The Eastern Competition for Multinational Cryptocurrency Companies' Location (Part 2): Are Cryptocurrency Mining Enterprises More Suitable to Settle in Hong Kong?

Author: TaxDAO

Introduction: Tax Issues Faced by Mining Enterprises

Mining, as a "productive industry" in the field of crypto assets, faces numerous challenges and risks due to its high investment and heavy asset operation model, one of the main risks being tax issues. Mining activities directly generate crypto assets, and different countries or regions have varying tax treatments and regulations regarding the generation of crypto assets, significantly impacting mining profits. Singapore and Hong Kong, as two financial centers in Asia, have relatively open and friendly policies towards crypto assets, each with its own fiscal and tax characteristics and advantages, making them ideal cases for the location of crypto asset mining enterprises.

From a tax perspective, the location and operation of multinational mining company headquarters have a significant impact on tax costs, from explicit differences in tax rates to implicit costs of reporting and paying taxes. Mining companies headquartered in different countries face a complex and changing tax environment. This article analyzes the advantages and disadvantages of the fiscal and tax policies in Singapore and Hong Kong, exploring more suitable location and operational strategies for crypto asset mining enterprises.

This article first compares the fiscal and tax policies of Singapore and Hong Kong regarding multinational company headquarters, including corporate income tax rates, tax incentives, and tax treaties; secondly, it analyzes the fiscal and tax characteristics of crypto asset mining enterprises, including sources, calculations, and reporting methods 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 both locations for crypto asset mining enterprises and provides recommendations and outlooks.

1 Review: Corporate Tax Policies in Singapore and Hong Kong

Singapore's corporate income tax rate is 17%, but there are many tax incentives, such as the Productivity and Innovation Credit (PIC) Scheme, International Headquarters (IHQ) Award Scheme, and Advanced Manufacturing and Engineering (AME) Scheme, which can allow qualifying companies to enjoy an effective tax rate as low as 5%. Hong Kong's corporate income tax rate is 16.5%, and since 2018, it has implemented a two-tiered profits tax system, imposing a tax rate of 8.25% on the first HKD 2 million (approximately USD 256,000) of profits, while the excess is still taxed at 16.5%.

Both Singapore and Hong Kong have extensive networks of tax treaties, having signed double taxation avoidance agreements (DTA) with multiple countries or regions, which can reduce the potential for double taxation in cross-border transactions. Both locations also participate in international cooperation and initiatives regarding information exchange and anti-avoidance, such as the Multilateral Competent Authority Agreement (MCAA) and the Base Erosion and Profit Shifting (BEPS) Action Plan. For more information on the tax systems of Singapore and Hong Kong, please refer to the first article in this series.

2 Fiscal and Tax Characteristics of Crypto Asset Mining Enterprises

2.1 Analysis of Mining Mechanisms and Characteristics

Mining income refers to the rewards obtained by participating in the consensus mechanism of the crypto asset network using computer equipment, verifying transactions, or creating new units of crypto assets. The sources of mining income can be divided into two types: one is fixed block rewards, meaning that miners receive a certain amount of crypto assets each time a new block is added to the blockchain; the other is variable transaction fees, meaning that a certain percentage or amount of fees is paid to the miners verifying each transaction. The calculation method for mining income depends on the consensus mechanism used, mainly including two types: Proof of Work (PoW) and Proof of Stake (PoS).

PoW refers to miners needing to solve complex mathematical problems to compete for block rewards and transaction fees, with their income being proportional to the computational power they invest. Mining enterprises that extract such currencies typically need to invest significant resources to purchase high-performance mining machines and build mining facilities; at the same time, the mining process also consumes a large amount of electricity. Bitcoin uses the Proof of Work mechanism.

PoS refers to miners needing to stake a certain amount of crypto assets to participate in network consensus, with their income being proportional to the crypto assets they hold or lock. The PoS method was introduced to overcome the shortcomings of PoW; in PoW, although a large amount of computational power is invested in block nodes, this computational power is consumed by calculating random numbers, ultimately resulting in only one node's workload being effective. To save resources and costs, the PoS method requires investors to lock their crypto assets in a staking pool for a period of time, and those who lock their crypto assets are called stakers. The PoS mechanism posits that the more crypto assets a staker locks, the less incentive they have to undermine the crypto system (as it would also harm their own interests). Therefore, when stakers lock their crypto assets, PoS assigns them a probability value based on the amount of assets locked and the number of days locked (referred to as "coin age"). The higher the probability value, the more likely the staker is to obtain the right to mine a block and thus receive corresponding rewards.

