This article will continue to explore the selection of centralized cryptocurrency exchanges from a tax perspective.
Author: Ray
1. Introduction
In previous articles, we have conducted a preliminary analysis of the financial environment and tax policies in Hong Kong and Singapore, and discussed the advantages and disadvantages of mining companies settling in Hong Kong and Singapore. In this article, we will continue to explore the selection of centralized cryptocurrency exchanges (CEX) from a tax perspective. Centralized cryptocurrency exchanges refer to digital platforms or markets where users can buy, sell, and trade various cryptocurrencies, such as Coinbase and Binance. Unlike decentralized cryptocurrency exchanges, the term "centralized" in centralized cryptocurrency exchanges means that the exchange has centralized authority or entity management, and the operators of the exchange can control users' funds and transactions. According to data from Coincarp and CoinMarketCap, the current top fifteen cryptocurrency exchanges are all centralized exchanges, and many of them have an Eastern background, including Binance, Bybit, OKX, Gate.io, Kucoin, HTX, MEXC, and Bitget. It is worth noting that among these centralized cryptocurrency exchanges with an Eastern background, several have been registered in or have been in Singapore, such as Kucoin, MEXC, and Bitget. Even some exchanges, such as OKX and Gate.io, which have moved their place of registration to Malta or the Cayman Islands, have also established subsidiaries or Asian headquarters in Hong Kong and Singapore. It can be seen that Singapore and Hong Kong are the main registration locations for centralized cryptocurrency exchanges in Asia. In addition to the open attitude of Singapore and Hong Kong towards cryptocurrencies, we also attempt to seek the institutional and economic reasons behind this phenomenon from the perspectives of regulation and tax policies.
2. Main Types of Revenue for Centralized Cryptocurrency Exchanges
Unlike mining companies, the business content of centralized cryptocurrency exchanges is more diverse, and their sources of revenue are more extensive. Currently, the main sources of revenue for centralized cryptocurrency exchanges include the following:
(1) Fee income. Centralized cryptocurrency exchanges charge a certain percentage of fees during the process of matching user transactions, including order placement fees, transaction fees, withdrawal fees, etc.
(2) Listing fees. The so-called listing fee refers to the fee charged by centralized cryptocurrency exchanges to the project party before listing the tokens of a project. Although exchanges do not necessarily charge listing fees, the total amount of this income is still considerable in today's environment of numerous new projects.
(3) Lending income. Centralized cryptocurrency exchanges not only provide intermediary services such as trading matching but also engage in financial services such as lending. For example, in leveraged trading, exchanges can lend users the financial funds held by other users on the exchange and earn the interest differential.
(4) Advertising and sponsorship income. Centralized cryptocurrency exchanges have a large user traffic, and providing advertising services or accepting sponsorships can also generate substantial income for the exchanges.
(5) Cryptocurrency issuance and appreciation income. Currently, the cost of issuing coins on the chain is not high, and exchanges often issue their own on-chain tokens, such as Binance's BNB and OKX's OKB. This type of ICO income is also an important source of revenue for exchanges. In addition to issuing cryptocurrencies, exchanges also hold a portion of cryptocurrencies as reserve funds or investment assets. When these cryptocurrencies appreciate, if the exchanges sell them for cash, they can also generate substantial income.
(6) Direct trading income. Some exchanges may directly participate in leveraged and perpetual contract trading, and may even engage in games with specific counterparties using the backend data they control. Due to the double disadvantage users have compared to exchanges in terms of funds and information, exchanges often make huge profits in this way. Of course, this behavior carries serious moral and legal risks, but in the absence of effective restraint due to difficulties in obtaining evidence and inadequate regulation, this behavior has become an important source of income for some small and medium-sized exchanges.
The diverse types of business revenue for centralized cryptocurrency exchanges pose challenges to regulatory and tax systems. In response, Singapore and Hong Kong have not only made targeted regulatory provisions but have also included relevant income within the existing tax system, which will be further analyzed in the following sections.
3. Regulatory and Tax Policies for Centralized Cryptocurrency Exchanges in Singapore
3.1 Regulatory Policies for Centralized Cryptocurrency Exchanges in Singapore
Before introducing the regulatory and tax policies applicable to centralized cryptocurrency exchanges, it is necessary to briefly explain the classification of cryptocurrencies by the Monetary Authority of Singapore (MAS), as this directly affects the regulatory content applicable to centralized cryptocurrency exchanges.
