The Battle of the East in the Location of Multinational Crypto Firms (III): HQ Location for Centralized Cryptocurrency Exchanges

1. Introduction

In our previous series of articles, we have made a preliminary analysis of the financial environment and tax policies of Hong Kong and Singapore, and discussed the advantages and disadvantages for mining companies to locate in Hong Kong and Singapore respectively, and in this article, we will continue to explore the location of centralized cryptocurrency exchanges (CEXs) from a tax perspective. Centralized cryptocurrency exchanges are digital platforms or marketplaces where users can buy, sell and trade various cryptocurrencies, such as Coinbase and Binance. unlike decentralized cryptocurrency exchanges, the term “centralized” in the context of centralized cryptocurrency exchanges implies that there is a centralized authority or entity managing the exchange. Unlike decentralized cryptocurrency exchanges, the term “centralized” implies that there is a centralized authority or entity that manages the exchange and that the operator of the exchange is able to control users' funds and transactions. According to data from Coincarp and CoinMarketCap, the top 15 cryptocurrency exchanges are all centralized exchanges, and several of the centralized cryptocurrency exchanges have Eastern backgrounds, including Binance, Bybit, OKX, Gate.io, Kucoin, HTX, MEXC, and Bitget. It is worth noting that among these centralized cryptocurrency exchanges with Eastern backgrounds, there are several more centralized cryptocurrency exchanges that are or have been domiciled in Singapore, such as Kucoin, MEXC, and Bitget, and even if some of the exchanges, such as OKX and Gate.io, have relocated their domiciles to areas such as Malta or the Cayman Islands, they still set up their Hong Kong and Singapore subsidiaries or Asian headquarters. It can be seen that Singapore and Hong Kong are the main places of registration for centralized cryptocurrency exchanges in Asia. In addition to the openness of Singapore and Hong Kong to cryptocurrencies, we can also try to seek the institutional and economic reasons behind this phenomenon from the perspective of regulation and tax policy.

2. Main types of revenue for centralized cryptocurrency exchanges

Unlike mining enterprises, centralized cryptocurrency exchanges have richer business contents and wider sources of income. At present, the main revenues of centralized cryptocurrency exchanges include the following:

(1) Fee income. Centralized cryptocurrency exchanges charge a certain percentage of handling fees in the process of aggregating user transactions and other processes, including pending order handling fees, order eating fees, cash withdrawal fees, etc.

(2) Coin up fee. The so-called coin-up fee refers to the fee charged by centralized cryptocurrency exchanges to the project side before going live with the tokens of a project. Although exchanges do not necessarily charge uploading fees, and the amount of uploading fees is not fixed, the total amount of this income should not be underestimated in today's endless new projects.

(3) Lending Revenue. Centralized cryptocurrency exchanges do not only provide intermediary services such as trade aggregation, but also carry out financial business such as lending services. For example, in leveraged trading, exchanges can lend to users the financial funds of other users that are deposited on the exchange and earn a spread from them.

(4) Advertising and sponsorship revenue. Centralized cryptocurrency exchanges have a large flow of users, and providing advertising services or accepting sponsorships can also enable exchanges to achieve considerable revenue.

(5) Cryptocurrency issuance and value-added revenue. At present, the cost of issuing cryptocurrencies on the chain is not expensive, and exchanges often issue their own on-chain tokens, such as BNB issued by Binance and OKB issued by OKX, etc. This type of ICO revenue is also an important source of income for exchanges. In addition to issuing cryptocurrencies, exchanges also hold a portion of cryptocurrencies as reserves or investment assets, and after these cryptocurrencies increase in value, exchanges will also receive a considerable amount of income if they sell them for cash.

(6) Direct trading revenue. Some exchanges may be directly involved in leveraged and perpetual contract trading, and may even play with specific counterparties through the back-office data they possess. Because users have a double disadvantage in terms of capital and information compared with the exchange, the exchange can often use this to make huge profits. Of course, this behavior carries serious moral and legal risks, but with the difficulty of forensics and inadequate regulation, this behavior has not been effectively curbed, but has instead become an important source of income for some small and medium-sized exchanges.

