Current Status and Trends of Cryptocurrency Taxation and Regulation in China

Taxation of cryptocurrencies has become a hot topic in both theoretical and practical fields. Many issues need to be addressed, including whether and how tax authorities can levy taxes; how industry entities deal with compliance and whether they can obtain regulatory certainty; and whether and how individuals can be taxed on gains from cryptocurrency activities. These are also hot issues for tax authorities, businesses and industry stakeholders in China.

Series I Status of taxation and administration

For some time now, tax authorities in some regions have conducted tax audits of businesses engaged in cryptocurrency production and individuals who have obtained large excess profits through cryptocurrency transactions, providing some insight into subsequent tax collection and management.

Taxability of cryptocurrencies

There is no clear basis for cryptocurrency taxation in China's tax law. According to the principle of statutory taxation, the actual taxation process will create a great deal of uncertainty for both the tax office and the company. The tax law does not clarify the tax obligations, taxation objects and taxation management methods in the acquisition, holding, transaction, payment and transfer of cryptocurrency. However, in the spirit of the Corporate Income Tax Act and the Individual Income Tax Act, it is taxable to some extent if an enterprise or individual obtains economic benefits in the above-mentioned cryptocurrency value creation process, or other forms of economic gains that can be exchanged for products and services in the market.

Currently, cryptocurrencies are not legal tender in China, and their conversion transactions with legal tender are not supported by policies and regulations, or even explicitly prohibited, but market transactions and payments can be carried out overseas. Although a Chinese resident taxpayer cannot directly engage in cryptocurrency transactions in China, he/she still has the obligation to carry out global taxation as a resident taxpayer and declare profits from cryptocurrency transactions abroad as foreign income for taxation. On the other hand, when cryptocurrency producers or related enterprises exchange goods or pay employees through cryptocurrency, the commodity properties of cryptocurrency are also reflected, and whether it can be managed in accordance with barter taxation is also controversial. However, in accordance with the spirit of the tax law, cryptocurrency holders formulate a financial attribute of the cryptocurrency held, and then buy the goods and services exchanged and the salaries of employees through the payment function of the financial attribute, which is essentially a merger of two links. Then, in the first link, the commodity attributes of cryptocurrency need to be supported by market value, and the exchange function is given to reinforce the commodity attributes. Therefore, the formulation and quantification of the value involved in this case is taxable in an economic sense, and can be measured in terms of specific market value.

In short, taxation is a complex field of economics and law, where tax authorities are legally empowered by legislation to levy taxes on the economic actions or economic income of taxpayers. Although cryptocurrencies are new and involve many links in their value chain, the act of taxation by tax authorities still has some economic support in the current situation where the legislative system of tax laws and regulations is still insufficient and unclear.

Uncertainty of cryptocurrency taxation

The uncertainty of cryptocurrency tax administration is mainly reflected in legislation and enforcement. The current tax legislation does not provide a specific tax law, provisional regulations or normative documents to clarify the specific objects of taxation and the determination of tax obligations, so as to realize that there are legal objects for taxation and a legal basis for tax payment. Accordingly, the problems faced by law enforcement are even greater. The lack of a legal basis at the bottom and the absence of a top-level tax collection and management system will make it a contradictory issue for tax authorities at all levels to manage taxes in accordance with the law as the main law enforcement agency. Due to the lack of legal basis and unclear regulations on tax collection and administration, tax authorities have different understanding of the determination of tax obligations and different caliber of enforcement, which will easily lead to large differences between tax authorities and legal entities, and eventually lead to tax litigation. On the judicial side, due to the lack of legislation and enforcement, it is also a great test to see how the judiciary can achieve a fair and impartial judgment, especially since the tax system itself is very complex and huge, and cryptocurrency is an emerging product, which also indirectly brings greater pressure on the judicial system.

Uncertainty also exists with regard to collection and administration procedures. It is also difficult for tax authorities at all levels to obtain specific transaction information of cryptocurrency practitioners and to have entry points or grips for tax collection. Even if there is a tax collection law in the future, it is still unclear how to effectively exercise tax collection power and scientifically govern taxation.

Inspiration from cryptocurrency cases

Some regional tax authorities have targeted cryptocurrency producers and individuals who have made high excess profits from cryptocurrency trading for tax purposes, in different ways and by different means. The author believes that this is not necessarily a signal for official taxation, but it is sufficient for practitioners, companies and individuals in the industry, as well as professional service providers, to prepare and plan in advance.

Although individual cases do not necessarily represent the official attitude, there are inevitably some factors behind the accident, and it cannot be ruled out that this is a pilot trial by some taxation authorities. In the current form, the legislation still needs to be strengthened and optimized, and it will take some time for it to reach the level of law enforcement by the tax authorities, and the occurrence of individual cases will not affect the whole legislative enforcement process. However, for industry practitioners, it is important not to overlook case handling. Although the final result may not be the best, it may be used by other tax authorities as a reference for comparison and may implicitly influence tax treatment.

Series II: Future taxation trends

Cryptocurrency taxation is not only a hot topic in the academic and regulatory fields, but also a topic for industry practitioners to study in depth, clarify their thinking on taxation and study the future trends of taxation regulation.

Improve legislation and tax by law

First, legislation will be gradually improved. Currently, there are very few legal provisions related to cryptocurrency, except for a few restrictive joint documents issued by multiple ministries and bureaus. The Ministry of Finance and the General Administration of Taxation have not issued any new documents, which has led to the highly uncertain situation that exists today. However, with the gradual development of new economic sectors, and the increasing improvement of emerging fields such as digital economy, cryptocurrency, metaverse, AI, Web3, etc., the corresponding tax legislation will be gradually upgraded and clarified. Regardless of taxation or non-taxation, the level of legislation will be gradually clarified to provide clarity to the executive authorities and industry stakeholders.

Tax authorities are statutory tax authorities. Only with sufficient clarity and authorization at the legislative level can tax authorities at all levels truly levy taxes in accordance with the law and provide certainty to taxpayers. Although some of the links are currently more controversial or even not supported or prohibited by law, there are still some links in the entire cryptocurrency value chain that are highly profitable. The subsequent timely legislative improvements will enable tax authorities to tax these economic gains and further regulate the healthy development of the industry.

Strengthen tax regulation with digital technology

With the construction of e-government year by year, the future taxation authorities will gradually strengthen their taxation and management capabilities, and taxation supervision by digital technology will become mainstream. Cryptocurrency, due to decentralization and transaction facilitation, makes the industry develop rapidly and promotes the development of cross-border trade to a certain extent. However, all these remarkable features pose major challenges for tax authorities. Many practical issues arise, such as how to monitor tax sources, how to obtain transaction information in each link, how to monitor cross-border transaction data, and how to optimize international tax rules accordingly.

From the current legal and economic environment, there is a general trend to strengthen the taxation and regulation of the cryptocurrency industry in the future. Tax authorities will use big data systems to obtain information on cryptocurrency holdings, transactions, and circulation of industry stakeholders, screen high and medium risk taxpayers through risk control models, and verify and validate each account. This includes acquiring information on overseas cryptocurrency transactions through international tax collaboration tools such as intelligence exchange and country reports, mastering domestic and overseas tax-related data from industry stakeholders, and then combining it with the optimized and improved tax laws for taxation. The industry will also break down data barriers between departments, realize cryptocurrency value chain monitoring in high-frequency fields such as cryptocurrency transactions and payments through the capture and monitoring of data on the chain, learn the tax-related data of each chain to improve tax efficiency. Taxation authorities can also use blockchain technology to optimize the electronic tax system, improve the algorithm and optimize the arithmetic power to realize tax control by digital technology in the field of cryptocurrency.

Change perceptions to make taxation more rational

The development of the cryptocurrency industry will be promoted in a healthy direction. Various regulators will provide guidance to the cryptocurrency industry and rational management, and tax authorities will also tax rationally in the future. For the tax authorities, they should change the traditional concept and reshape the concept of taxation and management in the cryptocurrency industry, reasonably divide the different links in the cryptocurrency value chain, rationally determine the tax obligations, so as to get rid of the inherent thinking that the higher the income is, the heavier the tax burden should be. Different tax regulations and spirits should be applied to different links of cryptocurrency production and acquisition, holding and payment, and trading and transfer, in order to avoid one-size-fits-all taxation and administration for high income.

