According to 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 rates for encrypted assets in Japan
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Japan considers cryptocurrencies as properties and taxes the income from cryptocurrencies as miscellaneous income based on the Payment Services Act (PSA) and the Financial Instruments and Exchange Act (FIEA).
Individuals who buy or sell cryptocurrencies in the previous fiscal year and earn income exceeding 200,000 yen are required to declare the total amount of cryptocurrencies and pay taxes. Japan implements a progressive tax rate system for 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 ranges from 15% to 55% (including residential tax), and individuals can pay up to 55% of their income in taxes, indicating a very high personal income tax rate for encrypted assets.
The tax rate for corporations generally includes national and local taxes and ranges from 23% to 29.74% in 2022.
2. Discussion on tax system modification demands
2.1 Excerpt from the press release of the tax system modification proposal
2.1.1 Canceling the taxation of unrealized gains on third-party issued tokens at the end of the period
The National Tax Agency of Japan revised some corporate tax rules in June 2023, allowing companies to exempt themselves from taxing the unrealized gains on the cryptocurrencies they issue. However, the unrealized gains on tokens issued by third parties are still subject to taxation.
2.1.2 Separate taxation of individual cryptocurrency transactions at a rate of 20%
By separately taxing cryptocurrency transactions, taxes can be reduced by carrying forward and deducting losses incurred in the year and the following 3 years. According to a survey by the Japan Blockchain Association, 43.9% of respondents stated that if the taxation method is changed to separate declaration, the investment amount would increase by more than 2 times.
2.1.3 Abolishing income tax on profits from exchanging cryptocurrencies
This change would make it easier to apply use cases suitable for Web3, such as DeFi and NFT markets, and improve the convenience of cryptocurrencies.
2.2 Comparison of capital gains tax rates in various countries
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 belong to the 25%, 28%, 33%, or 35% tax rate brackets, with a long-term capital gains tax rate of 15%; for individuals in the highest tax rate bracket (currently 37%), the long-term capital gains tax rate is 20%.
Germany considers cryptocurrencies as private currency or assets and requires capital gains tax to be paid. If a person 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 classifies cryptocurrencies as movable property and requires capital gains tax to be paid. Profits from the sale of cryptocurrencies are taxed at a unified rate of 30%, which includes 17.2% for social contributions. Long-term holding of cryptocurrencies is not tax-free.
Due to the absence of capital gains tax, most cryptocurrencies in Malaysia are tax-free.
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 either 10% or 20% capital gains tax.
2.3 TaxDAO’s Perspective
From the motivation behind the proposed tax system modifications by the Japanese industry association, which includes 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, there are high expectations for the tax system modifications. Whether these expectations can be realized is unknown, and we only present some perspectives from a tax system standpoint.
1. Cancelling the taxation of unrealized gains on third-party token issuances at the end of the fiscal year is relatively reasonable in our opinion. The simple logic is that it is unreasonable to pay taxes based on unrealized gains on the balance sheet. If all the unrealized gains are offset by losses when actually sold in the future, it would be a great financial burden for taxpayers, unless carried forward for tax refund, but the whole process involves significant loss. It would be more reasonable to tax the gains realized upon actual disposal.
2. Taxing individual cryptocurrency asset transactions separately at a rate of 20%. From the comparison with the countries listed in 2.2 above, most countries either exempt capital gains from cryptocurrencies or tax them mostly at 20% or below. Therefore, this demand has some basis in horizontal comparison. Moreover, Japan has separate taxation provisions for individual capital gains, such as real estate, land, and stocks, so the industry association can actively strive for it. Besides tax rates, there are also many issues related to laws, customs, and regulatory games. Prior to this, the Japanese tax authorities may have classified cryptocurrency gains as high-tax income to avoid excessive speculation.
3. Abolishing income tax on profits from exchanging cryptocurrencies each time. This point may not be expressed accurately due to translation issues. If it means whether profits from cryptocurrency-to-cryptocurrency exchanges can be exempt from taxation, such a practice exists in France, where only exchanges for fiat currency are subject to tax obligations. If this goal is achieved, it would be easy to avoid taxes by using cryptocurrencies for various daily business settlements without converting them into fiat currency. It is speculated that the Japanese government may not easily agree to this.
III. Reasonable Tax System for Cryptocurrencies
The characteristics of cryptocurrencies bring unprecedented complexity to tax regulation. These characteristics include information opacity, significant value fluctuations, high-frequency trading, and many business activities carried out without centralized institutions (such as DeFi) being regulated. To solve these problems, it is necessary to establish a tax framework that aligns with the characteristics of cryptocurrencies, similar to “pillar one” in the “two-pillar” approach to address digital economy issues.
Currently, many countries are still using relatively outdated domestic tax laws for regulation, which is highly inappropriate. 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, facilitating transparent tax regulation;
2. Capital gains tax should be the primary tax imposed on cryptocurrencies, instead of transaction taxes. The tax burden should not exceed that of TMT and the financial industry;
3. Tax exemptions or preferential treatment should be provided to smaller entities, taking reference from traditional tax systems;
4. The tax collection and management process should align with the characteristics of cryptocurrencies, aiming for simplicity and efficiency. Effective tools and data analysis capabilities should be used to automate and simplify the process as much as possible, avoiding excessive consumption of social resources during calculations.