The diversified types of business revenues of centralized cryptocurrency exchanges pose challenges to the regulatory and tax systems. In this regard, Singapore and Hong Kong have not only made targeted regulatory provisions, but also covered the relevant income within the scope of the established tax system, which will be analyzed in detail later.

3. Singapore's Regulation and Tax Policy on Centralized Cryptocurrency Exchanges

3.1 Singapore's Regulatory Policies on Centralized Cryptocurrency Exchanges

Before describing the regulatory and taxation policies applicable to centralized cryptocurrency exchanges, it is important to briefly describe the classification of cryptocurrencies by the Monetary Authority of Singapore (MAS), as this directly affects the content of the regulation to which centralized cryptocurrency exchanges are subject.

According to the MAS, cryptocurrencies are categorized into three main types: Utility Token, Security Token, and Payment Token. Utility tokens refer to tokens that can be exchanged for a specific type of goods/services; security tokens refer to tokens that are used for Initial Coin Offering (ICO) or for financing; and payment tokens include any cryptocurrency that can be used for payment. In practice, of course, these three types of tokens often overlap on top of specific tokens.

In Singapore, utility tokens are not regulated by a specific act; securities-based tokens and payment tokens are regulated by two specific acts, the Payment Services Act and A Guide to Digital Token Offerings. According to the requirements of the Payment Services Act, financial institutions trading payment tokens need to apply for a license, and among the four types of financial institutions entitled to apply for the right to operate payment tokens, licensed exchanges (Approved Exchanges) face the most stringent regulatory requirements for cryptocurrency derivatives, especially with the passage of the Financial Services and Market Bill. Especially with the passage of the Financial Services and Market Bill, the direct or indirect trading, exchange, transfer, safekeeping of cryptocurrencies, and the provision of related investment advice have been brought under the scope of regulation.

Specifically, under the Payment Services Act, Singapore's centralized cryptocurrency exchanges are engaged in Business A, Account issuance service; Business C, Cross-border money transfer service; and Business F, Digital payment token service. token service (payment digital currency service), need to apply for a Standard Payment Institution License (SPI) or a Large Payment Institution License (MPI) according to the transaction scale. It should be noted that exchanges obtaining the aforementioned licenses are currently only allowed to engage in spot business but not contract business, or securities-based cryptocurrency token business, and these restrictions greatly affect the revenue streams of Singapore's centralized cryptocurrency exchanges. In addition, the use of cryptocurrencies to raise funds will be regulated by securities regulations under the Digital Token Offering Guidelines.

3.2 Singapore's Tax Policy on Centralized Cryptocurrency Exchanges

Taxes in Singapore are not complicated, and the main taxes related to centralized cryptocurrency exchanges are Corporate Income Tax (CIT) and Goods and Services Tax (GST).

3.2.1 Corporate Income Tax

Singapore's corporate income tax is based on the territoriality principle, which means that, unless otherwise specified, income arising in or sourced from Singapore or received in Singapore from sources outside Singapore is subject to corporate income tax. Centralized cryptocurrency exchanges operate in countries around the world, and therefore their country-sourced income is taxable under CIT.

In terms of tax rate, the standard rate of corporate income tax in Singapore is 17%, with a 75% tax deduction for the first S$10,000 of normal taxable income, a 50% tax deduction for S$10,001 - S$200,000, and a 17% corporate income tax rate for the remainder of the normal taxable income. However, the corporate interest income tax rate is 15%. It should be noted that Singapore operates a Headquarters Program, which is available to all businesses established or registered in Singapore that provide headquarters services to their regional or global network of companies. Once eligible for the policy, the company's income can be tax-free, at a preferential rate of 5 percent or 10 percent. For centralized cryptocurrency exchanges looking to tap into the Asian market, there is an opportunity to take advantage of this strong tax incentive if they choose to register their regional headquarters in Singapore.

