The government of Kyrgyzstan has suggested a taxation scheme for cryptocurrency mining. If it is approved, the virtual money mining will be legalised in the country. However, the suggested tax rate, according to experts, may discourage the miners. 

The draft law of this kind was announced by deputy minister of economy of Kyrgyzstan, Dastan Kadyrov, back in late June. The official told journalists that the agency was preparing amendments, which imposed tax for miners at the rate of 20 per cent of the consumed energy price.

A document published in late August on the official website of the government indicated a lower tax rate of 15 per cent. But according to experts, this is still too high tax burden for miners as their income is extremely unstable.

The background statement of the draft law explains that it is designed to introduce cryptocurrency mining taxation in the republic. This will increase the public revenue and contribute to the principle of fair universal taxation in Kyrgyzstan, regardless of the type of operation.

Status not determined

The need to introduce a tax for such a field of activity as cryptocurrency mining was seriously discussed in Kyrgyzstan shortly after the State Economic Crime Service had publicly reported this mid-July about the detection of the “crime of the century”.

The State Economic Crime Service (GSBEP) discovered a large mining farm, which was organised by citizens of China and Kyrgyzstan. They registered two LLCs in the Pervomaisky district of Bishkek. Officially, the first company was listed as a computer laboratory that studies, develops and releases software. Although in fact it did not produce anything and did not pay taxes.

The second company operated as an electricity reseller. The damage from its activities was estimated as millions of soms. The company was buying electricity from the Natsionalnaya Elektricheskaya Set Kyrgyzstana [National Power Grid of Kyrgyzstan] and Elektricheskie Stantsii [Electric Stations] and reselling it to the mining farm, i.e. to the first company.

Financial police officers found out that in 2018 the company received a profit of 21 million soms (300.6 thousand dollars) from its intermediary services, but did not pay taxes from this amount. GSBEP ceased the activities of the Bishkek-based mining farm stating the illegal business, and brought several charges against the company, including “Tax evasion by organisations” and “Customs evasion”.

This story has revealed many problems existing in the area of cryptocurrency mining in Kyrgyzstan. And the lack of any legal status for this type of entrepreneurial activity seems to be the main one.

Cryptocurrency mining companies are neither allowed nor prohibited: mining farms do not actually exist in the legislation of the republic. This, among other things, means that the owners of such enterprises cannot defend their interests in court if they think that sanctions against them are unlawful.

Everything is calculated

Now the Ministry of Economy is proposing to introduce the terms “cryptocurrency”, “cryptocurrency mining”, and “hashing” into law. And, most importantly, to supplement the section of the Tax Code “Special tax regimes of the Tax Code of the Kyrgyz Republic” with chapter 60 “Cryptocurrency mining tax”. The developers of the draft law determined the taxable base of the mining tax in the form of taxpayer’s expenses for the payment of electricity consumed during cryptocurrency mining, including VAT and sales tax.

The draftsmen note that there are at least two options of cryptocurrency mining taxation. In the first one, the tax is based on the income of miners. The second option provides for taxation of the amount of expenses for the virtual money mining.

According to the background statement, the draftsmen abandoned the first option because of the “inability to control the generation of income from this type of activity.” The ministry of economy considers the second option of taxation the most reasonable as there is a real opportunity to control the consumption of electricity by mining farms.

In this regard, the drafters proposed to establish a tax for miners at the rate of 15 per cent of the amount of electricity costs. This, according to them, will increase public revenues by 346.8 million soms (4.96 million dollars) annually.

The draft law contains detailed calculations, which, according to the draftsmen, should help understand where this figure came from.

The ministry of economy calculated the possible income of Kyrgyz miners and arrived at a conclusion that it can reach 436 thousand dollars or 30.4 million soms per day. This is 13.08 million dollars or 913 million soms per month (at the rate of 69.8 soms / 1 dollar).

To receive such income, it is necessary to consume electricity for 228 million soms (3.26 million dollars) per month. This amount was obtained by the following calculations:

1.32 kW * 24 hours * 30 days * 80,000 hardware devices = 76.0 mW;

Plus ventilation 20%:

76.0 mW * 1.2 = 91.2 mW;

With 2.5 soms per 1 kW, electricity costs will be:

91.2 mW * 1,000,000 * 2.5 soms = 228 million soms.

However, experts are confused about the calculated income of miners. Programmer and cryptocurrency expert Daniil Vartanov said it is extremely difficult to predict any income and its volume.

“This is a very rough estimate because miners’ income changes every day and every hour due to the fluctuations in many parameters,” Vartanov said.

