Digital currencies, commonly referred to as cryptocurrencies, have revolutionised the financial landscape by introducing decentralised and borderless means of value transfer. As their adoption grows, taxation becomes more complex. One area that often raises questions is whether withholding tax (WHT) applies to digital currencies, particularly in relation to dividend tax. This article explores whether digital currencies are subject to withholding tax, examining various scenarios and tax implications.
Understanding Withholding Tax
Governments impose withholding tax by deducting a portion of income payments, such as interest, dividends, or royalties, before the recipient receives the funds. This system ensures tax compliance and simplifies the collection of taxes from non-residents earning income within a particular jurisdiction.
How Are Digital Currencies Classified for Tax Purposes?
The tax treatment of digital currencies varies across jurisdictions due to their unique characteristics. In the United States, the Internal Revenue Service (IRS) classifies cryptocurrencies as property rather than currency. As a result, general tax principles applicable to property transactions govern digital asset transactions. Buying, selling, or trading cryptocurrencies may lead to capital gains or losses, depending on the holding period and the price difference between purchase and sale.
When Does Withholding Tax Apply to Digital Currencies?
The applicability of withholding tax to digital currencies depends on the nature of the transaction and specific jurisdictional tax regulations.
Payments to Independent Contractors and Employees
Businesses that pay independent contractors using digital currencies must account for tax implications. The fair market value of the cryptocurrency at the time of payment determines the tax liability. If the total payment exceeds $600 in a year, the IRS requires businesses to report it.
For employees, wages paid in digital currencies are taxable and must be reported. These payments are subject to income tax withholding, as well as Social Security and Medicare taxes.
Dividend Payments in Digital Currencies
When companies distribute dividends in digital currencies, tax treatment depends on the jurisdiction’s regulations. In the United States, shareholders must report the fair market value of the cryptocurrency received as dividend income. Companies may also need to withhold taxes on these dividend payments based on the recipient’s tax status.
Cross-Border Transactions and Withholding Tax
For international transactions, withholding tax may apply to payments made to foreign individuals or entities. Tax treaties between countries determine the specific rate and applicability. For example, a US company paying royalties in digital currencies to a foreign entity may need to withhold tax at a rate specified in the relevant tax treaty.
How Do Tax Authorities Track Digital Currency Transactions?
Governments are developing new methods to monitor transactions. Tax authorities use blockchain analytics and exchange reporting requirements to enforce withholding tax compliance. While dividends in cryptocurrencies may be taxed similarly to traditional dividends, other digital asset earnings—such as staking rewards and DeFi yields—may also fall under withholding tax regulations depending on jurisdictional rules.
Tax Reporting Obligations
Individuals must report income from digital assets on their tax returns, including mining rewards, staking earnings, or payments received in cryptocurrencies.
Brokers must also comply with new reporting obligations. From 1 January 2025, they must report the gross proceeds from customers’ crypto sales and exchanges. This requirement enhances IRS oversight of digital asset transactions.
How Different Countries Tax Digital Currencies
Tax treatment of digital currencies differs worldwide. The Court of Justice of the European Union ruled that exchanging traditional currencies for bitcoin is exempt from VAT. However, each EU member state has its own regulations regarding income tax and withholding tax on cryptocurrency transactions.
In Belarus, under the Decree on the Development of Digital Economy, certain digital currency transactions were excluded from taxation until 1 January 2023. This temporary exemption encouraged digital asset adoption within the country.
Challenges in Enforcing Withholding Tax on Digital Currencies
Several challenges arise when applying withholding tax. Price volatility makes it difficult to determine fair market value at the time of a transaction. Additionally, evolving regulations often lag behind industry developments, creating ambiguity in tax laws. Ensuring compliance requires robust tracking and reporting systems, which pose challenges for both taxpayers and tax authorities.
Failing to withhold tax on crypto payments can result in severe penalties, including fines, interest charges, and potential legal action. As regulations continue to evolve, businesses and individuals must remain informed to avoid financial and legal risks.
Conclusion
Determining whether withholding tax applies to digital currencies depends on transaction type and jurisdictional regulations. As digital assets become more integrated into global financial systems, individuals and businesses must stay informed about their tax obligations. Consulting tax professionals, like Global Tax Recovery, and keeping up with regulatory developments can help navigate the complexities of digital currency taxation.