A key feature of Singapore's corporate income tax is that it does not tax capital gains. In general, centralized cryptocurrency exchanges domiciled in Singapore are not subject to corporate income tax on the sale of cryptocurrencies held by them, while their borrowing income falls within the scope of taxation of corporate income tax. As for ICO proceeds, if the ICO issues security-based tokens, the ICO proceeds are similar to IPO proceeds, which are capital gains and are not subject to tax. In contrast, if the centralized crypto asset exchange receives dividend-type income from the security-based tokens it holds, it is still subject to corporate income tax. It is important to note that in tax practice, centralized cryptocurrency exchanges must prove that they hold cryptocurrencies for the purpose of investment rather than trade, otherwise they will not be able to enjoy the non-taxation of capital gains. Considering that ICOs or the sale of cryptocurrencies are often not the main source of income for centralized cryptocurrency exchanges, the direct benefit of this non-taxation provision for centralized cryptocurrency exchanges is more limited.

3.2.2 Goods and services tax

A goods and services taxpayer is a taxpayer that is registered or required to be registered for goods and services tax, where goods include cryptocurrencies and services include financial services such as lending. Taxpayers of goods and services tax refer to taxpayers who have registered or are required to register for goods and services tax, which is levied mainly on (1) taxable goods produced and taxable services provided by taxpayers in the course of the business activities they are engaged in; and (2) goods imported into Singapore. As such, commissions, uploading fees, lending and borrowing, advertising and sponsorship income, and income from the sale and purchase of cryptocurrencies on centralized crypto exchanges are subject to the Goods and Services Tax (GST).

In addition, according to the 2019 IRAS e-Tax Guide, GST: Digital Payment Tokens issued by IRAS, trading in payment tokens is not subject to GST. Currently, the standard rate of Goods and Services Tax (GST) has been gradually increased from 7% to 9%, which is not too high when compared horizontally with similar tax rates in various countries, and coupled with the fact that Transaction Payment Tokens are not subject to GST, the tax does not actually put undue tax pressure on centralized cryptocurrency exchanges along with other effective tax burden holders.

3.3 Other Tax Policies

In addition to Singapore's own tax system, we should also pay attention to Singapore's offshore tax credit agreements, given that centralized cryptocurrency exchanges operate globally and are likely to constitute permanent establishments in multiple countries, and that centralized cryptocurrency exchanges domiciled in Singapore will be overly taxed if the offshore tax credit is weak. As of early 2024, Singapore has entered into bilateral tax agreements with more than 80 countries (or territories), which will help centralized cryptocurrency exchanges registered in Singapore avoid double taxation and reduce their tax burden. However, the United States does not have a relevant tax agreement with Singapore.

4. Hong Kong's Regulatory and Taxation Policies on Centralized Cryptocurrency Exchanges

4.1 Hong Kong's regulatory policy on centralized cryptocurrency exchanges

The Hong Kong Securities and Futures Commission (SFC) is the main regulator of cryptocurrencies, and organizations such as the Hong Kong Monetary Authority (HKMA) and the Hong Kong Insurance Authority (HKIRA) also regulate cryptocurrencies in concert. In Hong Kong, cryptocurrencies are categorized into three main types, namely securities-based cryptocurrencies, functional cryptocurrencies and virtual commodities, and the level of regulation adopted for different cryptocurrencies varies. Hong Kong has relatively clear regulatory requirements for securities-based cryptocurrencies in documents such as the “Statement on the Regulatory Framework for Virtual Asset Portfolio Managers, Fund Distributors and Trading Platform Operators”, the “Position Paper on the Regulation of Virtual Asset Trading Platforms”, and the “Consultation Conclusions on the Proposed Regulatory Requirements Applicable to Operators of Virtual Currency Trading Platforms Licensed by the Securities and Futures Commission”, and the “Consultation Conclusions on the Proposed Regulatory Requirements Applicable to Operators of Virtual Currency Trading Platforms”. The regulation of stablecoins and other cryptocurrencies is also gradually moving towards soundness with the release of documents such as the Conclusion of Discussion Paper on Crypto-assets and Stablecoins, but before the publication of the regulation on stablecoins, exchanges are not allowed to provide trading services in the retail market for stablecoins, and algorithmic stablecoins These regulations will have a big impact on the stablecoin business of centralized cryptocurrency exchanges registered in Hong Kong.

