In the wave of digital economy, virtual currency transactions have swept the world and become a new hot spot for investors to pursue wealth. In this digital gold rush, China's vague legal positioning of virtual currency and strict transaction supervision have made tax issues more complicated. Understanding relevant obligations is not only related to legal compliance risks, but may also directly affect investment decisions and returns. This article will focus on personal virtual currency transactions, explore the possibility and path of Web3 tax compliance under the existing regulatory framework in China, and provide a reference for building a healthy and sustainable Web3 ecosystem.
What is virtual currency?
To figure out whether virtual currency is subject to tax, you first need to understand what virtual currency is and whether its buying and selling is allowed.
Cryptocurrency is any form of money that exists digitally or virtually and uses cryptography to secure transactions. Cryptocurrencies have no central issuer or regulator, but instead use a decentralized system to record transactions and issue new units.
At present, according to the Notice on Preventing Bitcoin Risks (Yinfa [2013] No. 289) (hereinafter referred to as "Document No. 289") issued by the People's Bank of China and other five ministries and commissions, the Notice on Preventing Risks of Token Issuance and Financing issued by the People's Bank of China and other seven ministries and commissions on September 4, 2017 (hereinafter referred to as "94 Notice"), and the Notice on Further Preventing and Dealing with Risks of Virtual Currency Trading Speculation issued by the People's Bank of China and other ten ministries and commissions on September 24, 2021 (hereinafter referred to as "924 Notice"), virtual currency is defined as not having monetary attributes such as legal compensation and compulsion, not having the same legal status as currency, and cannot and should not be circulated and used as currency in the market. However, none of the above notices deny the property attributes and commodity attributes enjoyed by virtual currency.
Furthermore, Document No. 289 mentioned that "Bitcoin trading is a commodity trading behavior on the Internet, and ordinary people have the freedom to participate under the premise of assuming their own risks", and Notice 924 mentioned that "there are legal risks in participating in virtual currency investment and trading activities. Any legal person, non-legal person organization or natural person who invests in virtual currency and related derivatives and violates public order and good morals will have the relevant civil legal acts invalid, and the losses caused by this will be borne by the person himself." It can be seen that under the current system in China, citizens have the right to buy and sell virtual currency.
So, since virtual currency can be bought and sold as personal property or commodities, does this behavior need to be taxed?
Do I need to pay taxes?
This article only discusses the most basic personal virtual currency transactions, and does not consider other situations such as airdrops, DeFi income, token staking, etc. We can consider the question of whether taxes are required from several aspects.
From the perspective of the state, virtual currency trading is not an industry that is encouraged to develop, so there are no corresponding tax incentives and exemptions. In addition, under the current policy and economic environment, the state will not give up collecting taxes from this potential source of tax.
From a regulatory perspective, first of all, taxing individuals falls under the category of personal income tax. According to the provisions of the Individual Income Tax Law of the People's Republic of China, the following personal incomes shall be subject to personal income tax.
From the perspective of taxation, if the purpose of individuals trading virtual currencies is to obtain income, then the more appropriate categories may be interest, dividends, bonus income or property transfer income. However, in the economic structure of holding virtual currencies, there is no entity that can generate income or there is an expected return of benefits for the occupied funds. Therefore, in terms of the purpose of holding and the nature of the assets, it is more in line with property transfer income.
From a legal perspective, China has not yet issued any tax laws or regulations specifically targeting virtual currencies. China's virtual currency tax policy mainly relies on the interpretation of existing tax laws and the practice of local tax authorities.
In addition to the above-mentioned (Individual Income Tax Law of the People's Republic of China), the current (State Administration of Taxation's reply on the issue of collecting individual income tax on income from individuals buying and selling virtual currency online) (State Tax Letter [2008] No. 818) states that "the income obtained by individuals who purchase virtual currency from players online and sell it to others after adding a markup is taxable income for individual income tax and should be calculated and paid in accordance with the "property transfer income" item". Although this reply was issued before the birth of Bitcoin, blockchain virtual currency and game virtual currency are no different in legal terms, so individual income tax should also be paid in accordance with property transfer income.
How should the tax be calculated?
The tax law stipulates that the income from property transfer is the balance after deducting the original value of the property and reasonable expenses from the income from the transfer of the property. The applicable proportional tax rate is 20%.
In practical cases, transfer income is generally easier to confirm, while how to confirm the original value of the property (purchase cost) becomes the key to calculating the tax payable.
