Skip to main content
SearchLoginLogin or Signup

An Exploration on Cryptocurrency Corporations’ Fiscal Opportunities

Published onMay 02, 2023
An Exploration on Cryptocurrency Corporations’ Fiscal Opportunities
·

KEYWORDS

Decentralized finance, cryptocurrencies, fiscal evasion opportunities, corporations, exploratory

Introduction

Cryptocurrencies’ fast-growing worth coupled with recent developments in blockchain technologies has given a momentum for the decentralized finance industry to emerge. Enterprises in this industry are developing transparent, open-source and permissionless online financial services. In 2021, the industry handled close to US$2.3 trillion. Given its increased popularity, governments worldwide have started to issue new legislations regarding cryptocurrency uses, or to modify existing ones (Salami 2021) (Ducas and Wilner 2017) (Ponsford 2015).

Whilst decentralization allows for greater freedom than does the traditional financial system, decentralized finance enterprises still need to have a certain legal structure. Indeed, although these enterprises are often shown as independent from the traditional system, they need to legally establish themselves. Hence, they need to face and comply with new legislations. However, the purpose of decentralized finance technologies is to enable pseudo-anonymous online transactions without the intervention of a third party. The ideology behind such technologies is liberal (and even libertarian for some) and aims to reduce the intervention of institutions such as governments or banks in the digital economy (Campbell-Verduyn 2018). Thus, regulating cryptocurrency transactions runs counter to the very reasons they have been developed. Alternatively, decentralized finance enterprises may relocate their operations to offshore jurisdictions, just like traditional enterprises. Offshore jurisdictions offer non-resident corporations one or more of the following advantages: 1) bank secrecy allowing for a high level of opacity on account holders; 2) low or near-zero tax rates on corporations’ incomes or capital gains; and 3) a lax legal framework to evade certain norms, such as data retention standards or the "know your customer" principle [1](Alstadsæter et al. 2022; Yeoh 2018; Garcia-Bernardo et al. 2017)(Alstadsæter et al. 2022; Yeoh 2018; Garcia-Bernardo et al. 2017)(Alstadsæter et al. 2022; Yeoh 2018; Garcia-Bernardo et al. 2017).

Beyond such offshore jurisdictions, given the novelty of cryptocurrencies and the lack of legislation in specific jurisdictions, decentralized finance enterprises may find similar fiscal opportunities. Nevertheless, assessing such new opportunities is complex as many factors come into play, from considering tax laws on cryptocurrencies to evaluating specific legislations that may be advantageous to considering the jurisdictions’ political stability, to name a few. Still, investigating these opportunities as they emerge, as well as understanding the global landscape surrounding tax evasion for decentralized finance enterprises, is paramount. It is the first step in preventing cryptocurrency capital flight, especially considering the amount of money handled by the decentralized finance industry as of today.

This study explores tax evasion opportunities for decentralized finance enterprises through two objectives. First, to what extent jurisdictions, considering their corporate tax levels, apply their tax laws to cryptocurrencies is evaluated. Second, how such evasion opportunities relate to jurisdictions’ level of financial development and cryptocurrency adoption is assessed. The latter forms a proxy to measure a jurisdiction’s capability to accommodate decentralized finance enterprises.

To do so, we leverage key data sources, including PWC’s Worldwide Tax Summaries, the 2021 Law Library of Congress’s report on the Regulation of Cryptocurrency, financial indexes from the International Monetary Fund (IMF) and Chainalysis’s Cryptocurrency Adoption Index. From these data sources, for each jurisdiction, variables on corporate income tax (CIT) and capital gains tax (CGT), the tax laws on cryptocurrencies, the level of financial development and the level of cryptocurrency adoption were extracted. Then, we explored tax evasion opportunities by linking jurisdictions’ CIT/CGT rates with tax laws on cryptocurrencies. To consider a jurisdiction’s capability to accommodate decentralized finance enterprises, we used the machine learning tool Uniform Manifold Approximation and Projection for dimension reduction (UMAP), which allowed us to visualize the features of jurisdictions all together.

All in all, the study highlights that:

  • Traditional offshore jurisdictions represent tax evasion opportunities for decentralized finance enterprises.

  • Beyond these offshore jurisdictions, there exist a substantial number of additional tax evasion opportunities for decentralized finance enterprises.

  • In general, a jurisdiction’s high financial development does not necessarily translate to high cryptocurrency adoption.

Through its exploratory stage, this study opens a vast array of research avenues related to tax evasion and decentralized finance.

