Main Takeaways
Innovative industries like crypto bring new challenges to policymakers and tax administrators who must adapt old frameworks to new assets – or come up with entirely new ones.
Tailored tax policies that are equitable and proportionate and come with technically precise guidelines can benefit both the crypto industry and national economies.
Levying taxes on gross crypto trades, introducing withholding requirements for intermediaries, and neglecting internationally tested best practices are considered suboptimal approaches to taxing digital asset-related activity.
Robust tax policies are the cornerstone of every economy. The history of tax regimes around the world suggests that successful tax policy boils down to striking the right balance between efficiency and fairness – a complex formula that varies based on each country's economic and social context.
Innovative business models and industries often bring new challenges to policymakers and tax administrators, pushing them to design and apply appropriate rules and guidelines. These new frameworks must give users and service providers sufficient clarity to enable them to operate compliantly while boosting the economy via innovation. Digital assets, for instance, offer a myriad of novel use cases, given their unique capacity to hold and transfer value without interacting with traditional financial intermediaries. Granted, this warrants novel approaches to taxation.
This blog lays out some general principles that make good tax policy for the crypto-asset sector and highlights some of the best practices globally, as well as pitfalls to watch out for when designing crypto tax rules.
Do’s: Ideas for good tax policy and administration
Introduce bespoke frameworks
Do: Introduce crypto-specific provisions to accommodate the full range of novel activities and transaction types that may occur in this sector.
Why: Existing tax legislation often dates back many decades, and trying to fit digital assets into these frameworks often doesn’t work well.
Emphasize clarity
Do: Provide detailed and technically precise rules or guidance. If crypto-specific legislation is not yet available, issue official FAQs or guidelines.
Why: Most people already find doing their taxes daunting, and dealing with crypto transactions only compounds the complexity. Detailed rules and guidelines can be extremely helpful in this regard.
Make it proportionate
Do: Levy taxes and introduce reporting obligations for crypto that are in line with, or at least no more burdensome than the treatment given to similar industries (such as finance and tech).
Why: To avoid disincentivizing digital asset innovation by making crypto-related tax compliance more costly and burdensome than other similar types of activity.
Tax equitably and efficiently
Do: Privilege taxes on realized capital gains instead of transactional taxes, which are often uneconomical in the digital finance industry.
Why: Digital assets and crypto-related services are commonly operated in a similar fashion to the financial industry where investments and highly tradable assets are broadly exempted from VAT (value-added tax) or GST (goods and services tax). Otherwise, the tax cost would make them virtually unfeasible.
Promote attractive policy
Do: Offer better-than-standard tax treatment of crypto-related activities, such as lower tax rates or exemptions for capital gains from digital-asset disposals.
Why: To attract talent, innovation, economic growth, and high value-adding taxpayers. Recent decades have been marked by tax incentives for inbounding tech investments and professionals. The same policies should be applied to crypto, the next big tech disruptor.
How: A variety of relevant policy measures can already be found in different parts of the world. Here are a few examples:
i) No capital gains taxation on the sale of crypto assets, for investors or occasional (i.e. non-professional) traders. This general policy is applied, for example, in Singapore, Belgium, Malaysia, Hong Kong, and Switzerland.
ii) Capital gains exemption for long-term holdings. Germany and Portugal are cases where this beneficial treatment was recently introduced for crypto assets held for over 12 months.
iii) Capital gains exemption if below a de minimis threshold. This policy is followed, for example, by the United Kingdom and Brazil.
iv) Capital gains tax only upon conversion to fiat (directly or indirectly), i.e. non-taxation of crypto-to-crypto transactions. France, Portugal, and Austria are countries that have introduced this approach.
Don’ts: Tax policies that stifle crypto innovation
Taxing gross transactions
Don’t levy taxes on gross crypto trades – including various fees associated with such transactions – instead of taxing realized capital gains.
Why: Such an approach imposes significant (and sometimes unbearable) tax costs to trading activity. Firstly, it can punish even occasional investors, who could be taxed on losing trades – even if tax refunds for such overpayments are offered later. Secondly, such taxes would place a virtually impossible burden on market makers, who typically enter into hundreds or thousands of automated transactions per day aiming to have numerous small-profit trades. At the end of each period, a market maker would likely have a much higher tax liability than profits to cover it. Meanwhile, it is market makers who provide critical liquidity for the crypto economy. When they leave, the markets take a hit. The main knock-on implication is the draining of local liquidity and volumes and an increase in volatility, effectively stifling local crypto markets. A shrinking crypto economy would drive players out of the market which, in its turn, leads to a decline in total tax revenue.
These cascading negative impacts have already been observed in jurisdictions where transactional taxes of this nature were introduced. The two most salient cases are:
Indonesia: trading volume on local crypto exchanges decreased by approximately 60%, according to Coinmarketcap data, after the implementation of transaction taxes over gross transactions (0.11% VAT and 0.1% income tax, to be withheld by local exchanges) in May 2022.
India: weekly trading volume on local crypto exchanges dropped from the highs of ~$800M to the lows of $2M following the implementation of a transaction tax on gross transactions (1% of Tax Deducted at Source or “TDS”) in July 2022 (as per Coinmarketcap).
Consider instead: Privileging taxes that are levied over realized capital gains only.
Relying on Withholding Tax Obligations to Enforce Compliance
Don’t implement withholding tax obligations on intermediaries such as exchange platforms. Although at first glance it might seem like an adequate tool to enforce tax compliance in the crypto space, it can easily bring detrimental impacts to the industry.
Why: Here are a few things that can go wrong:
If a withholding tax obligation is imposed on trades, it would essentially become a transactional tax, producing the effects mentioned in the point above.
If a withholding tax obligation is imposed on other income streams, such as mining or staking rewards, it risks being inequitable or unattainable. Inequitable because it could inaccurately assume the legal nature of these events (such as treating as interest something that is not); unattainable because often there is no easily identifiable intermediary, such as with DeFi products and services.
Withholding tax obligations are likely to be much more challenging to execute in crypto compared to other industries. One reason is that the actual withholdings would be mostly done in crypto while, with few exceptions, their subsequent collection to public revenue would need to be in fiat. This creates an additional step of conversion, bringing not only significant complexity but also a potential roadblock, as fiat off-ramp channels are not always available.
Consider instead: Leveraging crypto reporting frameworks that are currently being adopted, such as the CARF by the OECD.
Misaligning domestic tax policy with (good) international standards
Don’t ignore international best practices. Crypto tax policymaking is in its nascent stage and is expected to develop significantly in the following years. That said, certain standards have already started forming around the globe, and these should not be ignored. An important example is the widespread exemption of cryptocurrency transactions from VAT/GST.
Why: Deviating from meaningful policies like this one would likely put a nation in a highly disadvantaged position in terms of industry development.
Consider instead: Participating in international bodies where technical discussions take place to leverage best practices and rules being shaped and used worldwide more easily.
Want to learn more about the taxation of cryptocurrencies and what Binance does to streamline users’ tax filing experience? Please refer to the following resources:
