The Eastern Battle for the Location of Multination (Part Two)

Introduction: Tax Issues Faced by Cryptocurrency Mining Enterprises

Cryptocurrency mining, as a "productive industry" in the field of digital assets, faces many challenges and risks due to its high investment and asset-heavy operational model. One of the primary risks is related to taxation. Mining activities directly generate digital assets, and the tax treatment and regulations for these assets vary significantly from one country or region to another, significantly impacting the profitability of mining operations. Singapore and Hong Kong, as two financial centers in Asia, have relatively open and friendly policies towards digital assets. They also have their unique fiscal features and advantages, making them ideal case studies for the location choice of cryptocurrency mining enterprises.

From a taxation perspective, the location of the headquarters and operations of multinational mining companies significantly impacts their tax costs. This includes both the explicit differences in tax rates and the implicit costs of tax compliance. Mining companies headquartered in different countries face a complex and changing tax environment. This article analyzes the pros and cons of the fiscal policies in Singapore and Hong Kong, discussing more suitable location and operational strategies for cryptocurrency mining enterprises.

The article first compares the fiscal policies of Singapore and Hong Kong for multinational company headquarters, including corporate income tax rates, tax reliefs, and tax treaties. It then analyzes the fiscal characteristics of cryptocurrency mining enterprises, including the sources, computation, and reporting of income and costs, as well as the different tax treatments and risks they may face in different countries or regions. Finally, it evaluates the suitability of Singapore and Hong Kong for cryptocurrency mining enterprises and offers suggestions and insights.

1 Review: Corporate Tax Policies in Singapore and Hong Kong

Singapore's corporate income tax rate is 17%, but many tax incentives, such as the Productivity and Innovation Credit (PIC) Scheme, the International Headquarters (IHQ) Scheme, and the Advanced Manufacturing and Engineering (AME) Scheme, can effectively reduce the tax rate to as low as 5% for qualifying companies. Hong Kong's corporate income tax rate is 16.5%. Since 2018, a two-tiered profit tax system has been implemented, taxing the first HKD 2 million (approximately USD 256,000) of profits at 8.25% and the remainder at 16.5%.

Both Singapore and Hong Kong have an extensive network of tax treaties, having signed Double Taxation Agreements (DTAs) with many countries or regions to reduce the issue of double taxation in cross-border transactions. Both regions are also participants in international cooperation and initiatives on information exchange and anti-tax avoidance, such as the Multilateral Competent Authority Agreement (MCAA) and the Base Erosion and Profit Shifting (BEPS) project. For a more detailed analysis of the tax systems of Singapore and Hong Kong, please refer to the first article in this series.

2 Fiscal Characteristics of Cryptocurrency Mining Enterprises

2.1 Analysis of Mining Mechanisms and Characteristics

Mining income refers to rewards obtained by using computer equipment to participate in the consensus mechanism of digital asset networks, verifying transactions, or creating new digital asset units. There are two types of mining income: fixed block rewards, received whenever a new block is added to the blockchain, and variable transaction fees, paid to miners who validate each transaction. The method of calculating mining income depends on the consensus mechanism used, mainly Proof of Work (PoW) and Proof of Stake (PoS).

In PoW, miners compete for block rewards and transaction fees by solving complex mathematical problems. Their income is proportional to their computational power. Mining enterprises dealing with such currencies generally need to invest significant resources in purchasing high-power mining machines and building mining facilities, along with substantial electricity consumption. Bitcoin, for instance, uses the PoW mechanism.

PoS involves miners staking a certain amount of digital assets to participate in network consensus. Their income is proportional to the amount of digital assets they hold or lock. The PoS method was introduced to overcome the shortcomings of PoW, where much computational power is invested in block nodes but wasted on calculating random numbers, with only one node's work being effective. To save resources and increase block allocation efficiency, the Delegated Proof of Stake (DPoS) mechanism emerged. DPoS is a voting-based algorithm where stakers vote on who gets the right to mine blocks. The voting weight of the stakers is still determined by the amount of locked assets and the duration of the lock (referred to as "coin age"). The selected miner then shares a portion of the mining rewards with the stakers.

However, most retail investors do not have sufficient capabilities to mine blocks. To further prevent resource wastage and improve block allocation efficiency, the Delegated Proof of Stake (DPoS) mechanism emerged. DPoS is a voting-based algorithm where stakers vote to elect who has the right to mine blocks. The weight of a staker's vote is still determined by the locked assets and the age of the coins. The miners "selected" by the stakers will then return a portion of their mining profits to the stakers in the form of dividends.

