The Battle of the East for the Location of Transnational Cryptocurrency Companies (Part 2) Is Hong Kong More Suitable for Mining?

The East's Cryptocurrency Company Clash Continues Part 2 Examines Hong Kong's Mining Potential

Author | TaxDAO

Introduction: Tax Issues Faced by Mining Companies

Mining, as a “productive industry” in the field of digital assets, faces many challenges and risks due to its high investment and asset-heavy operating model. One of the main risks is taxation. Mining activities directly generate digital assets, and different countries or regions have different tax treatments and regulations for digital assets, significantly impacting mining profits. Singapore and Hong Kong, as two financial centers in Asia, have relatively open and friendly policies towards digital assets, as well as their own financial and tax characteristics and advantages, making them ideal cases for choosing mining company locations.

From a taxation perspective, the location and operation of multinational mining company headquarters have a significant impact on tax costs. From explicit tax rate differences to implicit declaration and tax payment costs, mining companies located in different countries face complex and ever-changing tax environments. This article analyzes the advantages and disadvantages of the financial and tax policies of Singapore and Hong Kong and explores the most suitable location and operational strategies for digital asset mining companies.

This article first compares the financial and tax policies of Singapore and Hong Kong for the headquarters of multinational companies, including corporate income tax rates, tax exemptions, and tax treaties. Next, it analyzes the financial and tax characteristics of digital asset mining companies, including the sources, calculation, and reporting methods of income and expenses, as well as the different tax treatments and risks they may face in different countries or regions. Finally, it provides a comprehensive evaluation of the suitability of the two locations for digital asset mining companies and offers recommendations and prospects.

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1 Review: Corporate Tax Policies of Singapore and Hong Kong

Singapore has a corporate income tax rate of 17%, but it has many tax incentives such as the Productivity and Innovation Credit (PIC) Scheme, the International Headquarters (IHQ) Scheme, and the Automation Support Package (AME Scheme), which allow eligible companies to enjoy actual tax rates as low as 5%. Hong Kong has a corporate income tax rate of 16.5% and has implemented a two-tiered profit tax system since 2018. It imposes a tax rate of 8.25% on the first HKD 2 million (approximately USD 256,000) of profit and 16.5% on any remaining profit.

Both Singapore and Hong Kong have extensive networks of tax treaties and have signed Double Taxation Avoidance Agreements (DTA) with multiple countries or regions, which can reduce the potential issue of double taxation in cross-border transactions. Both locations also participate in international cooperation and initiatives on information exchange and anti-tax avoidance, such as the Multilateral Competent Authority Agreement (MCAA) on Automatic Exchange of Information 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 Tax and Financial Characteristics of Cryptocurrency Mining Companies

2.1 Analysis of Mining Mechanisms and Characteristics

Mining income refers to the rewards obtained by participating in the consensus mechanism of a cryptocurrency network, which involves using computer equipment to validate transactions or create new cryptocurrency units. There are two sources of mining income: fixed block rewards, where miners receive a certain amount of cryptocurrency whenever a new block is added to the blockchain, and variable transaction fees, where miners receive a certain percentage or amount of fees for verifying transactions. The calculation of mining income depends on the consensus mechanism used, which mainly includes two types: Proof of Work (PoW) and Proof of Stake (PoS).

PoW refers to miners competing for block rewards and transaction fees by solving complex mathematical problems. Their income is directly proportional to the computing power they invest. Companies involved in mining these types of currencies usually need to invest a large amount of resources in purchasing high-powered mining machines and setting up mining facilities. Additionally, mining also consumes a significant amount of electricity. Bitcoin, for example, uses the Proof of Work mechanism.

PoS requires miners to stake a certain amount of cryptocurrency to participate in network consensus, and their income is directly proportional to the amount of cryptocurrency they hold or lock. PoS was introduced to overcome the drawbacks of PoW. In PoW, although a large amount of computing power is invested in the block nodes, this power is consumed through computing random numbers, and ultimately only the work of one node is considered valid. To save resources and costs, PoS requires investors to lock their cryptocurrency in a staking pool for a certain period of time, and these investors are called stakers. According to the PoS mechanism, the more cryptocurrency a staker locks and the longer they lock it (referred to as “coin age”), the higher the probability value assigned to them. The higher the probability value, the more likely the staker is to have the right to mine a block and receive corresponding rewards.

However, most individual miners do not have enough capability to mine blocks. To further prevent resource waste and improve block allocation efficiency, the Delegated Proof of Stake (DPoS) mechanism was introduced. DPoS is a voting-based algorithm where stakeholders 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 coin age. Miners who are “elected” by stakers will distribute a portion of the mining earnings as dividends to the stakers.

In summary, the core difference between PoW and PoS lies in whether significant resources need to be invested and consumed, which also means that companies engaged in PoW mining require more fixed assets compared to PoS companies. In the next section, this article will further analyze the tax and financial characteristics of both types of companies. Currently, most mining companies are engaged in PoW mining, but with ETH transitioning to PoS in 2022, mining in a PoS manner is expected to become a new growth point.