On the one hand, the improvement of taxation and management capabilities depends on the improvement of the electronic taxation and management system and the full application of big data. On the other hand, taxation will be more scientific and rational if tax personnel strengthen their familiarity with the basic logic and mode of operation of the industry, understand and comprehend the business development model. Currently, the cryptocurrency industry is new to most tax authorities as well as staff. Lack of historical experience and cognitive bias will inevitably have a greater impact on the certainty taxpayers need. At the same time, the industry is now in the early stage of rough development. The outside world's understanding of the industry mainly focuses on the appearance of profiteering, wealth accumulation, and wealth creation, which will bring some irrational factors to taxation and tax determination. As the industry becomes more regulated and information leaks out, more regulators and related parties will become more familiar with the operation mode and business model of the cryptocurrency industry, and tax authorities will gradually change their philosophy and taxes rationally.

Taxation of cryptocurrencies has become a hot topic in both theoretical and practical fields. Many issues need to be addressed, including whether and how tax authorities can levy taxes; how industry entities deal with compliance and whether they can obtain regulatory certainty; and whether and how individuals can be taxed on gains from cryptocurrency activities. These are also hot issues for tax authorities, businesses and industry stakeholders in China.

Series III Insight Suggestions

Enhance risk awareness and eliminate fluke mentality

Although the tax authorities still have great uncertainty about whether and how to tax at this stage, the relevant tax regulations are still in a blank stage. However, in the economic aspect of taxation, there are still large links in the cryptocurrency value chain that are economically taxable. Meanwhile, combined with international tax experience, most developed economies are gradually improving their tax legislation to fill in the gaps in industry taxation. In the long run, China's legislature and tax authorities are likely to improve industry legislation and give tax authorities statutory taxation powers. The trend towards gradual taxation is inevitable.

Practitioners in the cryptocurrency industry and related parties should increase their risk awareness and eliminate the existence of a fluke mentality. Under the levy regulations, tax authorities have the rights and grounds to make retrospective adjustments to taxpayers. Short-term flukes do not imply future compliance.

Enhance compliance awareness and plan ahead for the layout

Those involved in the cryptocurrency industry need to enhance their awareness of compliance. Even if the current regulatory system is not yet clear, it is still necessary to enhance tax compliance as much as possible, sort out and retain the tax obligations and data that may arise from each link of cryptocurrency for the future. The tax treatment results for subjective non-payment and objective non-payment will be quite different. Make data backup, grasp the data initiative when communicating with tax authorities on specific issues in the future, and further reduce tax costs on the basis of cooperating with tax authorities' audits or investigations.

Enhance legal awareness and safeguard legitimate rights and interests

Currently, there are investigation cases against cryptocurrency industry stakeholders in some regions. Although it does not represent the official position or voice, it is a warning to industry stakeholders that they should not panic when encountering similar cases, but increase legal awareness, communicate rationally with tax authorities under existing tax laws, introduce business models, cooperate with the determination of tax obligations, and also use legal tools to safeguard the legitimate rights and interests of taxpayers.

Where there are significant differences with tax authorities on specific tax-related matters, make full use of administrative reconsideration and administrative litigation to seek judicial remedies, eliminate subjectivity and overreaction at the law enforcement level as far as possible. Achieve understanding based on tax laws, levy taxes according to tax laws, and effectively protect tax rights and interests.

Do cryptocurrencies, as legal property, need to be taxed in mainland China?

On September 1st, the Chinese People's Court Daily published an article titled "Recognition of the Property Attributes of Virtual Currency and Issues concerning the Disposal of Involved Properties." By analyzing the criminal law attributes of virtual currencies such as Bitcoin, the article believes that virtual currencies like Bitcoin have economic attributes and can be classified as property. Current relevant regulations explicitly define Bitcoin and other virtual currencies as virtual commodities, and administrative and legal policies do not completely prohibit virtual currency transactions. Under the current legal and policy framework, virtual currencies held by relevant entities in China still constitute legal property and are protected by law.

Do individuals need to pay taxes on the transfer income from privately held cryptocurrencies?

Regarding the tax issues concerning virtual currencies like Bitcoin, most major countries or regions worldwide have issued relevant tax regulations that stipulate taxation matters related to holding and transferring virtual currencies. For example, according to US tax law, individual capital gains from the transfer of Bitcoin are subject to income tax, and the tax rate varies based on the holding period. In Japan, individual income from the transfer of Bitcoin and other virtual currencies is subject to miscellaneous income tax, among others.