Context

Corporations may commit tax evasion and tax avoidance through offshore jurisdictions. Indeed, as fiscal regulation can be perceived as a stress on organisations, they might try to reduce it by being active in many jurisdictions, including fiscally advantageous ones (Phillips, Petersen, and Palan 2021). To do so, corporations transfer their profits to subsidiaries or branches located in countries with more favorable tax policies. This can be accomplished through loans or transactions between these entities, as well as through contracts or payments for intellectual property to companies based in jurisdictions with lower tax rates. Incoherencies between fiscal policies and treaties can also create tax evasion opportunities (Gravelle 2009). Tax evasion through offshore jurisdictions has been observed in the traditional finance industry as was exposed by the Panama Papers and Lux Leaks scandals (“Leaked Documents Expose Global Companies’ Secret Tax Deals in Luxembourg - ICIJ” 2014)(“Giant Leak of Offshore Financial Records Exposes Global Array of Crime and Corruption - ICIJ” 2016). Jurisdictions which offer advantageous tax policies are also available to the decentralized finance industry, yet there may be additional opportunities with cryptocurrencies.

This study explores tax evasion opportunities for decentralized finance enterprises. As we consider the taxation of cryptocurrencies, the focus is set on decentralized finance enterprises with crypto revenue. Such revenue may take many forms, such as trading fees for exchanges or spread for staking services as well as transaction fees in the case of payment services. Crypto revenue also includes investment firms realizing capital gains by trading cryptocurrencies. For decentralized finance enterprises, corporate profits may be taxed as income or as capital gains, depending on the activities through which they are realized.

Given that cryptocurrency exchanges do not systematically share information with tax authorities, individual investors may use them to commit tax fraud. This is changing as, for example, the American Internal Revenue Service (IRS) has announced that, starting in 2023, exchanges will have to share information with the government agency (IRS 2022). This should bring the state an estimated additional tax revenue of 28 billion US$ on crypto capital gains (Weil 2022). Despite this measure affecting mostly individual investors, it is an indicator that regulators are closing in on tax evasion involving cryptocurrencies. There are already some cases of companies being charged with tax fraud regarding their crypto revenue, yet many more cases will be revealed as more resources are allocated (Canada 2003). Hence, exploring global tax evasion opportunities for decentralized finance enterprises is a first step at understanding the size and scope of the fiscal challenge to be tackled by regulators worldwide.

Data and Methods

Dataset

To analyze tax evasion opportunities, six variables from four data sources were extracted: (1) corporate income tax (CIT), (2) capital gains tax (CGT), (3) tax laws on cryptocurrencies, (4) Financial Institutions Index, (5) Financial Markets Index and (6) Cryptocurrency Adoption Index. Each variable, and its related data source, is presented below.

Corporate Income Tax (CIT) and Capital Gains Tax (CGT): To determine fiscally advantageous jurisdictions, we used PWC’s Worldwide Tax Summaries(“Worldwide Tax Summaries Online” n.d.). It is a well-established and open resource that includes information on corporate and individual tax rates worldwide. From the 2021 dataset, we extracted the corporate income tax (CIT) and the capital gains tax (CGT). In many jurisdictions, capital gains might be included in a corporation’s revenue and taxed as CIT while others do not include it in their fiscal regime. However, it is necessary to consider CGT as some jurisdictions might be fiscally advantageous only in this aspect. Cryptocurrency-generated income may be taxed under any of those categories, depending on the status or the use of cryptocurrency (or digital assets) in a chosen jurisdiction. As we built the dataset, there were five jurisdictions1 for which we had data on all variables except CIT and CGT. To avoid deleting these jurisdictions during the analysis, we manually collected their CIT and CGT rates on their respective government websites. This led us to gather information for 162 jurisdictions.

Table 1 below presents the descriptive statistics for the CIT and CGT for 162 jurisdictions. On average, the corporate income tax (CIT) is 21% (std=0.9), with a minimum of zero and a maximum of 40%. The average capital gains tax (CGT), on the other hand, is, on average, 17% (std=0.10), with a minimum of zero and a maximum of 35%.

Table 1 – Descriptive Statistics for CIT and CGT

N

Min

Mean (std)

Med

Max

CIT

162

0

0.21 (0.09)

0.22

0.40

CGT

162

0

0.17 (0.10)

0.20

0.35

Figure 1 presents the distributions of both variables, along with a scatterplot to depict their relations. As shown in the Figure, CIT and CGT correlate at 0.59, illustrating that, although related (jurisdictions that have high CIT will tend to have high CGT), they still differ. Indeed, some jurisdictions have high CIT but low CGT, which can represent an opportunity for fiscal evasion.

