Cryptocurrency Taxes: How They Work and What Gets Taxed

As cryptocurrencies continue to revolutionize the world of finance, the world of tax tries to keep up. When something is virtual, it is much more difficult to work out where it exists for tax purposes, but at the same time, while in some respects ‘this time it’s different’, the general principles that apply to all other assets can equally apply to crypto.

So, to a certain extent, the answer to ‘which countries are the most tax friendly for crypto?’ is ‘those that are most welcoming to investors generally’, as opposed to uniquely favoring digital asset investors.

How money gets made in crypto

Let’s start with a summary of the three main ways money can be made in crypto.

Firstly, there is mining, the process whereby investors create currencies through computing power. Under most country tax systems, this equates to carrying on a trade with a view to making a profit and is taxed in the same way as any other business, with the profit made being taxed. The main question is whether it is done in the name of the investor as self-employment income or through a company. Clearly, mining takes up a large amount of computing power and energy, and if the income is being generated from the revenue of selling those assets, then those costs should be deductible under general principles. The position is less clear if the asset is mined and kept — normally those costs should be matched against the cost of the asset created in the same way that manufacturing costs are, and recognition deferred until the asset is sold. So they’d still be taxed, but at the time of sale.

I have seen it written in many places that mining is tax-free because there is no specific law taxing it. I do wish that were true, but in most cases I can think of, where something completely new has been invented, it’s almost always been possible to fit within existing tax rules, and I don’t see crypto mining as necessarily being that different. Most often, it is considered as a trade or a business.

Secondly, there is the gain made in buying and selling currencies. This splits two ways — it can either be a trade or business, or it can be a long-term investment where the aim is a capital gain. In many ways, this is no different from any other currency trading. A high-volume trader who makes their main living buying and selling currencies is carrying on a trade and that trading income is taxable.

However, someone who only trades occasionally and holds for an extended period, may be more in it for capital gain, and so would be subject to tax on capital gains rather than on income.

Clearly, the dividing line between the two needs to be drawn somewhere, and each country has done so in slightly different ways. Some look at the frequency of trading or the holding period to determine if it’s a trade or an investment. Others look at wider factors, such as whether the investor has a full-time job as well, or if crypto trading is their only source of income.

Finally, where crypto is used to pay regular bills, then the mere fact that something is paid for in crypto means that it’s no different from any other barter transaction — there is a market price at which the relative valuation of the exchanged assets is agreed on, and it is exactly the same as money changing hands at that price.

Where crypto thrives

Ultimately, a country that doesn’t tax any capital gains will also not tax crypto. And, if they don’t tax income either, then it’s even clearer.

So, the Cayman Islands and the UAE are probably the friendliest countries for crypto because they tax neither capital gains nor income — but they’re the friendliest for every other asset class as well.

Countries that don’t tax capital gains, such as Singapore or Switzerland, will also be attractive, but will potentially catch high frequency traders as trading income. And, for those with high values of holdings, it’s important to watch out for the wealth tax in Switzerland.

Countries that don’t tax income earned abroad, such as Costa Rica or Panama with their territorial systems, Cyprus with its non-domicile regime, will also be attractive. And, if you don’t mind paying some tax, Italy and Greece with their flat tax caps are also popular, although Italy’s recent decision to double the amount to EUR 200,000 may shift the balance in favor of Greece, which so far is retaining the EUR 100,000 cap.

So, while this time is different, many of the usual tax issues end up being important. Low-tax countries generally are also good for crypto investors, and obtaining residence by investment is generally a popular option as there is no physical business to relocate as everything happens online anyway.