Analysis How to Solve the Tax Problem, the Biggest Headache for the Cryptocurrency Industry in Japan?

How to Solve Japan's Cryptocurrency Tax Problem?

Author: TaxDAO

According to reports from Wu, the Japan Blockchain Association, represented by Yuzo Kano, submitted a request to the government on the 28th to modify the taxation system for encrypted assets. This article will provide some opinions for reference.

1. Current Tax Rate for Encrypted Assets in Japan

Japan considers cryptocurrencies as property and taxes the income from cryptocurrencies as miscellaneous income based on the Payment Services Act (PSA) and the Financial Instruments and Exchange Act (FIEA).

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Individuals who buy or sell cryptocurrencies in the previous fiscal year and earn more than 200,000 yen are required to declare the total amount of cryptocurrencies and pay taxes. Japan implements a progressive tax rate system for all income, including miscellaneous income. The tax rate ranges from 5% to 45% depending on the individual’s income tax bracket. In addition, a mandatory resident tax of 10% applies to all tax rates. Therefore, the effective tax rate in Japan is between 15% and 55% (including residence tax), and individuals can pay up to 55% of their income as taxes, indicating a very high personal income tax rate for their cryptocurrency assets.

The tax rate for corporations generally includes national and local taxes, with a comprehensive tax rate ranging from 23% to 29.74% in 2022.

2. Discussion on Tax System Modification Demands

2.1 Excerpt from the press release of the proposed tax system modification

2.1.1 Eliminate taxation on unrealized gains of tokens issued by third parties at the end of the period.

The National Tax Agency of Japan revised part of the corporate tax rules in June 2023, allowing companies to exempt the unrealized gains of their own issued cryptocurrencies from taxation at the end of the period. However, unrealized gains of tokens issued by third parties are subject to taxation.

2.1.2 Individual cryptocurrency asset transactions taxed separately at a rate of 20%.

By taxing them separately, it is possible to offset and deduct losses incurred within 3 years after the year in which the losses occurred, which can alleviate the tax burden. According to a survey by the JBA, 43.9% of respondents said that if the tax declaration is changed to separate taxation, the amount of investment will increase by more than double.

2.1.3 Abolish income tax on profits from each exchange of cryptocurrency assets.

This would make it easier to apply use cases suitable for Web3, such as DeFi and NFT markets, and is expected to improve the convenience of cryptocurrency assets.

2.2 Comparison of Capital Gains Tax in Various Countries

United States

For individual income taxpayers, the lowest two tax rate brackets (10% and 15%) have a long-term capital gains tax rate of 0%; the tax rates for individual income are 25%, 28%, 33%, or 35%, with a long-term capital gains tax rate of 15%; for individuals in the highest tax bracket (currently 37%), the long-term capital gains tax rate is 20%.

Germany

Germany classifies cryptocurrencies as private currency or assets and requires the payment of capital gains tax. If an individual holds cryptocurrencies for more than a year, any profits from selling them are tax-free. However, if an individual holds cryptocurrencies for less than a year, they are subject to capital gains tax, which is calculated based on their income tax rate.

France

France classifies cryptocurrencies as movable assets and requires the payment of capital gains tax. Profits from the sale of cryptocurrencies are taxed at a unified rate of 30%, which includes a 17.2% social contribution. Long-term holdings of cryptocurrencies are not tax-free.

Malaysia

Due to the absence of capital gains tax, most cryptocurrencies in Malaysia are tax-free.

United Kingdom

The United Kingdom does not have separate short-term and long-term capital gains tax rates. All capital gains are taxed at the same rate, and capital gains from cryptocurrencies are subject to a 10% or 20% capital gains tax.

2.3 TaxDAO’s Perspective

Based on the motivations behind the proposed tax system modifications submitted by the Japanese industry association, they primarily include strengthening industry competitiveness, protecting industry interests from excessive tax burdens, and promoting Web 3.0 as a growth strategy for Japan and nurturing the market. The expectations for the modified tax system are high, but whether they can be realized is unknown. We will only provide some perspectives from a tax perspective.

1. Cancelling the taxation of unrealized gains on third-party token issuances at the end of the year is relatively reasonable in our opinion. The simple logic is that it is unreasonable to pay taxes based on unrealized gains on paper. If the unrealized gains are completely offset by losses when actually selling in the future, it would create significant financial pressure for taxpayers. Unless carried forward for tax refund, the entire process would result in significant losses. Taxing based on actual gains upon disposal is more reasonable.

2. Taxing individual cryptocurrency transactions separately at a rate of 20%. Based on the countries listed in 2.2 above, most countries exempt capital gains from cryptocurrencies or tax them at a rate of 20% or below. Therefore, this demand has certain basis in horizontal comparison. Moreover, Japan has separate taxation rules for individual capital gains, such as real estate, land, and stocks, which the industry association can actively strive for. Besides tax rates, there are also many issues related to laws, customs, and management strategies. Before this, the Japanese tax authorities classified cryptocurrency gains as high-tax income, which may also have regulatory considerations, such as preventing excessive speculation.

3. Abolishing the imposition of income tax on profits from each cryptocurrency exchange. The expression may not be very accurate due to translation issues. If it is intended to express whether profits from cryptocurrency-to-cryptocurrency exchanges can be exempt from tax, such practice exists in France, where only exchanges to fiat currency are subject to tax obligations. If this goal is achieved and cryptocurrencies are widely used in various daily business settlements without being exchanged into fiat currency, tax avoidance would be easily achievable. However, it is speculated that the Japanese government may not easily agree to this.

III. Reasonable Cryptocurrency Tax System

The characteristics of cryptocurrency assets bring unprecedented complexity to tax regulation, including information opacity, significant value fluctuations, high-frequency trading, and many business activities without centralized institutions (such as DeFi) that are subject to regulation. To address these challenges, it is necessary to establish a tax framework that is in line with the characteristics of cryptocurrency assets, such as “Pillar One” in the “Two-Pillar” approach to address digital economy issues.

Currently, many countries are still using relatively outdated domestic tax regulations, which are already outdated. We believe that an ideal tax system should have the following characteristics:

1. The CARF framework should be applicable to more countries and regions and be legislated domestically, which is conducive to transparent tax regulation;

2. Capital gains tax should be the main tax imposed on cryptocurrency assets, without imposing turnover tax. The tax burden should not exceed that of TMT and the financial industry;

3. For smaller entities, reference to traditional tax systems should be made for tax exemptions or preferential treatments;

4. The stages of tax collection and management should be in line with the characteristics of cryptocurrency assets, simple and efficient. Combining effective tools and data analysis capabilities to automate and simplify the process as much as possible, avoiding excessive consumption of social resources in the calculation process.

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