Author: TaxDAO
Exchange Traded Funds (ETFs) are similar to stocks and are traded on stock exchanges, allowing buying and selling at market prices that fluctuate throughout the trading day based on supply and demand. These funds typically hold a variety of assets such as stocks, commodities, or cryptocurrencies, aiming to track the performance of specific indices or assets. Compared to mutual funds, the net asset value of ETFs is calculated multiple times during the trading day, enabling investors to trade fund shares at prices close to the underlying asset market prices, providing greater liquidity and flexibility.
With the approval of a Bitcoin spot ETF by the U.S. SEC, the tax treatment of this has also become a focus of investor attention. This article will focus on the tax treatment that U.S., Hong Kong, and Singapore investors may encounter when investing in a U.S. Bitcoin ETF.
1. Definition of Bitcoin ETF
1.1 Bitcoin ETF
A Bitcoin ETF holds Bitcoin or contracts related to Bitcoin prices and is traded on traditional stock exchanges, allowing investors to gain exposure to Bitcoin price fluctuations without directly holding or managing Bitcoin, thereby eliminating concerns about security and digital wallets.
In the ever-changing cryptocurrency investment landscape, Bitcoin ETFs have become an important financial instrument. There are mainly two types of Bitcoin ETFs: Bitcoin spot ETFs and Bitcoin futures ETFs, each catering to different investment strategies and risk preferences.
1.2 Bitcoin Spot ETF
A Bitcoin spot ETF directly holds Bitcoin as its underlying asset, meaning the performance of the spot ETF is directly linked to the real-time value of the held Bitcoin. When investors purchase shares of a spot ETF, they are essentially buying Bitcoin, but without personally holding Bitcoin.
1.3 Bitcoin Futures ETF
A Bitcoin futures ETF does not directly hold Bitcoin but invests in Bitcoin futures contracts, allowing investors to speculate on future price movements of Bitcoin without directly holding Bitcoin or futures contracts. Financial institutions raise funds and establish Bitcoin futures ETFs by issuing shares and purchasing Bitcoin futures contracts to track the future price of Bitcoin. When investors purchase shares of a Bitcoin futures ETF, they are essentially buying a portion of the fund that holds these contracts, indirectly betting on the future price of Bitcoin.
1.4 Comparison of Bitcoin Spot ETF and Futures ETF
The main differences between Bitcoin spot ETFs and Bitcoin futures ETFs include underlying assets, performance influencing factors, liquidity requirements, potential price differences, and exposure and risks.
The difference in underlying assets means that Bitcoin spot ETFs directly hold Bitcoin, while the value of Bitcoin futures ETFs comes from futures contracts related to Bitcoin.
The difference in performance influencing factors lies in Bitcoin spot ETFs being linked to the real-time price of Bitcoin, while Bitcoin futures ETFs are influenced by the contract market.
In terms of liquidity requirements, Bitcoin spot ETFs need to hold and securely store Bitcoin, so they do not trade frequently to ensure that the ETF price is consistent with the spot price of Bitcoin, while Bitcoin futures ETF trading is more frequent, with a more complex liquidity management process and the possibility of rollover at contract expiration.
There may be potential price differences between the two types of Bitcoin ETFs because Bitcoin spot ETFs typically closely track the spot price of Bitcoin, while Bitcoin futures ETFs are affected by dynamic contract markets and contract expiration dates.
In terms of exposure and risk, the exposure of Bitcoin spot ETFs is a direct exposure to Bitcoin price fluctuations, with the risk mainly related to Bitcoin price movements, while the exposure of Bitcoin futures ETFs is an indirect exposure to Bitcoin price and risk, influenced by Bitcoin volatility and the complexity of the contract market (such as leverage and expiration dates).
2. Taxation of ETF Investments
The operation of ETFs mainly involves several aspects: creation and redemption of shares, and investors receiving returns (dividends, income from market trading through spreads).
