Hong Kong Virtual Money Income and Encryption Fund Tax Guide

Written by: Crypto Miao

With the rapid development of the global cryptocurrency market, an increasing number of businesses and individuals in Hong Kong are using virtual currencies as income, replacing traditional fiat currencies such as Hong Kong dollars and US dollars. While this provides a richer form of assets, it also brings numerous tax challenges. As the government strengthens tax regulation on cryptocurrencies, understanding how to properly address tax-related issues has become a compulsory course for relevant enterprises.

Regulatory situation

Hong Kong has not yet established a dedicated independent regulatory framework specifically for crypto assets, but since 2017, the Securities and Futures Commission (SFC) of Hong Kong has begun to regulate the ecosystem of "security-type" tokens. This includes licensing requirements for trading platforms, "virtual asset" portfolio managers, and funds, aimed at ensuring compliance with existing Securities and Futures Ordinance (SFO) regulations. Moreover, existing laws cover money laundering, terrorist financing, fraud, and cybercrime, regardless of whether they involve "virtual goods," reflecting the broad applicability of regulation.

Tax policy

The tax behavior of virtual assets is regulated by the guidelines issued by the Hong Kong Inland Revenue Department in 2020, titled "Profits Tax – Digital Economy, E-commerce, and Digital Assets" (hereinafter referred to as DIPN 39). Since 2022, blockchain-related businesses have grown by 250%, and Hong Kong is considered one of the fastest-growing regions for cryptocurrency business globally by 2025.

Cryptocurrency income

1 For individuals:

DIPN39 states: Employees, especially those working in the digital asset-related industry, may receive remuneration in the form of cryptocurrency (such as salary). Even when remuneration is paid in cryptocurrency, the treatment for salary tax applicable to labor income remains unchanged. The amount of labor income that employees need to declare should be the market value of the cryptocurrency at the time of receipt.

Therefore, the market value of rewards obtained in the form of cryptocurrency (such as wages) is declared as taxable income for salary tax. This applies to all employees, especially common in the digital asset industry. This regulation ensures that the tax treatment of cryptocurrency rewards is consistent with traditional wages, reflecting the flexibility of the Hong Kong Inland Revenue Department in adapting to the digital economy.

2 For the company:

The DIPN39 stipulates: Individuals engaging in commercial activities may use cryptocurrencies for transactions for various purposes. For instance, the individual may accept payment from customers in cryptocurrency, or use cryptocurrency to purchase goods. The market value of the cryptocurrency on the transaction date should reflect the amounts of sales and purchases.

Therefore, companies in Hong Kong that receive cryptocurrency payments for business activities, or receive new cryptocurrencies in the course of their operations, must convert them into Hong Kong dollars at the market value on the transaction date and include them in the company's taxable income.

Virtual Currency Fund Tax Policy

First, whether a Hong Kong fund needs to pay tax depends on whether it meets the Unified Fund Exemption (UFE) system. The Unified Fund Exemption (UFE) system was introduced on April 1, 2019, through the Inland Revenue (Exemption for Funds) (Amendment) Ordinance 2019, aiming to provide a uniform profits tax exemption treatment for all eligible funds operating in Hong Kong, regardless of whether they are locally registered, and must meet the definition and trading requirements set out in the Inland Revenue Ordinance.

The conditions that meet UFE include:

1. The fund meets the definition of tax exemption;

2. The taxable profit should come from qualified transactions (ancillary transactions less than 5%);

3. Qualified transactions in Hong Kong are executed or arranged by designated persons, or the fund is a qualified investment fund.

Among them, the taxable profits of the fund must come from "qualified transactions", including: securities trading, shares of private companies, futures contracts, foreign exchange contracts, deposits (excluding lending), exchange-traded commodities, foreign currencies, over-the-counter derivatives, etc.

During the trading process, virtual currency funds are likely to hold tokens other than security tokens, such as utility tokens (platform tokens) or payment tokens (stablecoins), which do not meet the exemption criteria of the Unified Fund Exemption (UFE) system.