Overall, Hong Kong is more concerned about protecting investors' rights and regulations on centralized cryptocurrency exchanges are getting stricter. Prior to June 2023, Hong Kong adopted a voluntary licensing regime and centralized cryptocurrency exchanges engaging in non-security-based tokens were not required to be licensed. However, with the massive influx of retail investors into the market and the emergence of non-security-based tokens, Hong Kong started to implement a new licensing regime from June 2023, under which all virtual asset trading platforms that are doing business in Hong Kong or promoting to Hong Kong investors are required to be licensed and regulated by the Securities and Futures Commission. regulation by the SFC.

Currently, centralized cryptocurrency exchanges may be required to obtain three types of licenses: under the Securities and Futures Ordinance (SFO), trading of securities-based tokens conducted by virtual asset exchanges requires the obtaining of License No. 1 (Securities Trading License) and License No. 7 (License for the Provision of Automated Trading Services); and under the Money Laundering Countermeasures Ordinance (MLCCO), trading of non-securities based tokens conducted by virtual asset exchanges requires the obtaining of VASP license (Virtual Asset Service Provider License). Asset Service Provider license). However, securities-based virtual currencies are still the main trading category of centralized cryptocurrency exchanges in Hong Kong. In addition, it should be emphasized that according to the requirements of the “Consultation Summary on the Proposed Regulatory Requirements Applicable to Operators of Virtual Currency Trading Platforms Licensed by the Securities and Futures Commission”, exchanges should conduct due diligence prior to the listing of each and every cryptocurrency without exemptions on a per-coin basis to safeguard sufficient liquidity of cryptocurrencies listed on the exchange.

4.2 Hong Kong's Tax Policy on Centralized Cryptocurrency Exchanges

4.2.1 Income Tax (Profits Tax)

The most important feature of Hong Kong's income tax is that it adopts the Territorial Source Concept (TSC) in the scope of taxation, i.e. whether one is a tax resident or not is not the key to profits tax, the key is whether the profits are sourced in Hong Kong, and profits sourced outside Hong Kong are not subject to profits tax in Hong Kong. For centralized cryptocurrency exchanges engaging in global business, if they choose to register in Hong Kong and operate their business outside Hong Kong, they can theoretically claim the offshore income exemption for such business income and be exempt from tax. In practice, the sources of business income of an exchange are more diversified, and proving that the business income is derived from overseas and responding to queries from the Hong Kong authorities is uncertain on a case-by-case basis.

In terms of the basis of taxation, as with the general standard for corporate income tax, the profit (or loss) after deducting chargeable expenses and costs from taxable income is the taxable income for income tax purposes. Meanwhile, another feature of Hong Kong's income tax is that capital gains are not taxed unless the act of asset disposal is in the nature of a trade. This also helps centralized cryptocurrency exchanges holding cryptocurrencies to reduce their tax burden. In terms of tax rates, the income tax rate for Hong Kong companies has been 16.5% in recent years, and since April 2018, the profits tax rate has been reduced to 8.25% on a company's first HK$2 million of profits, with subsequent profits continuing to be taxed at 16.5%, a two-tiered system that has helped small and medium-sized exchanges to get off the ground and grow.

Specifically, according to the “Departmental Interpretation and Practice Note No. 39 Profits Tax: Digital Economy, Electronic Commerce and Digital Assets” (DIPN 39) of the Inland Revenue Department (IRD), which was amended in March 2020, profits generated from ICOs conducted in Hong Kong are subject to income tax. According to the six badges of trade, profits derived from digital assets, including cryptocurrencies, purchased through channels such as ICOs or trading platforms and used for long term investment purposes (i.e. “capital”) are not subject to income tax, whereas profits derived from transactions conducted for the purpose of business are subject to income tax. DIPN 39 clarifies that cryptocurrencies acquired as a result of commercial transactions, including “airdrops” and “forks”, are considered business income and assessed for income tax accordingly. Considering the type of business income of centralized cryptocurrency exchanges, the benefits of not taxing capital income such as dividends and interest are more limited, and the main benefit of Hong Kong's tax policy lies in the territorial source principle.

