency into foreign fiat currency, and in this regard any person conducting a small-scale overseas remittance business must be registered in accordance with the Foreign Exchange Transactions Act in order to provide such services. Despite the foregoing, however, it is arguable whether remitting cryptocurrency directly overseas by itself constitutes the remittance of funds as prescribed by the Foreign Exchange Transactions Act. Due to the paucity of specific interpretations and court cases, it is necessary to have further discussions regarding the general legislative trend and intention as to whether or not such transactions should be seen as actual remittances.

With regard to know-your-customer (KYC) and AML obligations, there are certain related statutes such as the Act on Real Name Financial Transactions and Confidentiality, and the Act on Reporting and Using Specified Financial Transaction Information – however, these statutes only apply to financial institutions.

The relevant statutes do not apply to cryptocurrency exchanges, as these are not financial institutions. However, in reality, in order to send or receive money to or from a bank, cryptocurrency exchanges should comply with KYC and AML obligations in any event. As most of the proposed legislation relevant to cryptocurrencies already prescribes such obligations, relevant procedures should be prepared in advance.

The Personal Information Protection Act is a general statute on the protection of personal information, which applies to all personal information processors and personal information entities. The Act on Promotion of Information and Communications Network Utilization and Information Protection is a special statute that applies to the relationship between service providers and service information entities that use electronic communications networks (such as the internet). As cryptocurrency exchanges provide services online, both of the aforementioned statutes apply to them as information and communication service providers in charge of the establishment and operation of exchanges.

Cryptocurrency exchanges are not limited to a specific country, but may include users from various nations. In this regard, cryptocurrency exchanges should be aware that if there is a user from the European Union (EU) on an exchange, the General Data Protection Regulation (GDPR), which requires the appointment of a registered EU agent, will apply to companies processing EU users' information. In other words, a registered agent located in the EU shall be appointed for the benefit of all EU citizens using that exchange.

In addition to the specific regulations mentioned above, cases of improperly conducting ICOs or operating cryptocurrency exchanges are generally subject to criminal penalties. For example, an ICO seemingly without any underlying business value can be found guilty of fraud. Also, if a cryptocurrency is listed on an exchange, but cannot be properly used in any transactions due to some deficiency, the representative director of the relevant cryptocurrency exchange may be punished for "receiving or giving bribes by breach of trust", and directors who arbitrarily use the funds raised through such exchanges may be punished for embezzlement or misappropriation.

Furthermore, the Supreme Court has recently ruled that 'bitcoin is an intangible property containing value, which can be subject to misappropriation thereof' (Supreme Court Decision 2018do3619, dated May 30 2018). In light of this judgment, it seems highly likely that the court will be more active in directly intervening in cases of misconduct arising in cryptocurrency transactions, by applying criminal penalties in relation to such acts as fraud or embezzlement.

Cryptocurrency transactions may generate a variety of tax implications depending on the type of transaction involved. The applicable taxes may be roughly divided into income tax, corporate tax, capital gains tax, inheritance tax, and value-added tax.

Personal income tax may be levied if there is a business/commercial purpose for the transaction. In other words, if an individual transacts in cryptocurrency only for investment purposes, no personal income tax for such transfers will be levied. Since income tax is generated only if expressly stipulated under the Income Tax Act, where an individual conducts cryptocurrency transactions or investments for his/her own business purposes, any income arising therefrom may be subject to income tax as business income or as integrated income.

Legislation governing cryptocurrency exchanges is expected to be passed in the near future

In the case of taxes on corporations, the Corporate Tax Act states that corporate taxes will be levied upon corporations whose assets have increased in value, regardless of the cause of the increase. In this regard, the profits from corporate investments into cryptocurrency transactions may be subject to corporate tax. However, it still remains a question as to whether any overseas profits can be taxed in Korea if a Korean corporation conducts its ICO overseas and gains profits from it. The Corporate Tax Act defines a domestic corporation as a 'corporation having its head office, principal office, or place of actual business in Korea,' and taxation authorities define a 'place of actual business' as a place where commercial decision-making processes are practically executed.

Therefore, even if a domestic corporation conducts its ICO through a foreign corporation, if it is proven that important business decisions are ultimately conducted by the domestic entity, then the ICO may be deemed as being practically executed by that domestic entity and therefore taxed in Korea accordingly.

In the case of inheritance tax and gift tax, taxable items are any assets which have economic value. Considering that, there is no legal question that inheriting or bestowing cryptocurrency for free will be taxed – however, it is somewhat unclear how to evaluate the market value of such assets in order to calculate the applicable tax amount.

Lastly, regarding value-added tax (VAT), taxation authorities have expressed their basic and fundamental stance as reflected in the statement that 'VAT can be imposed if cryptocurrency is transferred as a good, but VAT cannot be imposed if it is used as a currency'. With respect to VAT cryptocurrency, there are many ongoing discussions domestically and overseas, and also within academia, but as of yet there has been no established standard for determining whether or not a cryptocurrency may be characterised as a good or as a currency in any particular case.

As stated earlier, there are still no specific statutes which directly regulate ICOs in Korea. Due to the legal uncertainty in Korea, ICOs will likely continue for the time being to be established in foreign countries such as Malta, Singapore, Switzerland, Estonia, Hong Kong, and Gibraltar.

Likewise, there are still no specific statutes to control the establishment and operation of cryptocurrency exchanges. That said, however, legislation governing cryptocurrency exchanges is expected to be passed in the near future, as the Korean government has recently announced its intention to regulate cryptocurrency exchanges in accordance with its authoritative interpretations. In fact, currently there are several legislative proposals that have already been made that contain specific details on the establishment requirements and operating procedures for exchanges.

Cryptocurrency exchange operators must prepare for the requirements detailed in the proposed cryptocurrency legislation. In addition, the KBA's self-regulatory proposal, albeit without any binding force, should also be fulfilled (in this regard, in July 2018 the KBA announced its results regarding whether 12 main exchanges in Korea had been in compliance with its self-regulatory proposal – fortunately, all were found to be in compliance).

Lastly, as has been much publicised, the price of Bitcoin – which skyrocketed to KRW24 million (approximately $21,500) at the end of 2017 – shed about two-thirds of its value so far in 2018, down to approximately KRW7 million. Considering the rapidly changing nature of the cryptocurrency market, it is not readily apparent how it will ultimately develop. In light of all this, investors and cryptocurrency exchange operators should continue to monitor legislative trends in the future, while continuing to act in accordance with the Korean government's authoritative interpretations.

About the author
		Chan-sik Ahn Partner, HMP Law Seoul, Korea T: +82 2 772 2809 F: +82 2 772 2800 E: csahn@hmplaw.com W: www.hmplaw.com Chan-sik Ahn is a partner in HMP Law's corporate practice group and the head of HMP's tech and comms team. Chan-sik provides clients with proactive, strategic and specialised legal advice on current or potential legal issues relating to various breakthrough technologies that represent the fourth industrial revolution, such as blockchain, cryptocurrencies, initial coin offerings, cryptocurrency exchanges, drones, electric cars, driverless cars, games, and the sharing economy

About the author
		Ga-ram Shon Associate, HMP Law Seoul, Korea T: +82 2 772 2782 F: +82 2 772 2800 E: shongr@hmplaw.com W: www.hmplaw.com Ga-ram Shon is an associate in HMP Law's corporate and finance practice group and a member of HMP's tech and comms team. He specialises in technology law, data protection, corporate governance, finance, litigation, and tax. In particular, he focuses on providing legal advice and training in new industry fields such as cryptocurrencies, ICOs, cryptocurrency exchanges, data protection compliance programs, and drones.