2.2 Tax Types Involved in Mining Income

The tax treatment of cryptocurrency mining income mainly depends on the definition and classification of cryptocurrency assets, as well as the recognition and measurement of mining income and expenses in the country or region. Mining income is subject to two main types of taxes depending on the country or region:

1. Direct taxes, such as income tax and capital gains tax on mining income. Most countries that involve mining business treat mining income as business income for individuals or companies and impose corporate income tax or personal income tax. The income tax rate is determined based on factors such as the status of the miner (individual or company), income level, and place of residence. For example, in the United States, according to the provisions of the U.S. Internal Revenue Code, miners of virtual currencies like Bitcoin are considered self-employed income earners, therefore, they need to pay taxes according to federal income tax and self-employment tax regulations. In countries where mining companies or individuals hold cryptocurrency mining proceeds for a certain period and then sell them to obtain capital gains, they are required to pay capital gains tax or income tax. In the United States, for example, the capital gains tax is paid based on different rates depending on the holding period. Few countries and regions do not impose capital gains tax under certain conditions, such as Singapore and Hong Kong.

2. The other type is value-added tax or goods and services tax on mining income. Currently, there is no unified opinion among different countries or regions regarding the implementation of value-added tax or goods and services tax on mining income. In the European Union, except for France, most countries (such as Germany, Ireland, Sweden, etc.) do not apply value-added tax to mining business. Israel, based on regulations issued in 2017 regarding the taxation of virtual currency activities, treats mining business as a service and imposes a value-added tax rate of 17%. New Zealand also considers mining business as a service and imposes a 15% goods and services tax.

Some countries may impose consumption tax on mining companies considering industry resource adjustment, such as the United States. According to the “Budget Supplement Explanation” released by the U.S. Department of the Treasury in March 2023, one clause suggests that consumption tax should be levied in stages based on the cost of electricity used in cryptocurrency mining. These companies will be required to report their electricity consumption and the type of electricity used. The proposal suggests implementing new tax rules starting from 2024, gradually increasing the tax rate by 10% each year over a three-year period, reaching a maximum rate of 30%.

2.3 Financial and Tax Issues to be Handled by Mining Companies

Based on different mining methods and the tax regulations of the country or region, mining companies need to deal with the following financial and tax issues:

Determining the timing and amount of mining income. Generally, mining income of a mining company is recognized when block rewards or transaction fees are obtained, that is, when the revenue is realized. However, companies mining DPoS cryptocurrencies may need to recognize income when the cryptocurrency assets are staked in the pool and voting is completed, without waiting for the nodes to mine and distribute dividends, as the dividend income at this point is “recognizable” under the accrual accounting method. Different recognition timings would affect the income measurement and tax reporting of mining companies. Additionally, due to the significant price fluctuations of cryptocurrency assets, mining companies also need to determine the exchange rate at which cryptocurrency assets are converted into the reporting currency for accounting and reporting purposes. Generally, mining companies can refer to the exchange rates published by local official or authoritative institutions or use the rates provided by cryptocurrency trading platforms.

How to calculate and deduct mining costs and expenses properly. For mining companies using the PoW method, their main costs and expenses include purchasing computing equipment, paying electricity bills, and leasing premises, etc. These costs and expenses can be deducted or amortized as production expenses according to relevant regulations. For mining companies using the PoS or DPoS method, their main costs and expenses include staking fees, network service fees, etc. Whether these costs and expenses can be deducted as expenses depends on the nature of staking cryptographic assets and the tax treatment in the country or region. For example, in the United States, staking cryptographic assets are considered an investment activity and, therefore, cannot be deducted as expenses.

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

3 Analysis of Singapore and Hong Kong’s Policies on Cryptocurrency Mining Companies

3.1 Regulatory Framework and Development Trends in Singapore and Hong Kong

Singapore and Hong Kong are both among the most important financial centers in Asia and are also important markets for the cryptocurrency industry. Both places have an open and inclusive regulatory attitude towards cryptographic assets, and their policy direction is relatively stable.

In Hong Kong, cryptocurrency mining is not an illegal activity, but if the activity is conducted on a large scale, it may be subject to data center regulations. Due to the scarcity of land in Hong Kong (Hong Kong has the world’s most expensive land prices), operating cryptographic asset mining activities in Hong Kong involves a lot of land use rights issues. At the same time, mining companies must ensure that the buildings they operate comply with the Building Energy Efficiency Regulations, a law and regulation for intensive electricity demand. Similar to Hong Kong, Singapore does not have specific regulations for cryptocurrency mining, but if mining activities involve issues such as electricity consumption, taxation, or others, local environmental and land requirements must also be complied with.