According to MAS regulations, cryptocurrencies are classified into three main categories: Utility Tokens, Security Tokens, and Payment Tokens. Utility Tokens refer to tokens that can be exchanged for specific goods/services; Security Tokens refer to tokens used for initial coin offerings (ICOs) or financing; Payment Tokens include any cryptocurrency used for payments. Of course, in practice, these three types of tokens often overlap with specific tokens.
In Singapore, Utility Tokens are not currently subject to specific regulations; Security Tokens and Payment Tokens are regulated by two specialized laws, the Payment Services Act and the A Guide to Digital Token Offerings. According to the requirements of the Payment Services Act, financial institutions trading in Payment Tokens need to apply for a license. Among the four types of financial institutions authorized to apply for Payment Token operating rights, Approved Exchanges face the most stringent regulation of cryptocurrency derivatives, especially with the passage of the Financial Services and Market Bill, which includes activities such as direct or indirect trading, exchange, transfer, custody of cryptocurrencies, and provision of related investment advice within the regulatory scope.
In summary, according to the provisions of the Payment Services Act, centralized cryptocurrency exchanges in Singapore mainly engage in A business (Account issuance service), C business (Cross-border money transfer service), and F business (Digital payment token service), and need to apply for a Standard Payment Institution License (SPI) or a Major Payment Institution License (MPI) based on their trading volume. It is important to note that exchanges that obtain the aforementioned licenses are currently only allowed to engage in spot trading and are not allowed to engage in contract business or security token business, which greatly affects the sources of income for centralized cryptocurrency exchanges in Singapore. In addition, under the provisions of the A Guide to Digital Token Offerings, activities involving cryptocurrency financing will be subject to securities regulations.
3.2 Tax Policies for Centralized Cryptocurrency Exchanges in Singapore
Singapore's tax system is not complex, and the tax types related to centralized cryptocurrency exchanges mainly include Corporate Income Tax (CIT) and Goods and Services Tax (GST).
3.2.1 Corporate Income Tax
Singapore's corporate income tax follows the territorial principle, which means that unless otherwise provided, income generated in Singapore or sourced from Singapore, or income received in Singapore from outside Singapore, is subject to corporate income tax. Since centralized cryptocurrency exchanges conduct business globally, their income from various countries is subject to corporate income tax.
In terms of tax rates, the standard corporate income tax rate in Singapore is 17%. Within the normal taxable income, the first 10,000 Singapore dollars can enjoy a 75% tax exemption, and the portion from 10,001 to 200,000 Singapore dollars can enjoy a 50% tax exemption. The remaining portion is subject to a 17% corporate income tax rate. However, the tax rate for interest income is 15%. It is important to note that Singapore implements the "Headquarters Incentive," which applies to companies providing headquarters services for their regional or global corporate networks established or registered in Singapore. Once the conditions for this policy are met, the relevant income of the company can enjoy tax exemption, a 5% or 10% preferential tax rate. For centralized cryptocurrency exchanges wishing to expand into the Asian market, choosing to register their regional headquarters in Singapore will have the opportunity to benefit from this significant tax incentive policy.
The main feature of Singapore's corporate income tax is the non-taxation of capital gains. Generally, centralized cryptocurrency exchanges registered in Singapore do not need to pay corporate income tax when selling the cryptocurrencies they hold, and their lending income falls within the scope of corporate income tax. As for income from ICOs, if the ICO issues security tokens, the income is similar to IPO income and is not subject to taxation. However, if a centralized cryptocurrency exchange obtains dividend-like income from the securities tokens it holds, it is still subject to corporate income tax. It is important to note that in tax practice, centralized cryptocurrency exchanges must prove that their purpose of holding cryptocurrencies is for investment rather than trading, otherwise they will not be able to enjoy the tax exemption for capital gains. Considering that ICOs or selling cryptocurrencies are often not the main source of income for centralized cryptocurrency exchanges, this tax exemption provision has limited direct benefits for centralized cryptocurrency exchanges.
3.2.2 Goods and Services Tax
Taxpayers of goods and services tax refer to those who are registered or required to be registered for goods and services tax, and here, goods include cryptocurrencies, and services include financial services such as lending. The scope of goods and services tax mainly covers (1) taxable goods produced in the taxpayer's business activities and taxable services provided, and (2) goods imported into Singapore. Therefore, centralized cryptocurrency exchanges need to pay goods and services tax on their fees, listing fees, lending, advertising and sponsorship income, and cryptocurrency trading income.
