The State Administration of Taxation recently announced the levy of individual income tax on income obtained through network virtual currency transactions. The announcement is as follows:

Official Reply of the State Administration of Taxation Concerning the Levy of Individual Income Tax on Income Obtained Through Network Virtual Currency Transaction

(No. 818 [2008] of the State Administration of Taxation)

Beijing Local Taxation Bureau:

Your Request for Instructions regarding the Issues concerning the Levy of Individual Income Tax on the Income Obtained Through Network Virtual Currency Transaction (No. 114 [2008] of Beijing Local Taxation Bureau) has been received. We hereby reply to your request as follows:

  1. The income obtained by individuals through selling the virtual currency at added price after purchasing it from players by network are taxable incomes for individual income tax, and shall be levied individual income tax as income from transfer of property.
  2. The original property value of the virtual currency sold by individuals should be the price for purchasing network virtual currency and the related taxes payment.
  3. The original property value shall be verified by the competent administration of taxation in case that the individual fails to furnish the certificate of the original property value.

State Administration of Taxation  

28th September 2008

According to this announcement, the income from the sale of virtual currency with increased value is taxable at 20%. The implementation of this tax appears ridden with hurdles. First, it is unclear whether this tax only cover trading between virtual currency and real currency. Many question whether trading virtual currency for goods and/or services will also be taxed. Second, since this is a tax on individuals, a person’s online alias must be linked to that person’s real life identity. Does this mean China will soon implement a mandatory network real-name ID system? Third, tracking online transactions poses a significant problem for authorities. Tax is collected by the provincial tax authority based on the location of the transaction. With online transactions, the transaction location is often difficult to ascertain as the internet service provider is often not located in the same province as the actual user. If the provincial tax authority cannot determine what transactions occur in their jurisdictions, how can they police such transactions?

Fourth, levying tax is another hurdle. According to China’s Individual Income Tax Law, income paying entity shall be responsible for withholding individual income tax on the taxable income. In the absence of a legal withholding entity, individuals who obtain the income shall make a tax payment declaration to the taxation administration. In the case of virtual currency, there is usually no legal withholding entity because most trading of virtual currency occur between individuals. Is it possible for the provincial tax bureau to implement an effective levying system?

Chinese media reports the following responses from various provinces:

  • Shanghai Local Taxation Bureau will start implementing this tax in the coming weeks, but did not specify the methods for implementation.
  • Chongqing Local Taxation Bureau will temporarily not implement this tax.
  • Zhejiang Local Taxation Bureau is currently analyzing how to implement this tax, and does not project a date for implementation.
  • On November 11th, Beijing Local Taxation Bureau announced the following implementation rules for this tax: (1) for transactions with verifiable income, the income will be taxed at 20%; and (2) for transactions with unverifiable income, the entire transaction amount will be taxed at 3%. Beijing Local Taxation Bureau requests individuals to make tax payment declarations to the Bureau after transactions involving virtual currency.  

We will have to wait and see how this tax will be actually implemented.