Figure 1 – Pair plots CIT-CGT

In 2021, the Organisation for Economic Co-operation and Development (OECD) agreed on a global minimum tax rate of 15% to prevent multinational enterprises from taking advantage of differing tax regimes. This new framework was signed by 137 countries and was supposed to be enforced in 2023 (“Tax Challenges Arising from the Digitalisation of the Economy – Global Anti-Base Erosion Model Rules (Pillar Two) - OECD” n.d.). Although potentially a game changer, as of today this standard has not been enforced in most jurisdictions. Thus, the data gathered for this study is still up to date, as the minimum rate will not be enforced until at least 2024 (“The Latest on the Global Tax Agreement: The EU Adopts Pillar Two” 2022).

We used this 15% rate as a threshold to separate what we defined as advantageous and non-advantageous fiscal jurisdictions. Those who set CIT and/or CGT lower than the global standard are considered advantageous fiscal jurisdictions while those who set their CIT and/or CGT equal to or above the global standard are considered non-advantageous fiscal jurisdictions.

Tax laws on Cryptocurrencies: To assess whether a jurisdiction applies tax laws on cryptocurrencies or not, we used the 2021 Law Library of Congress’s report on the Regulation of cryptocurrency around the world (The Law Library of Congress 2021) produced by the US Global Legal Research Directorate. This document reports tax laws on cryptocurrencies and the regulatory framework surrounding them in 137 jurisdictions. Specifically, it classifies whether the jurisdictions apply tax laws and anti-money laundering and counter-financing of terrorism laws (AML/CFT laws) to cryptocurrencies. We collected from the documents whether a jurisdiction applies tax laws to cryptocurrencies or does not. However, nine jurisdictions were reported with an “unclear” application of tax laws. We manually investigated each of them and we could clarify the outcome only for one: the Philippines, which has specified that their tax laws apply to cryptocurrencies. For the remaining eight jurisdictions, due to the absence of information on their government websites, we inferred that tax laws are not applied to cryptocurrencies (as otherwise, pieces of legislation would be available)2.

Financial Institution and Financial Market Indexes: To determine the level of financial infrastructure in each jurisdiction (and thus if an opportunity can be exploited by decentralized finance companies), we used datasets created by the International Monetary Fund (IMF). Specifically, we selected the 2021 Financial Institution Index and the 2021 Financial Market Index for 189 jurisdictions, which are part of the IMF’s Financial Development Index. In some cases, as 2021 data was unavailable, we used 2020 data. The Financial Institutions Index captures the level of development of the banking sector through three subindexes: accessibility (ex: # of bank branches per capita), depth (ex: pension fund/GDP) and efficiency (ex: return on equity). The Financial Markets Index captures the level of development of the stock market and the debt market through three subindexes: accessibility (ex: # of debt issuers), depth (ex: stock market cap/GDP) and efficiency (ex: stock market turnover ratio). Those subindexes are aggregated and normalized on a 0-1 scale. The Financial Institutions Index and the Financial Markets Index represent the mean of those subindexes. The result ranges from 0 to 1, 1 being the most developed (“IMF DATA Access to Macroeconomic & Financial Data” n.d.).

Table 2 presents the descriptive statistics for both indexes. Hence, on average, jurisdictions score 0.46 (std=0.20) on the Financial Institutions Index, with a minimum of 0.8 and a maximum of 0.95. For the Financial Markets Index, on average, jurisdictions score 0.24 (std=0.27), with a minimum of zero and a maximum of 0.92. Figure 2 presents the distributions of both indexes, along with scatterplots mapping their relationship. Although the two indexes are related, with a Pearson correlation coefficient of 0.72, they capture different measures of a jurisdiction’s financial development. Many jurisdictions score zero in the Financial Markets Index, meaning that their stock and debt markets are nearly inaccessible, inefficient and/or lack depth. For example, some jurisdictions do not have their own stock exchange, such as Antigua and Barbuda or St Kitts and Nevis, which share the Eastern Caribbean Securities Exchange with six other Caribbean islands (“ECSE – Eastern Caribbean Securities Exchange” n.d.).

Table 2 – Descriptive Statistics Financial Institutions and Financial Market Indexes

N

Min

Mean (std)

Med

Max

FII

134

0.08

0.46 (0.20)

0.45

0.95

FMI

134

0

0.24 (0.27)

0.10

0.92

Figure 2 – Pair plots of Financial Institutions and Financial Market Indexes

Note that GDP per capita was not considered as a proper indicator of financial development, due to many discrepancies in the measure for the purpose of this study. For example, Ireland has the second-highest GDP per capita in EU yet its financial institutions and markets are much less developed than those of other Western European jurisdictions. In this case, this discrepancy can be explained by Ireland’s role as a haven for the registration of intellectual property (Law Society Gazette Ireland 2022). On the other hand, Hong Kong’s GDP per capita is less than half of Ireland’s yet its level of financial development is much higher. Also, additional country-specific characteristics were not included in the analysis. The idea was to explore tax evasion opportunities for decentralized finance enterprises considering tax rates, tax laws on cryptocurrencies and the capability of jurisdictions to host such enterprises.

Level of cryptocurrency adoption: Finally, to capture the level of cryptocurrency adoption in a jurisdiction, we used the 2022 Cryptocurrency Adoption Index ranking published by Chainalysis (Chainalysis 2022). This allowed us to consider the use of cryptocurrencies in a jurisdiction as opposed to other features. According to the documentation, to create the index, web traffic from cryptocurrency services was analyzed using Similarweb, which collects web traffic data (“Similarweb” n.d.). Specifically, the Cryptocurrency Adoption Index is based on five sub-indexes that capture a jurisdiction’s usage of different cryptocurrency services: 1) Centralized service value received ranking, 2) Retail centralized service value received ranking, 3) P2P exchange trade volume ranking, 4) DeFi (decentralized finance) value received ranking, 5) Retail DeFi (decentralized finance) value received ranking. From these sub-indexes, a score is calculated and 146 countries are ranked from 1 (highest cryptocurrency adoption) to 146 (lowest cryptocurrency adoption). We gathered the rank for the 146 jurisdictions. Due to the analysis (presented below) that requires having similar scales in the variables, we rescaled the variable from 0 to 1 by dividing the rank by 146. Then, for easier interpretation, we inversed the variable so 0 means lower cryptocurrency adoption and 1 means higher cryptocurrency adoption. Hence, in this study, the closer the jurisdictions’ final score is to 1, the higher the rank.

Final sample: By combining all datasets, we gathered information on CGT, CIT and tax laws on cryptocurrencies for 114 jurisdictions. Additionally, when considering information from the Financial Institutions Index, the Financial Markets Index and the Cryptocurrency Adoption Index, the dataset reduced to 91 jurisdictions.

Analytical Strategy

Quantifying opportunities: In the results section, we link three key variables together: 1) CIT, 2) CGT and 3) tax laws on cryptocurrencies, through a Sankey graph and report descriptive statistics related to them.

Exploring capability: To capture how financial capability (financial development and cryptocurrency adoption) relates to fiscal opportunities, the visualization technique UMAP: Uniform Manifold Approximation and Projection for Dimension Reduction, developed by McInnes et al. (2020), was used. Specifically, UMAP is a dimension reduction technique that projects high-dimensional data into lower dimensions. While doing so, it keeps the underlying structure (local and global) between the data points. UMAP has recently been used to assess intricate relationships in various fields, including cybersecurity (Paquet-Clouston et al. 2022), biotechnology (Becht et al. 2019) and population genetics (Dorrity et al. 2020).

For this study, the data points (jurisdictions) were projected from R6 (the six variables: CIT, CGT, tax laws on crypto, Financial Institutions Index, Financial Markets Index and the Cryptocurrency Adoption Index) to a visual plane R2. In the visual representation, the x and y coordinates of each point do not have semantic meaning (and thus we removed them from the representation in Figure 3); it is rather the distance between the points that matters.

Also, during the analysis, two important parameters needed to be adjusted: the minimal number of neighbors for each point in the original dimension and a distance measure. The first parameter balances between the local and global structure of the data by constraining the size of the local neighborhood when doing the approximation and projection (McInnes, Healy, and Melville 2020). The second parameter determines the tightness of the representation: to what extent the points can be packed together. These parameters are usually adjusted to create the best representation possible of the data points, which, for this study, resulted in n_neighbors = 10 and min_dist = 0.7. Note that when tweaking the parameters, the resulting representations were similar, and we chose the one that was the easiest to interpret from.

Testing observed relationships: UMAP allowed us to visualize high-dimensional data in lower dimensions. To assess whether the relationships observed are statistically significant, pairwise tests were employed and are reported below. More precisely, Mann-Whitney U Tests were computed to compare groups, such as jurisdictions that apply tax laws to cryptocurrencies versus those that do not. This nonparametric test ranks the respective values of each group and compares them (Shier 2004). It was favored over other parametric tests because of the small sample sizes (and uneven distributions) when creating groups of jurisdictions. For the tests, the null hypothesis (H0H_{0}) was: there is no difference between the two groups, and the alternative hypothesis (H1H_{1}) was: there is a difference between the two groups. For comparison of two continuous variables, Pearson correlations were computed. For these tests, the null hypothesis (H0H_{0}) was: there is no linear association between the two variables, and the alternative hypothesis (H1H_{1}) was: there is a linear association between the two variables. The significance level of the tests (α) was set to 0.05, meaning there is a 5% risk of concluding that a difference exists when there is no difference.

Results

Jurisdictions’ Tax Laws on Crypto, CIT and CGT

Of the 114 jurisdictions surveyed, 60% apply their tax laws to cryptocurrencies, and 40% do not. How these jurisdictions are distributed among advantageous fiscal jurisdictions and non-advantageous ones, considering both CIT and CGT, is presented below. To visualize the patterns, we also created a Sankey graph, depicted in Figure 3.

Table 3 – Jurisdictions distribution based on CIT, CGT and application of tax laws on cryptocurrency (N=114)

High CIT, High CGT

High CIT, Low CGT

Low CIT, High CGT

Low CIT, Low CGT

Tax on Crypto

47%

(N=53)

6%

(N=7)

0%

(N=0)

7%

(N=8)

No tax on crypto

23%

(N=26)

6%

(N=7)

0%

(N=0)

11%

(N=13)

Figure 3 – Relationship between tax laws on cryptocurrency and level of CIT and CGT

From the 60% of jurisdictions that apply tax laws to cryptocurrencies, 47% (N=53) have high CIT and high CGT, as shown by the gray line in the Sankey graph. They do not represent opportunities for either traditional finance or decentralized finance. A total of 6% (N=7) of jurisdictions have high CIT and low CGT, as shown by the green line. These jurisdictions may seem incoherent in their fiscal policy. For example, there is no CGT in Singapore while its CIT is as high as 17%. Yet, depending on the status given to cryptocurrencies, such jurisdictions can represent opportunities if revenues from cryptocurrencies are considered/interpreted as a capital gain.

There are no cases of low CIT and high CGT. The dark blue line in the Sankey graph represents the 7% (N=8) of jurisdictions with a low CIT and CGT. Those places, such as the British Crown Dependencies of Jersey and Guernsey, are opportunities for both traditional finance and decentralized finance.

On the other hand, of the 40% of jurisdictions that do not apply tax laws to cryptocurrencies, 23% (N=26) present high CIT and CGT. Those jurisdictions, depicted by the lower gray line, represent evasion opportunities for cryptocurrencies despite high taxation as the fiscal regime is not applied. Saudi Arabia is one of those countries where the decentralized finance industry is particularly unregulated (“Cryptocurrency Regulations by Country” 2022). The 6% (N=7) of jurisdictions which have high CIT and low CGT, as shown by the purple line, are opportunities for both traditional and decentralized finance when considering CGT. Additionally, decentralized enterprises, since the fiscal regime is not applied, represent evasion opportunities despite their high CIT.

Again, there are no cases of low CIT and high CGT. The black line represents the 11% (N=13) of jurisdictions with a low CIT and CGT. Those are opportunities for both traditional and decentralized finance and include infamous offshore jurisdictions like Bermuda and the Cayman Islands (“Tax Haven Ranking Shows Countries Setting Global Tax Rules Do Most to Help Firms Bend Them” n.d.).

The analysis of the fiscal frameworks regarding cryptocurrencies shows how opportunities for decentralized finance enterprises may differ from those available to traditional finance. This is due to several jurisdictions not applying tax laws on cryptocurrencies or applying them but offering low CIT and/or CGT rates.

Figure 4 - Exploring Jurisdictions’ Capability

However, note that one’s deregulated market could be unexploitable due to poor financial development. It may also be more interesting for an enterprise to register its activities where the cryptocurrencies are not totally unknown by the population. Hence, all opportunities presented above are not necessarily advantageous for decentralized finance enterprises. While considering jurisdictions’ CIT, CGT and whether they apply tax laws to cryptocurrencies, we explore jurisdictions’ capabilities to host decentralized finance enterprises. To do so, we assess jurisdictions’ levels of financial development and cryptocurrency adoption through a UMAP projection. Figure 3 presents this projection,

which includes 91 jurisdictions (the data points) divided in three distinct clusters (upper, middle, and lower), and is repeated in six graphs. Each graph shows how a variable (dimension) is distributed in the representation. Remember that the x- and y-axes do not have any meaning; it is rather the distance between the points that matter.

The first three subgraphs represent a different assessment on what was presented above. They also give context to the clusters, allowing us to better understand their meaning in the projection. In short, the first two graphs (CIT (1: > 15%) and CGT (1: > 15%)) depict that there are more opportunities on the CGT aspect than the CIT, as only a few jurisdictions have a lower than 15% rate on CIT. It also shows that all opportunities on the CIT aspect are also opportunities on the CGT aspect, captured in the middle cluster. The subgraph Cryptocurrency Tax Laws (1: Yes) illustrates how jurisdictions are distributed based on whether they apply their tax laws to cryptocurrencies or not. It shows that the clusters at the bottom center and half of the middle both include jurisdictions that do not apply tax laws on cryptocurrencies.

When we compare these three subgraphs, we see that the top and the largest cluster includes all jurisdictions that apply tax laws but also have high CIT and high CGT. The bottom-left cluster represents all jurisdictions that have high CIT and high CGT but do not apply tax laws on cryptocurrencies, which could represent evasion opportunities. The middle cluster includes both high and low CIT jurisdictions, only low CGT jurisdictions and mixed jurisdictions in terms of applying tax laws. The center of the cluster is composed of fiscally attractive jurisdictions as they offer either low CIT and CGT rates or only low CGT rates while also not applying tax laws.

The three additional subgraphs consider jurisdictions’ capabilities in terms of financial development and cryptocurrency adoption. The Financial Institutions Index (1: high) and the Financial Markets Index (1: high) graphs show that jurisdictions that apply tax laws to cryptocurrencies tend to have a higher level of financial development on both those variables. This was confirmed with a pairwise test (UU= 402, pp=0.000) as the score for the Financial Institutions Index (x  =0.61\overline{x\ }\ = 0.61, σ=0.18 ,\sigma = 0.18\ , x~ = 0.6\widetilde{x}\ = \ 0.6) for jurisdictions that apply tax laws on cryptocurrencies significantly differed from the score for those who do not (x  =0.42\overline{x\ }\ = 0.42, σ=0.16 ,\sigma = 0.16\ , x~ = 0.42\widetilde{x}\ = \ 0.42). It also differed significantly (UU= 437, pp=0.000) from the Financial Markets Index between jurisdictions that apply tax laws (x  =0.44\overline{x\ }\ = 0.44, σ=0.30 ,\sigma = 0.30\ , x~ = 0.49\widetilde{x}\ = \ 0.49) versus those who do not (x  =0.18\overline{x\ }\ = 0.18, σ=0.18 ,\sigma = 0.18\ , x~ = 0.15\widetilde{x}\ = \ 0.15).

The last subgraph, the Cryptocurrency Adoption Index (1: High), shows that jurisdictions in the upper left hand of the top cluster have high CIT and CGT, as well as high cryptocurrency adoption. This was corroborated as we find there are significant differences (UU= 174, pp=0.014) in the cryptocurrency adoption scores of jurisdictions that have high CIT (x  =0.58\overline{x\ }\ = 0.58, σ=0.30 ,\sigma = 0.30\ , x~ = 0.61\widetilde{x}\ = \ 0.61) compared to those that have low CIT (x  =0.33\overline{x\ }\ = 0.33, σ=0.27 ,\sigma = 0.27\ , x~ = 0.29\widetilde{x}\ = \ 0.29). There are also significant differences (UU= 502, pp=0.014) between the cryptocurrency adoption scores of jurisdictions that have high CGT (x  =0.59\overline{x\ }\ = 0.59, σ=0.30 ,\sigma = 0.30\ , x~ = 0.66\widetilde{x}\ = \ 0.66), compared to those with low CGT (x  =0.43\overline{x\ }\ = 0.43, σ=0.28 ,\sigma = 0.28\ , x~ = 0.46\widetilde{x}\ = \ 0.46).

In terms of applying tax laws, the upper cluster includes jurisdictions that have high cryptocurrency adoption and apply tax laws while the bottom cluster also includes jurisdictions with high cryptocurrency adoption but do not apply tax laws. This divided trend is observed in the statistics as well, as there are no significant differences (UU= 815, pp=0.20) in the Cryptocurrency Adoption Index score of jurisdictions that apply tax laws to cryptocurrencies compared to those who do.

Finally, from the projection, it is difficult to conclude whether there exists a relationship between the Cryptocurrency Adoption Index and the Financial Development Index (Institutions and Markets). A Pearson correlation shows that there exists no significant relationship between the Financial Institutions Index score and the Cryptocurrency Adoption Index score (rr = 0.03, pp=0.76). However, there exists a weak and significant correlation between the Cryptocurrency Adoption Index score and the Financial Markets Index score (rr = 0.23, pp=0.03), which means that the more developed a jurisdiction financial market is, the higher the cryptocurrency adoption level is, on average.

Discussion

We discuss the results of this study through three key takeaways below, while providing avenues for further research.

Traditional offshore jurisdictions are available to decentralized finance enterprises: When investigating tax evasion opportunities for decentralized finance enterprises, one realizes that some opportunities are obvious and easy to identify as they include all jurisdictions that have zero or near zero tax rates on CIT and/or CGT. They represent the middle cluster in the UMAP projection and are available for both traditional and decentralized finance enterprises. As shown in the results of this study, about half of them officially apply their tax laws to cryptocurrencies (N=15), while others do not (N=20). Yet, no matter what, the opportunity is still there. Such jurisdictions include the Bahamas, Singapore and Malta and are considered tax havens(“Corporate Tax Haven Index - 2021 Results” n.d.).

Moreover, to date, several offshore jurisdictions have already been recognized as of interest to proponents of decentralized finance. For example, Puerto Rico waved the capital gains tax on cryptoassets for residents, which attracted lots of American investors (“Could Puerto Rico Be Your Crypto Tax Haven?” 2022). The island of Malta is also known as the “island of the blockchain” for its friendly regulation of digital assets (“Malta Becomes the Blockchain Island After the Parliament Passes Three Bills That Create a Regulatory Framework for Blockchain Technology” n.d.). El Salvador is now famous for being the first jurisdiction to adopt Bitcoin as a legal tender, which is certainly a plus for international investors who are exempted from taxes since Bitcoin is considered as a currency (“Foreign Investors Exempt from Tax on Bitcoin Profits: El Salvador” 2021).

At any rate, offshore jurisdictions, coupled with the pseudo-anonymity of cryptocurrencies, represent a perfect tie-in for laissez-faire economic advocates. Further research should investigate whether (and how) decentralized finance enterprises take advantage of these traditional offshore jurisdictions.

There exist a substantial number of additional tax evasion opportunities for decentralized finance enterprises: Moreover, the results of this study also show that a substantial number of jurisdictions offer tax evasion opportunities only for decentralized finance enterprises. Indeed, there are 26 jurisdictions with high CIT and CGT rates, and 7 with high CIT and low CGT. None of those apply their tax laws to cryptocurrencies. Given that their fiscal regime is not inclusive of cryptocurrencies, these jurisdictions represent potential evasion opportunities unavailable to traditional finance. There are many reasons that could explain why a high-tax jurisdiction decides not to apply its tax laws to cryptocurrencies. For example, it could be part of a strategy to attract decentralized finance enterprises in order to position themselves as a crypto hub. Some of these jurisdictions could be battling with more pressing problems, such as armed conflict or political instability, or the lack of legislation might also be related to a lack of resources. For example, in Vietnam, the government has announced many times that cryptocurrency legislation is in the works, but nothing has been implemented yet (Prodent 2022). Further research should investigate these jurisdictions and better understand what makes a high-tax jurisdiction overlook cryptocurrencies.

A jurisdiction’s high financial development does not necessarily translate to high cryptocurrency adoption: The results also showed that financial development does not necessarily translate to cryptocurrency adoption. Indeed, the Financial Institutions Index does not correlate with the Cryptocurrency Adoption Index, while there exists a weak relation between the Financial Markets Index and the Cryptocurrency Adoption Index. This runs counter to the idea that high financial development means high cryptocurrency adoption. We conceptualized capability through those variables; however, results show that one does not mean the other. Hence, to better capture a jurisdiction’s capability to host decentralized finance enterprises, further research is needed. Where financial development is low and cryptocurrency adoption is high, cryptocurrencies could potentially represent an alternative to national fiat currencies. Investigating jurisdictions where cryptocurrency adoption is high, as opposed to their financial development, should be of interest to further research.

Limits and Further Research

Given the exploratory aspect of this study, there are many limits that need to be acknowledged. First, the use of third-party data reduced the size of the sample. Each data source considered different jurisdictions and only a limited number of jurisdictions overlapped among them. Second, the results of the study are limited by the use of third-party data, which can include unknown errors. Further research could gather more precise data on specific jurisdictions and test the relationships observed in this study. For example, our analysis did not include where corporations are established. They might be registered in offshore jurisdictions while operating worldwide. To remedy this, data on corporations’ tax residency and their jurisdictions of activity could be researched in the future. It would be interesting to put this in relation with the level of cryptocurrency adoption to consider the capability of opportunities with lesser financial development to attract corporations. To deepen the analysis, further research could also include additional variables on jurisdictions, such as internet adoption.

Another related limit is the ever-evolving landscape of the data, which can change within a few years. To keep the analysis relevant, it would be necessary to update the dataset periodically. Additionally, this study does not consider the legal status of cryptocurrencies, such as whether it is considered a currency, a security or a commodity. Unfortunately, there is no comprehensive data on the topic. For the currency aspect, only two jurisdictions recognize cryptocurrencies as legal tender, which does not affect the overall results of our study (Browne 2022). Nevertheless, the legal status of cryptocurrency impacts how cryptocurrency revenue is taxed; and, subsequently, tax evasion opportunities depend on this factor. The creation of a database on the legal status of cryptocurrencies might be limited by the unclear status in many jurisdictions, but it would contribute to further research on the topic.