In China, on one hand, due to the current policy that classifies virtual currency-related activities as illegal financial activities, there are legal risks for any legal entities, non-legal entities, or individuals involved in virtual currency investment and trading activities. On the other hand, specific regulations regarding the tax issues of gains from the transfer of Bitcoin and other virtual currencies have not been introduced in tax supervision. As a result, many practitioners have misconceptions and believe that gains from the transfer of Bitcoin and other virtual currencies are not subject to taxation and do not need to be declared.

However, firstly, current Chinese regulations do not prohibit individuals from holding cryptocurrencies such as Bitcoin. As mentioned at the beginning of the article from the Chinese People's Court Daily, according to existing legal framework, privately held virtual currencies are considered legal property and are protected by law. Secondly, the current tax laws in China have not issued specific regulations concerning Bitcoin and other virtual currencies, which does not mean that gains from the transfer of Bitcoin are exempt from tax. On the contrary, China's existing tax laws already encompass issues related to gains from the transfer of cryptocurrencies like Bitcoin.

Currently, the tax bureau in mainland China may obtain information about the transfer of personal cryptocurrency assets through various channels, including centralized cryptocurrency exchanges and service providers, information provided through CRS (Common Reporting Standard) exchanges, information provided by blockchain transaction tracking technology teams, and information provided by public security departments.

2. What tax obligations may be involved in the transfer of personal cryptocurrencies?

According to the current tax laws in China, the transfer of virtual currencies such as Bitcoin by individuals may be subject to individual income tax and other relevant taxes.

Currently, existing regulations in China classify Bitcoin and other virtual currencies as specific virtual commodities, and personally owned virtual currencies are considered personal property. When a transfer is made and income is generated, it falls under the category of taxable personal income, and individual income tax should be calculated and paid based on the category of property transfer income.

According to the "Individual Income Tax Law of the People's Republic of China," Article 1 states, "... residents shall pay individual income tax on income obtained within and outside the territory of the People's Republic of China in accordance with the provisions of this Law." Article 2 states, "... the following items of personal income shall be subject to individual income tax: ... (8)

 Income from property transfers," and the "Implementation Regulations of the Individual Income Tax Law of the People's Republic of China," Article 6 states, "The scope of various personal income as stipulated by the Individual Income Tax Law includes: ... (8) Income from property transfers, referring to income obtained from the transfer of negotiable securities, equity interests, shares of partnership enterprises, real estate, machinery and equipment, vehicles and ships, and other properties."

Previously, the State Taxation Bureau had issued a specific reply regarding the collection of personal income tax on virtual currency transactions. According to the provisions of the State Taxation Letter [2008] No. 818, individuals who acquire virtual currency from players through the internet and earn income by selling it to others at a higher price are considered taxable income for personal income tax. They should be subject to personal income tax calculation and payment according to the "income from transfer of property" category.

Although this regulation mainly targets virtual currencies such as game coins and Q coins, which are different from blockchain-based virtual currencies like Bitcoin, according to existing laws in our country, both types of virtual currencies are considered virtual commodities. Therefore, this regulation has certain reference value for the personal income tax of Bitcoin and other virtual currency transfer transactions.

3. What happens if taxes are not paid on income from cryptocurrency transfers?

Taxes should be paid on the income at the time it is obtained. Failure to declare and pay taxes on time may result in not only the payment of the owed taxes, but also the payment of late fees and penalties at a daily interest rate of 0.05% when verified by the tax authorities. In cases of tax evasion, there may be corresponding criminal liabilities, resulting in significantly high post-event costs.

4. How should individuals consider tax matters when it comes to income from cryptocurrency transfers?

If individuals have income from cryptocurrency transfers, they should consider tax matters from the perspective of their status as individual tax residents, including the types of taxes involved, the amount of taxes to be paid, and potential tax benefits that can be applied for.

However, tax regulations are complex, and tax matters themselves are quite specialized. In addition, the calculation of income from cryptocurrency transfers, such as Bitcoin, is intricate, making tax matters related to cryptocurrency transfers more complicated and uncertain. Therefore, it is advisable for individuals who are involved in income from cryptocurrency transfers, such as Bitcoin, to communicate in advance with tax professionals or institutions to understand whether they are subject to related tax issues and to plan ahead for how to declare and pay taxes in practice. This will help avoid unnecessary tax risks or costs that may arise from failure to timely declare taxes, imposition of tax obligations in multiple jurisdictions, or the need for repeat tax payments.