If you purchase a certain virtual currency with RMB, hold it, and then sell it for RMB, the selling price is the income and the purchase price is the cost.
Tax payable = (income - cost) * 20%
However, due to the characteristics of blockchain and the trading habits of investors, users may have made multiple purchases and coin-to-coin transactions during the period. When part of the funds are converted back to RMB, it may not be possible to accurately trace which purchase funds belong to. In this case, referring to the accounting methods commonly used for other assets, the proportional allocation method can be considered for accounting:
The tax payable is = (income - current cost) * 20%
If the taxpayer is unable to provide the basis for cost accounting, the tax bureau may conduct valuation or assess the levy through an appraisal agency.
To this end, investors should properly retain purchase receipts and snapshots of assets at the time of sale in order to accurately calculate costs and declare taxes.
How to plan your tax payments properly?
As an emerging digital economy, the Web3 industry's unique operating model and cross-border characteristics provide broad space for tax planning. Through reasonable planning, such as choosing jurisdictions with low tax rates or tax incentives, distinguishing income types to optimize tax treatment, optimizing asset structure design, and striving for tax exemptions and deferral tools, industry participants can effectively reduce their tax burden while complying with regulations.
It is worth noting that under the current Chinese individual income tax system, the treatment of investment gains and losses depends on the specific investment type and tax regulations. For most investments, including virtual currency transactions, the tax authorities usually calculate taxes on a separate basis, rather than on an annual net income or net loss basis (unlike the annual settlement of individual income tax comprehensive income). This means that losses from different transactions within the year cannot usually be used to offset gains from other transactions (unlike the regulations of companies, funds and the US IRS).
Under this framework, individual investors can also optimize their tax plans by reasonably adjusting the nature of their assets and the way they report them. For example, they can hold some stablecoins after exchanging them at the top of the market, and then convert them into legal tender at the bottom of the market, which allows investors to reasonably postpone paying some taxes.
Case 1: The cost of purchasing a virtual currency A is 50 yuan. After it rises to 100 yuan, 50 yuan is immediately sold for legal currency. After that, the market falls and the A held becomes 20 yuan. The amount of tax to be paid is:
The tax payable is = (50-25)*20%=5
Case 2: The cost of purchasing a virtual currency A is 50 yuan. After it rises to 100 yuan, it is exchanged for 50 yuan of stable currency. After the market falls, the A held becomes 20 yuan, and the total assets become 70 yuan. At this time, the 50 yuan stable currency is sold and exchanged for legal currency. The amount of tax required is:
The tax payable is = (50-35.7) * 20% = 2.86
In both cases, the investor finally sold the fiat currency for 50 yuan and held 20 yuan of A. However, the investor had to pay 5 yuan of personal income tax when exchanging fiat currency in a bull market, and only 2.86 yuan of personal income tax when exchanging fiat currency in a bear market. From the perspective of legal tax payment, this goes against everyone's intuitive idea of "withdrawing money in a bull market".
It should be noted that this assumption is based on the premise that the tax bureau allows the use of the proportional allocation method to calculate the tax base.
What are the risks of not declaring?
There is a popular saying that goes, "The tax bureau knows you better than you know yourself." Although this saying is somewhat exaggerated, it also reflects the comprehensive application of big data technology, multi-department information sharing, electronic tax systems, and intelligent risk monitoring in the modern tax collection and management system. Especially after the launch of China's "Golden Tax Phase III" system, its powerful data collection and analysis capabilities can restore your economic activities from multiple dimensions.
If you evade paying taxes, you will be ordered to make up the payment after being audited by the tax bureau, and a late payment penalty of 0.05% will be charged per day. You may also be fined no less than 50% and no more than 5 times the tax amount. In serious cases, you will also be held criminally liable.
Attorney Mankiw's Summary
In the Web3 era, tax compliance is becoming increasingly important. Although blockchain, cryptocurrency, and decentralized finance (DeFi) have brought new economic models and technological innovations, tax compliance is still a legal obligation that cannot be ignored.
Web3 practitioners and users must pay attention to tax policies, actively record transactions and retain transaction proofs, take snapshots of assets at key nodes, and reasonably plan tax payments within the scope permitted by law to avoid legal risks caused by non-compliance.
The complexity of tax obligations not only stems from policy uncertainty, but is also closely related to investors' perception of compliance. In the future, as the regulatory framework gradually improves, the rules in this area may become clearer, but before that, staying vigilant and actively adapting to changes will be the key for investors to protect their own interests in the Web3 field.
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