Thus, the core difference between PoW and PoS is whether substantial resources are invested and consumed. This implies that companies engaged in PoW mining need to invest more in fixed assets compared to those engaged in PoS. This article will further analyze the fiscal characteristics of these two types of enterprises. Most mining enterprises are involved in PoW mining, but with Ethereum's switch to PoS in 2022, mining using the PoS method is expected to become a new growth point.

2.2 Tax Types Involved in Mining Income

The tax treatment of cryptocurrency mining businesses primarily depends on the definition and classification of digital assets in the country or region, as well as the recognition and measurement of mining income and expenses. Depending on the country or region, mining income is mainly subject to the following taxes:

First, direct taxes, such as income tax and capital gains tax on mining income. Most countries involving mining businesses treat mining income as business income for individuals or corporations, subject to corporate or personal income tax. The tax rate depends on factors like the miner's identity (individual or corporation), income level, and residency. For example, in the United States, under provisions like Section 61 of the Internal Revenue Code, individuals mining virtual currencies like Bitcoin are considered self-employed, thus subject to federal income tax and self-employment tax. For capital gains realized from selling cryptocurrencies held for a period after mining, most countries require payment of capital gains tax or income tax, like in the U.S., where the rate varies based on the holding period. A few countries and regions, like Singapore and Hong Kong, do not involve capital gains tax under certain conditions.

Another tax on mining income is the value-added tax (VAT) or goods and services tax (GST). There is no unified opinion yet on the application of VAT or GST on mining income across different countries or regions. In the European Union, except for France, most countries (like Germany, Ireland, Sweden, etc.) consider mining activities exempt from VAT. Israel, according to its 2017 tax guidelines on virtual currency activities, treats mining as a service, charging 17% VAT. New Zealand also treats mining as a service, subject to a 15% GST.

Some countries levy consumption taxes on mining enterprises to adjust industry resources. For instance, in the U.S., the Treasury Department proposed in its March 2023 "Budget Supplemental Document" a phased-in consumption tax based on the electricity costs used in cryptocurrency mining. These companies would be required to report their electricity usage and the type of power used. The proposal suggests implementing the new tax rules starting in 2024, phasing them in over three years at a rate of 10% per year, reaching a maximum rate of 30% in the third year.

2.3 Fiscal Issues Mining Enterprises Need to Address

Depending on their mining methods and the tax regulations of their countries or regions, mining enterprises need to address the following fiscal issues:

(一) How to determine the timing and amount of mining income. Generally, mining income for a mining enterprise is recognized when block rewards or transaction fees are received. However, enterprises mining DPoS cryptocurrencies might need to recognize income upon entering the staking pool and completing the voting, without waiting for node mining and dividends, as the dividend income is "recognizable" under the accrual basis at that time. Different recognition timings affect the measurement of mining income and tax reporting. Moreover, due to the significant price volatility of digital assets, mining enterprises also need to determine the exchange rate for converting digital assets into their functional currency for accounting and reporting. Generally, mining enterprises can refer to official or authoritative exchange rates published locally or use rates provided by digital asset trading platforms.

(二) How to reasonably calculate and deduct mining costs and expenses. For enterprises using PoW, major costs and expenses include purchasing computing equipment, paying for electricity, renting premises, etc. These can be deducted or amortized as production expenses under relevant regulations. For those using PoS or DPoS, main costs include staking fees, network service fees, etc. Whether these can be deducted as expenses depends on the country or region's treatment of staked digital assets for tax purposes. For example, in the U.S., staking digital assets is considered an investment activity, thus not deductible as an expense.

(三) How to handle tax issues in cross-border transactions. Besides where to recognize mining income, due to the global circulation of digital assets, mining enterprises may be involved in cross-border transactions, such as purchasing computing equipment overseas, conducting mining activities abroad, or selling or exchanging digital assets internationally.

3 Policy Analysis for Cryptocurrency Mining Enterprises in Singapore and Hong Kong

3.1 Regulatory Framework and Development Dynamics in Singapore and Hong Kong

Singapore and Hong Kong are both among Asia's most important financial centers and key markets for the cryptocurrency industry. Both regions adopt an open and inclusive regulatory attitude towards digital assets, with relatively stable policy directions.

In Hong Kong, cryptocurrency mining is not illegal, but if conducted on a large scale, it may be subject to data center laws. Due to Hong Kong's scarce land (having some of the world's most expensive land prices), operating cryptocurrency mining activities in Hong Kong involves significant land use rights issues. Additionally, mining enterprises must ensure their buildings comply with the Building Energy Efficiency Ordinance, a law passed for intensive electricity demands. Similar to Hong Kong, Singapore does not specifically regulate cryptocurrency mining, but if mining activities involve electricity consumption, taxation, or other issues, they must comply with local environmental and land requirements.

Considering the high electricity consumption of PoW mining, electricity cost is the most significant variable cost for mining enterprises. Therefore, any mining enterprise is unlikely to deploy mines in countries like Hong Kong and Singapore with high land and electricity prices. Instead, they set up mines in other jurisdictions, with the mines providing hosting and maintenance services. Regional or global headquarters are established in places like Singapore or Hong Kong to receive mining profits and bear the main business risks. At this point, the economic substance of the business structure and balancing tax policies across regions become crucial for choosing the location of mining enterprise headquarters.

3.2 Impact of Tax Policies in Both Regions on Mining Enterprises

Hong Kong's tax policy is simpler for mining enterprises. As Hong Kong's corporate income tax strictly follows the territorial principle, it only taxes income sourced in Hong Kong. For instance, mining enterprises typically also engage in trading mining machines. If the decision-makers and business contracts are not handled within Hong Kong, theoretically, the income from mining machine trading can be declared as offshore income and exempt from Hong Kong income tax. However, resident companies in Singapore must pay income tax on foreign-sourced income. As mentioned earlier, when PoW mining enterprises establish international headquarters in Hong Kong/Singapore and set up mines in other countries or regions, establishing an international headquarters in Singapore may involve more complex tax procedures. Although Singapore's extensive DTAs generally prevent enterprises from double taxation disputes, the same overseas trade income profits would still face higher corporate income tax costs.

Although Singapore has its advantages for small-scale enterprises and clearer policies, the mining industry is highly scalable, with significant investments bringing substantial profits. Whether it's the mining machines required by PoW or the tokens required by PoS, a certain scale is necessary to create a profitable effect. Additionally, both Hong Kong and Singapore have not yet included cryptocurrency mining in their R&D expenditure super deduction. Therefore, for large-scale enterprise layouts, Hong Kong's actual income tax burden may be lower, making it more suitable for large-scale cryptocurrency mining enterprises.

However, Singapore has unique advantages for enterprises mining PoS tokens, as PoS mining does not require setting up physical mines globally, only requiring the enterprise to put tokens into the staking pool. Singapore's regulatory framework for exchanges and staking protocols is more comprehensive than Hong Kong's, so the systemic risks faced by PoS mining in Singapore may be lower. For instance, regarding Digital Payment Tokens (DPT), Singapore implements a comprehensive licensing system, while Hong Kong's licensing system is still in the process of implementation. Also, since PoS mining does not require setting up physical mines in other countries or regions, Singapore's tax policy does not bring additional administrative costs. Moreover, Singapore's tax incentives and policy support can reduce the actual tax rate and operational costs for enterprises using PoS, thus enhancing their revenue levels. For example, enterprises can apply to the Singapore Economic Development Board (EDB) for tax incentives like the Productivity and Innovation Credit (PIC) Scheme and the International Headquarters (IHQ) Scheme.

4 Conclusion and Recommendations

Through the analysis of policies regarding cryptocurrency mining enterprises in Singapore and Hong Kong, we believe:

(一) Both Singapore and Hong Kong are suitable as headquarters for cryptocurrency mining enterprises, but each has its strengths and weaknesses. Singapore has strong attractions in terms of regulatory framework, technological innovation, and market openness, while Hong Kong has a slight advantage in income tax rates.

(二) When choosing Singapore or Hong Kong as their headquarters, cryptocurrency mining enterprises need to consider their characteristics and needs, as well as the policy environment and market conditions in both places. If the enterprise mainly mines PoW tokens, Hong Kong is a more suitable choice, and it is essential to manage the tax burden of the actual mining jurisdictions properly. If the enterprise mainly mines PoS tokens, Singapore is a worthy consideration, more likely to benefit from the cumulative effect of tax incentives.

Both Singapore and Hong Kong are crucial financial hubs in Asia. With the advent of the Web3.0 era, governments in both regions are paying close attention to the forefront of digital assets, formulating relevant laws and guidelines to regulate the development of the cryptocurrency market. TaxDAO will systematically compare and analyze the fiscal policies of both regions, exploring more suitable location and operational strategies for multinational cryptocurrency enterprises. We welcome our readers to follow this series.

References

[1] Fan on Blockchain. (2022). Differences and Implementations of DPOS and POS.

[2] Zheng Mengya, Wang Kekou, Wang Zhenni, Yan Huqin. (2021). Research on Tax Issues of Cryptocurrencies in the Context of Digital Economy—Taking Bitcoin's Mining Mechanism as an Example. World Economic Exploration. 2021, 10(1): 1-8.

[3] Zhang Chunyan. (2021). Study on the Tax Issues of Cryptocurrency in the United States: From System Design to Tax Collection and Administration. Taxation and Economy (06),14-22.