2.1 Creation and Redemption
The "creation and redemption" mechanism is how ETFs obtain market exposure and is crucial to the operation of ETFs. Unlike mutual fund shares, retail investors can only buy and sell ETF shares in the market. Therefore, ETFs do not directly sell individual shares to retail investors or directly redeem individual shares from retail investors, but rely on Authorized Participants (APs). APs can be market makers, experts, or any other large financial institutions.
ETF share creation refers to when the ETF's share price is higher than its net asset value, and the ETF company wants to create new shares for its fund, it seeks the help of APs. APs purchase shares from the ETF by assembling and depositing a specified basket of securities and cash into the fund, exchanging ETF shares in-kind, thereby avoiding sales and capital gains taxes.
ETF redemption refers to when the ETF's share price is lower than its net asset value, and the redemption process is the opposite of the creation process. APs purchase a large number of ETF shares on the open market and deliver these shares to the fund. In return, APs receive a predefined basket of individual securities or cash equivalents. Redemption is also an in-kind exchange, thus avoiding capital gains taxes.
However, once APs receive ETF shares in the creation process, they are free to sell ETF shares to individual investors, institutions, or market makers in the secondary market at a price difference, triggering a taxable event, requiring payment of capital gains tax or income tax.
2.2 Returns Received by Investors
Investors need to pay personal income tax at a certain tax rate on stock dividends and dividend income obtained from the fund.
In addition, when investors buy and sell ETF shares in the market and earn income through spreads, they need to pay capital gains tax based on the selling price minus the buying price. When foreign investors purchase their country's ETF and receive interest dividends, they may be subject to withholding tax, which is a form of income tax levied by a country at the source. This tax is mainly levied when non-residents receive stock dividends and bond interest, for example, U.S. residents purchasing U.S. ETFs may not be subject to withholding tax, while Singapore residents investing in U.S. ETFs may be subject to withholding tax.
3. Tax Treatment for U.S. Residents Investing in U.S. Bitcoin ETFs
The taxation of Bitcoin ETFs at the lower level is generally similar to other ETFs, involving capital gains tax, income tax, and withholding tax. In the sale and redemption of ETFs, the sale is a capital gains tax event, while redemption is not a taxable event and does not require taxation.
3.1 Tax Treatment for U.S. Tax Resident Investing in Bitcoin Futures ETFs
The tax treatment of Bitcoin futures ETFs depends on the specific type of futures contracts the ETF invests in. Specific futures contracts are divided into two types:
(1) Exposure to regulated futures contracts ETF:
This refers to an ETF that holds a certain quantity or proportion of regulated futures contracts in its portfolio, making the ETF sensitive to the market performance, price fluctuations, or related risks of these contracts. According to Section 1256 of the U.S. Internal Revenue Code (IRC), "regulated futures contracts" refer to contracts that meet the following conditions: (a) the amount required to be deposited and the amount allowed to be withdrawn depend on the marking to market mechanism; (b) the contract is traded on a compliant exchange or is subject to its rules.
For Bitcoin futures ETFs, if their investment portfolio includes Bitcoin contracts traded on the Chicago Mercantile Exchange (Bitcoin contracts are generally traded on the Chicago Mercantile Exchange), since this exchange is a compliant exchange, the ETF falls under exposure to regulated futures contracts.
If a Bitcoin ETF's investment portfolio includes regulated futures contracts as defined in Section 1256 of the IRC, regardless of how long investors hold these ETFs (even if it's just for one day), when they sell the ETF and make a profit, 60% of the profit will be treated as long-term capital gains, and 40% will be treated as short-term capital gains.
(2) Exposure to unregulated futures contracts ETF:
This refers to an ETF whose investment portfolio only trades contracts in informal, unregulated markets, such as over-the-counter (OTC) contracts. These contracts may not be regulated or may be subject to limited regulation, and their terms and conditions can be freely negotiated between trading counterparties. These ETFs generally have higher risks due to the lack of standardization and trading transparency.