In addition, according to the IRAS's 2019 e-Tax Guide, GST: Digital Payment Tokens, trading in digital payment tokens is exempt from goods and services tax. Currently, the standard rate of goods and services tax has gradually increased from 7% to 9%. Compared with the tax rates of similar tax types in other countries, the 9% tax rate is not high. Furthermore, since trading in digital payment tokens is not subject to goods and services tax, this tax type does not impose significant tax pressure on centralized cryptocurrency exchanges and other actual taxpayers.
3.3 Other Tax Policies
In addition to Singapore's domestic tax system, considering that centralized cryptocurrency exchanges operate globally and may constitute permanent establishments in multiple countries, if the foreign tax credit relief is weak, the tax burden on centralized cryptocurrency exchanges registered in Singapore will be heavy. Therefore, we should also pay attention to Singapore's foreign tax credit relief agreements. As of early 2024, Singapore has signed bilateral tax treaties with over 80 countries or regions, which will help centralized cryptocurrency exchanges registered in Singapore avoid double taxation and reduce their tax burden. However, the United States has not signed relevant tax treaties with Singapore.
4. Regulatory and Tax Policies for Centralized Cryptocurrency Exchanges in Hong Kong
4.1 Regulatory Policies for Centralized Cryptocurrency Exchanges in Hong Kong
The Securities and Futures Commission is the main regulatory authority for cryptocurrencies in Hong Kong, and other institutions such as the Hong Kong Monetary Authority and the Insurance Authority also participate in the coordinated regulation of cryptocurrencies. In Hong Kong, cryptocurrencies are classified into security tokens, utility tokens, and virtual commodities, and the regulatory requirements for different types of cryptocurrencies vary. Hong Kong has clear regulatory requirements for security tokens in documents such as "Statement on Regulatory Framework for Management Companies, Fund Distributors and Trading Platform Operators for Virtual Asset Portfolios," "Position Paper on Regulation of Virtual Asset Trading Platforms," and "Consultation Conclusions on Proposed Regulatory Requirements for Licensed Virtual Asset Trading Platform Operators by the Securities and Futures Commission." However, the regulation of stablecoins and other cryptocurrencies is gradually becoming more comprehensive with the release of documents such as the "Conclusion of Discussion Paper on Crypto-assets and Stablecoins." Before the regulation of stablecoins is announced, exchanges are not allowed to provide trading services for stablecoins in the retail market, and algorithmic stablecoins are also not recognized. These regulations will have a significant impact on the stablecoin business of centralized cryptocurrency exchanges registered in Hong Kong.
Overall, Hong Kong pays more attention to protecting the rights of investors, and the regulation of centralized cryptocurrency exchanges is becoming stricter. Until June 2023, Hong Kong operated on a voluntary licensing system, and centralized cryptocurrency exchanges engaged in non-securities token activities did not require a license. However, with a large number of retail investors entering the market and non-securities tokens emerging continuously, Hong Kong began implementing a new licensing system in June 2023. All virtual asset trading platforms operating in or promoting to investors in Hong Kong are required to obtain a license from the Securities and Futures Commission and be regulated by it.
Currently, centralized cryptocurrency exchanges may need to obtain three types of licenses in Hong Kong: according to the Securities and Futures Ordinance, virtual asset exchanges conducting security token trading need to obtain Type 1 (Securities Trading License) and Type 7 (Automated Trading Service License); according to the Anti-Money Laundering Ordinance, virtual asset exchanges conducting non-securities token trading need to obtain a VASP license (Virtual Asset Service Provider License). However, securities tokens are still the main trading category for centralized cryptocurrency exchanges in Hong Kong. Additionally, it should be emphasized that according to the "Consultation Conclusions on Proposed Regulatory Requirements for Licensed Virtual Asset Trading Platform Operators by the Securities and Futures Commission," exchanges should conduct due diligence before each listing and for each cryptocurrency, without exemption by cryptocurrency, to ensure that the listed cryptocurrencies have sufficient liquidity.