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

Thus, the core difference between PoW and PoS lies in whether a large amount of resources needs to be invested and consumed, which also means that enterprises engaged in PoW mining need to invest more fixed assets compared to those engaged in PoS. This article will further analyze the fiscal and tax characteristics of the two types of enterprises in the next section. Currently, most mining enterprises engage in PoW mining, but with ETH's transition to PoS in 2022, mining through PoS is expected to become a new growth point.

2.2 Taxes Involved in Mining Income

The tax treatment of crypto asset mining businesses mainly depends on the definition of crypto assets, asset classification, and the recognition and measurement of mining income and expenses in the respective country or region. Mining income varies by country or region and mainly involves the following two types of taxes:

One is direct taxes, which include income tax and capital gains tax on mining income. Most countries involved in mining activities will treat mining income as business income for enterprises or individuals, subjecting it to corporate income tax or personal income tax. The income tax rate is determined based on the miner's identity (individual or enterprise), income level, residence, and other factors. For example, in the United States, according to Section 61 of the Internal Revenue Code, miners engaged in Bitcoin and other virtual currencies consider the virtual currency they obtain as self-employment income, thus needing to pay taxes according to federal income tax and self-employment tax regulations. For mining enterprises or individuals who hold the mined crypto assets for a period before selling them for capital gains, most countries require payment of capital gains tax or income tax, such as the U.S., which imposes capital gains tax at different rates based on the holding period. A few countries and regions do not involve capital gains tax under certain conditions, such as Singapore and Hong Kong.

The other type is value-added tax (VAT) or goods and services tax (GST) on mining income. Currently, there is no unified opinion among countries or regions regarding the imposition of VAT or GST on mining income. In the EU, almost all countries, except France, believe that mining activities are not subject to VAT (e.g., Germany, Ireland, Sweden, etc.). Israel, based on documents published in 2017 regarding taxation of virtual currency activities, treats mining activities as providing services and imposes a VAT rate of 17%. New Zealand also treats mining activities as services, imposing a GST of 15%.

Some countries impose excise taxes on mining enterprises for considerations such as industry resource adjustments. For example, in the U.S., according to the "Budget Supplementary Document" published by the U.S. Treasury in March 2023, one provision suggests imposing excise taxes based on the electricity costs used in cryptocurrency mining, requiring these companies to report their electricity consumption and the type of electricity used. The document proposes to implement new tax rules starting in 2024, phased in over three years at a rate of 10% per year, reaching a maximum tax rate of 30% by the third year.

2.3 Fiscal and Tax Issues Mining Enterprises Need to Address

Depending on the mining method and the tax regulations of the respective country or region, mining enterprises need to address the following fiscal and tax issues:

1. How to determine the timing and amount of mining income. Generally, mining enterprises recognize their mining income when they receive block rewards or transaction fees, meaning that income is recognized when it is realized. However, enterprises mining DPoS cryptocurrencies may need to recognize income once they have staked their crypto assets and completed voting, without waiting for block mining and dividend distribution, as the dividend income is "recognizable" under the accrual basis. Different recognition timings can affect the measurement of mining enterprises' income and tax reporting. Additionally, due to the significant price volatility of crypto assets, mining enterprises also need to determine the exchange rate for converting crypto assets into the local currency for accounting and reporting. Generally, mining enterprises can refer to the exchange rates published by local official or authoritative institutions or use the exchange rates provided by crypto asset trading platforms.

2. How to reasonably calculate and deduct mining costs and expenses. For mining enterprises using PoW, their main costs and expenses include purchasing computing equipment, paying electricity bills, and leasing premises. These costs and expenses can be deducted or amortized as production expenses according to relevant regulations. For mining enterprises using PoS or DPoS, their main costs and expenses include staking fees, network service fees, etc. Whether these costs and expenses can be deducted as expenditures depends on the nature of the staked crypto assets and the tax treatment recognized by the respective country or region. For example, in the U.S., staked crypto assets are considered an investment activity and therefore cannot be deducted as expenses.

3. How to handle tax issues involved in cross-border transactions. In addition to where mining income is recognized, due to the global circulation of crypto assets, mining enterprises may be involved in cross-border transactions, such as purchasing computing equipment overseas, conducting mining activities abroad, or selling or exchanging crypto assets overseas.

3 Policy Analysis of Crypto Asset Mining Enterprises in Singapore and Hong Kong

3.1 Regulatory Framework and Development Dynamics in Singapore and Hong Kong

Singapore and Hong Kong are among the most important financial centers in Asia and significant markets for the crypto asset industry. Both regions maintain an open and inclusive regulatory attitude towards crypto assets, with relatively stable policy directions.