The taxation of these ETFs is consistent with the taxation of general capital gains and is also consistent with the taxation of spot Bitcoin ETFs; this will be further discussed below.
3.2 Tax Treatment for U.S. Tax Resident Investing in Bitcoin Spot ETFs
The tax rules for spot Bitcoin ETFs are consistent with the general capital gains tax rules. If the assets of a Bitcoin ETF are sold before holding them for less than a year, the resulting short-term capital gains are subject to ordinary income tax. If the shares are held for more than 12 months before being sold, the resulting long-term capital gains are subject to capital gains tax. The specific tax rates depend on the investor's tax filing status and income level.
3.3 Tax Rates for U.S. Resident Individuals and Businesses Investing in ETFs
3.3.1 Tax Rates for U.S. Resident Individuals
Long-term capital gains: Long-term capital gains are divided into three tax brackets of 0%, 15%, and 20% based on the investor's total taxable income and tax filing status. For single taxpayers or heads of households, long-term capital gains up to $44,625 are tax-free; long-term capital gains between $44,625 and $492,300 are taxed at a rate of 15%; and the portion exceeding $492,300 is taxed at a rate of 20%.
Short-term capital gains/dividend income: Taxed at income tax rates ranging from 10% to 37%, depending on the total taxable income and tax filing status. For example, for single taxpayers or heads of households, the applicable tax rate is 10% for taxable income up to $11,000, and 37% for taxable income over $578,125.
Other taxes: If an investor's net investment income or modified adjusted gross income (MAGI) exceeds specific thresholds, the income above those thresholds may be subject to a 3.8% Net Investment Income Tax (NIIT). The thresholds for NIIT are $200,000 for single taxpayers or heads of households, $250,000 for married taxpayers filing jointly, and $125,000 for married taxpayers filing separately.
3.3.2 Tax Rates for U.S. Resident Businesses
The taxation of ETFs for businesses is similar to that for individuals, including the recognition of long-term and short-term capital gains. The tax rate for net capital gains is 21%. For businesses, gains and losses from the sale or exchange of capital assets held for more than 12 months are considered long-term capital gains or losses. Gains and losses from the sale or exchange of capital assets held for 12 months or less are considered short-term capital gains or losses. Net long-term capital gains exceeding net short-term capital losses are considered net capital gains and are taxed based on this amount. If there are long-term capital gains losses and short-term gains, the short-term gains can be taxed first and cannot be used to offset long-term losses.
3.4 Special Provisions for U.S. ETF Taxation
Bitcoin ETFs are also subject to the wash-sale rule. A wash sale refers to the sale or trade of securities at a loss and the purchase of "substantially identical" securities within 30 days before or after the sale. If a loss is deemed invalid, the wash-sale loss cannot be deducted and will be added to the cost basis of the new Bitcoin ETF, thereby increasing the cost basis. This cost adjustment effectively defers the tax deduction for the loss until the disposal of the new Bitcoin ETF. Additionally, the holding period for the new Bitcoin ETF must include the previous holding period of the sold Bitcoin ETF.
If an ETF's underlying assets include not only Bitcoin but also other assets such as currencies, futures, and metals, specific tax rules apply to individual investments in these special asset ETFs.
Currency ETFs: Most currency ETFs are structured as grantor trusts, meaning that profits from the trust create tax obligations for ETF holders and are taxed as ordinary income. This type of ETF does not have special tax treatment such as long-term capital gains, even if the ETF has been held for several years. Since currency ETFs involve currency pair trading, tax authorities assume that these trades are short-term.
Futures ETFs: These funds trade futures contracts of commodities, stocks, U.S. Treasury bonds, and currencies. Regardless of the holding period, gains and losses from these ETFs' futures contracts are taxed at a ratio of 60% long-term and 40% short-term. In addition, ETFs trading futures contracts must follow the mark-to-market valuation rule at the end of the year. This means that unrealized gains at year-end are treated as sales and are subject to taxation.