4.2 Tax Policies for Centralized Cryptocurrency Exchanges in Hong Kong
4.2.1 Profits Tax (Capital Gains Tax)
The main feature of Hong Kong's profits tax is the adoption of the territorial source concept, which means that the key to whether capital gains tax is levied is not whether the taxpayer is a tax resident, but whether the profit is sourced from Hong Kong. Profits from outside Hong Kong are not subject to capital gains tax in Hong Kong. For centralized cryptocurrency exchanges engaged in global business and choosing to register in Hong Kong while operating outside Hong Kong, theoretically, they can declare offshore income exemption and be tax-exempt for this income. In practice, the diverse sources of business income for exchanges have individual uncertainties in proving that the income is sourced from overseas and responding to inquiries from the Hong Kong authorities.
In terms of the basis of assessment, it is similar to the general standard for corporate income tax, where the assessable profits are the profits (or losses) after deducting allowable expenses and costs. Additionally, another feature of Hong Kong's profits tax is the non-taxation of capital gains, unless the disposal of assets has a trading nature. This also helps centralized cryptocurrency exchanges holding cryptocurrencies to reduce their tax burden. In recent years, the profits tax rate for Hong Kong companies has been 16.5%. Since April 2018, the profits tax rate for the first 2 million Hong Kong dollars of profits has been reduced to 8.25%, and the remaining profits continue to be taxed at 16.5%. This two-tier tax rate system helps small and medium-sized exchanges to start and develop.
Specifically, according to the Inland Revenue Department of Hong Kong's revised "Departmental Interpretation and Practice Notes No. 39 Profits Tax: Digital Economy, Electronic Commerce and Digital Assets" (DIPN 39) in March 2020, profits generated from ICOs conducted in Hong Kong are subject to income tax. According to the six badges of trade rule, if digital assets, including cryptocurrencies, are purchased through ICOs or trading platforms and used for long-term investment purposes (i.e., "capital"), the profits from such assets are not subject to income tax. Conversely, profits obtained for trading purposes are subject to income tax. DIPN 39 explicitly states that cryptocurrencies obtained through commercial transactions, including "airdrops" and "forks," are considered business income and should be assessed for income tax. Considering the types of business income for centralized cryptocurrency exchanges, the benefits of tax exemption for capital gains, interest, and other capital income are limited, and the main advantage of Hong Kong's tax policy lies in the territorial source principle.
4.2.2 Others
Hong Kong's tax system is relatively simple, and profits tax is the main tax that centralized cryptocurrency exchanges need to pay. Additionally, Hong Kong does not levy value-added tax, which also helps reduce the tax burden for centralized cryptocurrency exchanges in specific situations.
In terms of tax treaties, Hong Kong has signed tax treaties or arrangements to avoid double taxation with approximately 40 countries or regions, but the United States is not included.
5. Conclusion and Recommendations
In terms of regulatory systems, Singapore has a stricter and more mature regulatory system compared to Hong Kong. While Hong Kong has been gradually introducing regulatory policies, it still primarily focuses on the regulation of security tokens, leaving room for further improvement. The different regulatory intensities and focuses present different challenges for centralized cryptocurrency exchanges in Singapore and Hong Kong. Centralized cryptocurrency exchanges in Singapore need to face the challenge of overall strict regulation and limited business types, while those in Hong Kong need to deal with difficulties in license application and high due diligence costs.
In terms of tax policies, both Singapore and Hong Kong do not levy capital gains tax, but this provides limited benefits for centralized cryptocurrency exchanges. Additionally, the income tax rates and deduction standards for taxable income are relatively similar in both locations. The main difference in income tax lies in the fact that Singapore adopts the territorial source principle, while Hong Kong adopts the territorial source principle. Although the territorial source principle may be more favorable for centralized cryptocurrency exchanges, the application of this principle requires further determination, and the actual tax benefits should not be overestimated. Furthermore, Singapore has signed far more tax treaties with other countries than Hong Kong, which is more helpful in avoiding double taxation issues. In addition, Hong Kong does not levy value-added tax, while Singapore does, which gives Hong Kong's tax policy a greater advantage in cases where centralized cryptocurrency exchanges may become the actual taxpayers of value-added tax.
In conclusion, for centralized cryptocurrency exchanges, Singapore and Hong Kong each have their own characteristics in terms of regulatory systems and advantages in tax policies. Both are important financial centers and strategic regions. Centralized cryptocurrency exchanges should consider their business characteristics and compliance capabilities to choose the most suitable jurisdiction for registration.
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