Considering that PoW mining consumes a large amount of electricity, electricity cost is the most significant variable cost for mining companies. Therefore, it is unlikely that any mining company will deploy mining farms in countries like Hong Kong and Singapore where land prices and electricity prices are relatively higher. Instead, they will set up mining farms in other jurisdictions that provide hosting and operations services. Setting up regional headquarters or global headquarters in Singapore or Hong Kong to obtain mining profits and assume the main business risks becomes crucial for mining companies. At this time, the economic essence of the corporate business structure and the balanced tax policies between regions become the top priority for choosing the location of mining company headquarters.

3.2 Impact of Tax Policies in both places on Mining Companies

The tax policies in Hong Kong are simpler for mining companies. Due to Hong Kong’s strict territorial principle for corporate income tax, only income sourced from Hong Kong is subject to taxation. For example, mining companies typically engage in trading activities for purchasing and selling mining machines. If the decision-makers and business contracts are not handled within Hong Kong, theoretically, they can declare the income from mining machine trading as offshore income and be exempt from Hong Kong income tax. On the other hand, resident companies in Singapore need to pay income tax on income sourced from outside their jurisdiction. As mentioned earlier, when PoW mining companies establish mining farms in other countries or regions and set up their international headquarters in Hong Kong or Singapore, setting up an international headquarters in Singapore may involve more complex tax procedures. Although Singapore’s extensive Double Taxation Agreement (DTA) generally prevents companies from being involved in double taxation disputes, they still face higher corporate income tax costs when earning the aforementioned overseas trading income profits.

Although Singapore has its advantages in small-scale enterprises, with clearer policies, the mining industry relies heavily on economies of scale. Only with significant investments can large profits be generated. Whether it’s the mining machines required for PoW or the tokens required for PoS, a certain amount of investment is needed to achieve economies of scale and generate revenue. Additionally, both Hong Kong and Singapore do not currently include cryptocurrency mining in the calculation of R&D expenses for tax deduction. Therefore, for large-scale enterprises, the actual burden of corporate income tax in Hong Kong may be lower, making it more suitable for large-scale cryptocurrency mining companies to establish their presence.

However, Singapore has its unique advantages for companies mining PoS tokens because PoS mining models do not require companies to establish physical mining farms globally. They only need to allocate tokens to staking pools. Singapore has a more comprehensive regulatory framework for exchanges and staking protocols compared to Hong Kong. Therefore, the systematic risks faced by PoS mining in Singapore may be lower. For example, Singapore has implemented a comprehensive licensing system for Digital Payment Tokens (DPT), while Hong Kong’s licensing system is still in progress. Furthermore, since PoS mining does not require the establishment of physical mining farms in other countries or regions, Singapore’s tax policies do not bring additional administrative costs. In addition, Singapore’s tax incentives and policy support can help mining companies using PoS methods reduce their effective tax rates and operational costs, thereby increasing their income levels. For instance, Singapore has various measures for corporate income tax reduction, such as the Innovation and Productivity Tax Credit (PIC Scheme) and the International Headquarters Award Scheme (IHQ Scheme), which companies can apply for through the Singapore Economic Development Board (EDB).

4 Conclusion and Recommendations

Based on the analysis of Singapore and Hong Kong’s policies regarding cryptocurrency mining companies, we conclude that:

Singapore and Hong Kong are both suitable headquarters for cryptocurrency mining companies, but they have their own advantages and disadvantages. Singapore has strong appeal in terms of regulatory framework, technological innovation, and market openness, while Hong Kong has a slight advantage in terms of income tax rates.

When choosing between Singapore and Hong Kong as their headquarters, cryptocurrency mining companies need to consider their own characteristics and needs, as well as the policy environment and market conditions in both locations. If the mining company mainly mines PoW tokens, it is more suitable to choose Hong Kong and carefully manage the tax burden in the jurisdiction where the mining actually takes place. If the mining company mainly mines PoS tokens, Singapore is a worthy consideration as it is easier to obtain tax incentives and cumulative effects.

Singapore and Hong Kong are both important financial hubs in Asia. With the arrival of the Web3.0 era, the governments of both places have started to closely monitor the latest trends in cryptocurrency assets and formulate corresponding regulations and guidelines to regulate the development of the cryptocurrency market.TaxDAO will systematically compare and analyze the advantages and disadvantages of the financial and taxation policies in both places through specialized topics, in order to explore more suitable location and operational strategies for multinational cryptocurrency companies. Readers are welcome to follow.

References

[1] Fanshuo Blockchain. (2022). Differences and implementations of DPOS and POS.

[2] Zheng Mengya, Wang Kek, Wang Zhenx, Yan Huqin. (2021). Study on the tax issues of cryptocurrencies under the background of the digital economy—Taking the mining mechanism of Bitcoin as an example. World Economic Exploration, 10(1): 1-8.

[3] Zhang Chunyan. (2021). Research on the tax issues of encrypted digital currencies in the United States: from institutional design to tax collection and management. Taxation and Economy (06), 14-22.

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