In Hong Kong, cryptocurrency mining is not an illegal activity, but if conducted on a large scale, it may be subject to regulation under data center laws. Due to the scarcity of land in Hong Kong (land prices in Hong Kong are among the highest in the world), operating crypto asset mining activities there involves numerous land use rights issues. Additionally, mining enterprises must ensure that the buildings they operate comply with the Building Energy Efficiency Ordinance, a law aimed at addressing intensive electricity demand. Similarly, Singapore does not have specific regulations on crypto asset mining, but if mining activities involve electricity consumption, taxation, or other issues, local environmental and land requirements must also be adhered to.

Considering that PoW mining requires substantial electricity consumption, electricity costs are the primary variable cost for mining enterprises. Therefore, it is unlikely for any mining enterprise to deploy mining sites in countries like Hong Kong or Singapore, where land and electricity prices are high, but rather to set up mining sites in other jurisdictions, with the sites bearing custody and operational service responsibilities. Establishing regional or global headquarters in Singapore or Hong Kong to obtain mining profits and bear the main business risks is a priority. At this point, the economic substance of the enterprise's business structure and the balance of tax policies across regions become crucial for the location of mining enterprises' headquarters.

3.2 Impact of Tax Policies on Mining Enterprises in Both Regions

Hong Kong's tax policies are simpler for mining enterprises. Since Hong Kong's corporate income tax strictly follows a territorial principle, only income sourced from Hong Kong is taxed. For instance, general mining enterprises will inevitably engage in trading activities related to updating and selling mining machines; if decision-makers and business contracts are not handled within Hong Kong, theoretically, mining machine trading income can be declared as offshore income, thus exempting it from Hong Kong income tax. In contrast, resident enterprises in Singapore are required to pay income tax on income sourced from abroad. As mentioned in the previous section, PoW mining enterprises setting up mining sites in other countries or regions and establishing international headquarters in Hong Kong or Singapore may face more complex tax procedures. Although Singapore's extensive DTA agreements generally prevent enterprises from getting involved in double taxation disputes, they still face higher corporate income tax costs when obtaining profits from the aforementioned overseas trading income.

While Singapore has advantages for small-scale enterprises and clearer policies, the mining industry is one that exhibits significant economies of scale, requiring substantial investments to generate substantial profits. Whether it is the mining machines required for PoW or the tokens needed for PoS, a certain amount must be reached to achieve economies of scale for revenue generation. Additionally, both Hong Kong and Singapore have not yet included crypto asset mining in their enhanced deductions for R&D expenditures. Therefore, for large-scale enterprises, the actual tax burden in Hong Kong may be lower, making it more suitable for large-scale crypto asset mining enterprises to settle.

However, Singapore has unique advantages for enterprises mining PoS tokens, as the PoS mining model does not require enterprises to establish mining sites globally; they only need to stake tokens in the staking pool. Singapore's regulatory framework for exchanges and staking protocols is more comprehensive than that of Hong Kong, thus the systemic risks faced by PoS mining in Singapore may be lower. For example, regarding digital payment tokens (DPT), Singapore implements a comprehensive licensing system, while Hong Kong's licensing system still requires some time to be fully established. Additionally, since PoS mining does not require establishing physical mining sites in other countries or regions, Singapore's tax policies do not incur additional administrative costs. Furthermore, Singapore's tax incentives and policy support can allow PoS mining enterprises to reduce their effective tax rates and operating costs, thereby increasing their revenue levels. For instance, Singapore offers various tax relief measures for corporate income tax, allowing applications for the Productivity and Innovation Credit (PIC) Scheme and International Headquarters (IHQ) Award Scheme from the Economic Development Board (EDB) of Singapore.

4 Conclusion and Recommendations

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

1. Both Singapore and Hong Kong are suitable as headquarters for crypto asset mining enterprises, but each has its own advantages and disadvantages. Singapore has strong appeal in regulatory frameworks, technological innovation, and market openness; while Hong Kong has a slight advantage in income tax rates.

2. When choosing Singapore or Hong Kong as their headquarters, crypto asset mining enterprises need to comprehensively consider their own characteristics and needs, as well as the policy environment and market conditions of both regions. If a mining enterprise primarily mines PoW tokens, it is more suitable to choose Hong Kong and manage the tax burden of the actual mining jurisdiction effectively; if a mining enterprise primarily mines PoS tokens, Singapore is a worthy consideration, as it is easier to obtain the cumulative effects of tax incentives.

Singapore and Hong Kong are both important financial hubs in Asia. With the arrival of the Web 3.0 era, the governments of both regions have begun to closely monitor the cutting-edge dynamics of crypto assets, formulating corresponding regulations and guidelines to regulate the development of the crypto asset market. TaxDAO will systematically compare and analyze the advantages and disadvantages of the fiscal and tax policies in both regions through specialized topics, exploring more suitable location and operational strategies for multinational crypto asset enterprises. We welcome readers to pay attention.

References

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