Metal ETFs: Trading or investing in gold, silver, or platinum is considered "collectibles" in the eyes of tax authorities, and this policy also applies to trading or holding metal ETFs. For individuals, gains from collectibles are taxed as ordinary income if they are short-term. If held for more than 1 year, they are taxed at a higher 28% capital gains tax rate, which means they do not benefit from the normal long-term capital gains tax rate.
4. Tax Treatment for Hong Kong Residents Investing in Bitcoin ETFs
When Hong Kong investors invest in Bitcoin ETFs from other countries or regions, they may be subject to withholding tax. For example, if a Hong Kong resident invests in a U.S. Bitcoin ETF: Since there is no Double Taxation Agreement (DTA) between Hong Kong and the U.S., as non-U.S. tax residents, Hong Kong investors are required to pay a 30% withholding tax on dividends from U.S. ETFs. However, since Bitcoin ETFs do not generate dividends, there is no withholding tax issue. Additionally, Hong Kong residents investing in U.S. ETFs are not required to pay capital gains tax, only taxes as per Hong Kong regulations.
On the income tax front in Hong Kong, due to the territorial sourcing principle adopted in Hong Kong tax law, income generated outside of Hong Kong is generally not subject to taxation in Hong Kong. Therefore, unless the trading or gains from Bitcoin ETFs have specific Hong Kong elements, Hong Kong investors typically do not need to pay additional taxes on these gains in Hong Kong.
5. Tax Treatment for Singapore Residents Investing in Bitcoin ETFs
When Singapore investors invest in Bitcoin ETFs from other countries or regions, they may be subject to withholding tax. For example, if a Singapore resident invests in a U.S. Bitcoin ETF: Since there is no DTA between Singapore and the U.S., Singapore investors are required to pay a 30% withholding tax on dividends from U.S. ETFs, similar to Hong Kong investors. However, similarly, since Bitcoin ETFs do not generate dividends, there is no withholding tax issue; and Singapore residents investing in U.S. ETFs are not required to pay capital gains tax, only taxes as per Singapore regulations.
Singapore tax law also follows the territorial sourcing principle, only taxing income that is derived from or sourced in Singapore. However, Singapore tax law stipulates that if income derived from outside Singapore is remitted, transmitted, or brought into Singapore, it is also considered "sourced in Singapore" income.
Individual investors who remit income from Bitcoin ETF investments into Singapore generally need to pay personal income tax on that income. Singapore's personal income tax ranges from 0% to 24% in 2024, depending on the individual's taxable income.
Singapore resident businesses are exempt from tax on foreign-sourced dividend income if: (1) the highest corporate tax rate (headline tax rate) in the foreign country generating the income is at least 15% when the income is received in Singapore; (2) the income has been taxed in the foreign country; and (3) the exemption is deemed beneficial to the resident company by the authorities.
With adjustments to Singapore tax law, from January 1, 2024, gains from the sale of foreign assets may be subject to tax when remitted into Singapore under specific conditions, reflecting Singapore's gradual alignment with international tax standards. However, for income from Bitcoin ETF investments, if the income is not remitted into Singapore, investors generally only need to fulfill their withholding tax obligations to the U.S.
6. Conclusion and Recommendations
By examining the tax treatment of Bitcoin ETF investments for U.S., Hong Kong, and Singapore residents, it is evident that the taxation of Bitcoin ETFs is influenced by factors such as the ETF's place of registration and type, the investor's place of residence, and the jurisdiction of the investment target. Investors can plan their ETF tax burden and profits reasonably by understanding the tax policies of their place of residence and the ETF's place of registration in the creation and redemption, as well as the returns received by Bitcoin investors.
As cryptocurrency ETFs become a global hot topic, TaxDAO will analyze the regulatory and tax policies of cryptocurrency ETFs in major countries through special topics on ETF investments. We welcome readers to follow along.
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