If the fund does not meet the Unified Fund Exemption (UFE) criteria, it may still obtain tax-exempt status through the Offshore Fund Exemption (OFE) system, provided it meets the specific conditions of OFE. If the fund meets neither UFE nor OFE, its operating profits may be subject to profit tax.

Recognition of Operating Profit

Recognized as operating income

Profit is recognized as operating income, and the business profit tax applicable is either corporate profit tax (16.5% or a two-tier tax rate) or personal profit tax (progressive tax rate of 2%-17% or a standard tax rate of 15%).

If a cryptocurrency fund has investment advisors and fund management services in Hong Kong and is authorized to execute trades, the income from advisory fees, transaction fees, and management fees in that part is deemed to be income from conducting business in Hong Kong, and profits sourced from Hong Kong shall be subject to profits tax.

It is stipulated in DIPN39 that certain events (such as airdrops and blockchain forks) may generate new cryptocurrencies. If these new cryptocurrencies are obtained during the course of cryptocurrency business activities, they are considered business income and are subject to taxation. If the airdrop is part of a business activity (such as through a cryptocurrency trading platform or as a business promotion), it must be accounted for as business income at market value.

In Hong Kong, profits from operations such as trading, exchanging, and mining are also subject to profits tax based on operating income.

Recognized as capital gains

Due to the special nature of capital gains tax in Hong Kong, profits obtained from the disposal of capital assets (such as stocks, properties, bonds, etc.) in Hong Kong are usually exempt from taxation, whether for individuals or businesses.

According to the tax treatment of digital assets mentioned in the Hong Kong Inland Revenue Department's DIPN 39, long-term holding of cryptocurrency as an investment is exempt from capital gains tax. This means that if a fund trades digital assets, it may be regarded as asset disposal, and the resulting capital gains are usually not subject to tax. Therefore, it is important to confirm the legitimacy of the holding of digital assets and the identity of beneficial ownership (the attribution of profits); the nature of the transactions (for example, whether they belong to trading or lending of digital assets); and whether the expected transactions comply with the contractual arrangements with clients and counterparties (the purpose of the contract).

It is worth noting that the trading activities of a fund's trading or investment department in cryptocurrencies also need to distinguish the purpose of their trading. If a company frequently trades virtual currencies or uses them as part of obtaining commercial compensation, then its profits are considered business income and may be subject to taxation.

Things to Consider When Taxing Cryptocurrency

Things to note when calculating cryptocurrency profits in Hong Kong:

1. Tax Base

The purchase price or acquisition price of the cryptocurrency plus any fees or commissions paid constitutes the tax basis for calculating profits or losses.

2. Market Fair Value

The market fair value refers to the selling price of cryptocurrency on the open market at the time of trading. This price is usually determined by referencing reputable cryptocurrency exchanges or blockchain oracles to establish the currency price.

3. Holding Period

Timing is crucial when buying and selling cryptocurrencies, as it determines the duration of asset holdings, which in turn affects the substance of the business and the applicable tax rates. Considerations include trading frequency, holding period, holding proportion, etc. For example, if a company frequently trades virtual currencies, it will be regarded as business income and subject to capital gains tax; if held long-term, it is generally recognized as an investment, thus capital gains are not taxable.

4. Contract Arrangement

The cryptocurrency trading activities of the trading or investment department of the fund need to pay attention to how to plan business activities, as well as whether the held cryptocurrency is owned by the fund or held on behalf of others, and whether the expected trades comply with the contractual arrangements with clients and counterparties (the purpose of the contract).

5. Cost Deduction

Certain fees associated with cryptocurrencies, such as transaction fees or wallet storage fees, can be deducted from profits.

6. Save Record

Keep detailed records of all cryptocurrency transactions, as the Hong Kong tax authorities may require supporting documents. Complete records of cryptocurrency transactions should be retained in accordance with Section 51C of the Inland Revenue Ordinance.

As the cryptocurrency market in Hong Kong continues to develop and mature, the regulatory environment is expected to become more refined and stringent in the future. For individuals and businesses engaged in activities related to virtual currency income and crypto funds, compliance and proactive tax management are not only necessary means to tackle regulatory challenges but also the core competitive advantage to seize opportunities in the digital economy.