Also, these estimates do not include the so-called preliminary data on the number of mining hardware devices available in Kyrgyzstan. According to the draftsmen, there are 80 thousand of them. However, it is unclear what this number is based on.

“It’s quite unclear how these estimates were done. To get a more realistic picture, they should have visited every mining farm in the country and count all operating hardware devices,” independent IT expert Azis Abakirov wondered.

Another parameter stated by the ministry of economy raises doubts. Calculations are made based on the Internet information about technical parameters of one type of equipment for cryptocurrency mining – “ASIC Miner S9i”. Although, according to experts, there are many similar devices, and they all differ in their characteristics.

What about others?

IT experts wonder why this taxation mechanism was chosen. Government agencies obviously want to gain control over funds that have been uncontrolled so far. However, this approach can hardly be deemed productive when cryptocurrency miners have tax liability regardless of whether they have earned or not.

“Mining is merely power-consuming industry. In this case, it is no different from, for example, electrometallurgy or data centres. It’s unclear why they decided to have additional tax on this type of industrial production. We can imagine this will kill all legal mining and allow thievish tax officers to “milk” those mining farms that will be working illegally,” Daniil Vartanov said.

In different countries of the world, various approaches are applied to the mining taxation. In some places, miners pay a cryptocurrency income tax, in other places, there is a cryptocurrency capital gains tax.

Some countries apply a mixed tax approach to this type of activity. In Singapore, for example, income tax is only applied to digital currencies trading, only if it is not a long-term investment. In Sweden, the mining industry is taxed either as employment income or as business income.

Miners based in China are believed to live in the most comfortable conditions.

“If we speak about the conditions created for mining development, in this regard we have China and the rest of the world. The Celestial Empire is way ahead in this regard and the rest can be hardly seen from its distance: it has a lot of cheap electricity and a lot of mining equipment factories,” Vartanov explained.

Today China does have the majority of mining capacities. A huge number of farms are concentrated in the south-eastern regions of the country that are rich in hydropower resources.

However, in the past two years, the authorities of the Celestial Kingdom began to tighten the screws for miners. In early 2018, concern was expressed that cryptocurrency miners allegedly do the harm to the environment and violate tax laws. And in the spring of 2019, the National Development and Reform Commission of China (NDRC) revealed a draft law that called cryptocurrency mining “an undesirable industry” and proposed to ban it.

As to the approach to the legal regulation of cryptocurrency relations in the PRC, it is still under development. Cryptocurrency is considered by the regulatory authority as a commodity, and cryptocurrency exchanges (and other websites related to digital currency) must be registered with the Telecommunication Bureau. Taxation is implemented according to the standard rules for commodities: cryptocurrency transactions are subject to profits tax, income tax and capital gains tax, and its sale may be subject to value added tax.

It’s hard to say what the Kyrgyz version of mining taxation is based on – the background statement gives no references to international experience. Experts also find it difficult to name the countries where the tax rate for miners is based on this scheme.

Some suggest that that the idea is based on the Russia’s attempts to introduce something like a tax on overusing electricity. In early 2019, similar changes were proposed in Russia in order to force people, including miners, to pay for electricity at an “economically reasonable rate”, that is, an excessive price. The consideration of the draft law on raising electricity prices was postponed for an indefinite term.

Pros and cons

However, not all think the Kyrgyz approach to mining taxation is a failure.

“Why do we need to introduce some special rate of electricity for miners? The point is in tax regulation, not the revenue increase for energy companies. Whether the rate should be 15 per cent or lower is another question. As for the rest, I think the suggested taxation mechanism is simple and clear both for the business and the state,” Altynbek Ismailov, Director of High Technology Park (PVT), said.

According to him, the draft law in question is a leap forward for Kyrgyzstan, which will help bring this sector out of the shadows.

“The game rules for potential businessmen and investors who want to work in this sector will be finally laid down. I think there would be more companies going to legalise and show their capacities,” Ismailov said confidently.

However, not all are that optimistic about it. Azis Abakirov thinks mining and cryptocurrencies open a new prospective direction for the country and fair rules need to be made.

“Selling electricity to miners is the export of electricity Kyrgyzstan has always dreamed about. In my opinion, it’s enough to set a fair rate and to make money on selling electricity,” Abakirov said.

However, according to him, a 15 per cent tax rate suggested by the ministry of economy can seem too high to entrepreneur and they are more likely to leave for the countries with a more liberal situation. Daniil Vartanov has the same opinion and thinks that if such amendments are introduced, the prospects of mining development in Kyrgyzstan will become very shadowy.

“Anyway, miners have a very bright future in the world. However, it’s questionable whether Kyrgyzstan would have a share in this pie,” he said.