4.2.2 Others

Hong Kong's tax system is relatively simple, with income tax being the main tax to be paid by centralized cryptocurrency exchanges, while Hong Kong's exclusion of value-added tax also helps to reduce the tax burden on centralized cryptocurrency exchanges in certain circumstances.

In terms of tax treaties, Hong Kong has entered into tax treaties or tax arrangements for the avoidance of double taxation with around 40 countries (or regions), but the United States is not included.

5. Conclusion and Recommendations

In terms of regulatory system, Singapore has a more stringent and mature regulatory system than Hong Kong, while Hong Kong is still focusing on the regulation of securities-based cryptocurrencies, although it is launching standardized policies one after another, and there is more room for improvement. The different regulatory strengths and regulatory focuses make centralized cryptocurrency exchanges in Singapore and Hong Kong face different challenges. Singapore's centralized cryptocurrency exchanges need to face stricter regulation overall and restricted business types, while Hong Kong's centralized cryptocurrency exchanges need to face more difficult license applications and higher due diligence costs.

In terms of tax policy, both Singapore and Hong Kong do not tax capital gains, but this has limited benefits for centralized cryptocurrency exchanges. Meanwhile, the income tax rates and taxable income deductions in the two places are relatively similar, with the main difference in terms of income tax being that the former adopts the territorial principle while the latter adopts the territorial source principle. Although the territorial source principle may be more favorable to centralized cryptocurrency exchanges, the application of the principle requires further determination and the actual tax benefits should not be overestimated. At the same time, Singapore has far more external tax treaties than Hong Kong, which is more conducive to avoiding double taxation issues. In addition, Hong Kong does not levy VAT while Singapore does, which gives Hong Kong's tax policy a greater advantage in the event that a centralized cryptocurrency exchange may become the effective taxpayer of VAT.

In conclusion, for centralized cryptocurrency exchanges, Hong Kong and Singapore have their own characteristics in terms of regulatory regimes and advantages in terms of tax policies. Both are important financial centers and strategic market regions, and centralized cryptocurrency exchanges should choose a more suitable region for their domicile by taking into account their own business characteristics and compliance capabilities.

References.

[1].Abiodun, M. (2023, May 24). How can Singapore effectively manage cryptocurrency taxation?. [2].Cryptopolitan. Chuanwei “David” Zou (2022, June 23). A Tracking Study of Cryptocurrency Regulation in Hong Kong.  

[3].Coinmarketcap. Cryptocurrency prices, charts and market capitalizations.

[4].Kang Li and Jim Wang.(2021, December 30). Blockchain and taxation. a Plus... [5].

[5].TaxDAO. (2023, May 6). Hong Kong vs Singapore - A Comparison of Cryptocurrency Policies.  

[6]. NTAO. (2023, January 16). Tax Guide for Chinese Residents Investing in the Republic of Singapore....

[7]. State Administration of Taxation. (2023, January 16). Taxation Guidelines for Mainland Chinese Residents Investing in the Hong Kong Special Administrative Region... [8].

[8]. Luo sir said. (2020, August 17). Cryptocurrency Taxation|Singapore Cryptocurrency VAT Policy. .

[9]. Mouri Goro. (2023, May 24). Chaintech Exclusive: Hong Kong's New 324-Page Crypto Trading Regulation: One Coin, One Due Diligence, Stablecoins Not Tradable. Chaintech.

[10]. Qiao Cheyuan, Cheng Xiaoyu, Chen Yushi, and Liang Guochan. (2023, February 27). Hong Kong SFC Launches Consultation on Application Requirements for Virtual Asset Trading Platform Licenses (Licenses 1, 7 and Vasp)...

[11]. Inland Revenue Department of the Government of the Hong Kong Special Administrative Region of the People's Republic of China. (2011, March). Introduction to the Principles of Territorial Source Taxation.