The 2021 Law Library of Congress’s report on the Regulation of cryptocurrency around the world (The Law Library of Congress 2021) also collected data on the ban on cryptocurrencies, which we did not consider for the purpose of the study. The signification of a ban varies in different jurisdictions and its level of application is incoherent across jurisdictions. For example, certain jurisdictions apply tax laws to cryptocurrencies whilst also being marked as applying explicit bans (e.g., Turkey). Moreover, some jurisdictions have announced explicit bans on cryptocurrencies while also scoring high in cryptocurrency adoption, such as Vietnam and Indonesia[18][22]. To take into account these important jurisdictions, we decided to disregard this variable. Nevertheless, further research could investigate the purpose(s) of explicit bans on cryptocurrencies and their level of application.

Although this project has many limits, it is the first to explore the fiscal opportunities of decentralized finance corporations and to conceptualize the capability of fiscal opportunities.

Conclusion

This study explores tax evasion opportunities for decentralized finance corporations, given jurisdictions’ corporate tax rates and whether they apply tax laws to cryptocurrencies. It also discusses how these tax evasion opportunities are available, while considering jurisdictions’ levels of financial development and cryptocurrency adoption. All in all, the study finds that decentralized finance enterprises have a substantial number of tax evasion opportunities, both through traditional offshore jurisdictions and crypto-advantageous jurisdictions. The latter jurisdictions are usually considered high-tax fiscal regimes, but given that they do not apply tax laws, an opportunity arises, especially in those that have high financial development and high cryptocurrency adoption. However, such opportunities may be considered unstable as a change in legislation may lead to the disappearance of the opportunity quickly. This study is solely exploratory and further research should investigate each jurisdiction to better understand the opportunities that may emerge.

ACKNOWLEDGMENTS

This study was financed by an Exploration grant from Social Sciences and Humanities Research Council and granted by Université de Montréal. We thank Lorne Coughlin for reviewing the article.

REFERENCES

[1] I. Salami, “Challenges and Approaches to Regulating Decentralized Finance,” Am. J. Int. Law, vol. 115, pp. 425–429, ed 2021, doi: 10.1017/aju.2021.66.

[2] E. Ducas and A. Wilner, “The security and financial implications of blockchain technologies: Regulating emerging technologies in Canada,” Int. J., vol. 72, no. 4, pp. 538–562, Dec. 2017, doi: 10.1177/0020702017741909.

[3] M. P. Ponsford, “A Comparative Analysis of Bitcoin and Other Decentralised Virtual Currencies: Legal Regulation in the People’s Republic of China, Canada, and the United States,” Hong Kong J. Leg. Stud., vol. 9, pp. 29–50, 2015.

[4] M. Campbell-Verduyn, Ed., Bitcoin and beyond: cryptocurrencies, blockchains and global governance. London ; New York: Routledge, Taylor & Francis Group, 2018.

[5] A. Alstadsæter, G. Zucman, bluebery planterose, and A. Okland, “Who Owns Offshore Real Estate? Evidence from Dubai,” EU TAX Observatory, Working paper 1, May 2022. Accessed: Sep. 13, 2022. [Online]. Available: https://gabriel-zucman.eu/files/APZO2022.pdf

[6] P. Yeoh, “Secrecy in Teflon international financial centres,” Int. J. Law Manag., vol. 60, no. 3, pp. 777–797, May 2018, doi: 10.1108/IJLMA-03-2017-0060.

[7] J. Garcia-Bernardo, J. Fichtner, F. W. Takes, and E. M. Heemskerk, “Uncovering Offshore Financial Centers: Conduits and Sinks in the Global Corporate Ownership Network,” Sci. Rep., vol. 7, no. 1, Art. no. 1, Jul. 2017, doi: 10.1038/s41598-017-06322-9.

[8] R. Phillips, H. Petersen, and R. Palan, “Group subsidiaries, tax minimization and offshore financial centres: Mapping organizational structures to establish the ‘in-betweener’ advantage,” J. Int. Bus. Policy, vol. 4, no. 2, pp. 286–307, Jun. 2021, doi: 10.1057/s42214-020-00069-3.

[9] J. G. Gravelle, “Tax Havens: International Tax Avoidance and Evasion,” Natl. Tax J., vol. 62, no. 4, pp. 727–753, Dec. 2009, doi: 10.17310/ntj.2009.4.07.

[10] “Leaked Documents Expose Global Companies’ Secret Tax Deals in Luxembourg - ICIJ,” Nov. 05, 2014. https://www.icij.org/investigations/luxembourg-leaks/leaked-documents-expose-global-companies-secret-tax-deals-luxembourg/ (accessed Mar. 09, 2023).

[11] “Giant Leak of Offshore Financial Records Exposes Global Array of Crime and Corruption - ICIJ,” Apr. 03, 2016. https://www.icij.org/investigations/panama-papers/20160403-panama-papers-global-overview/ (accessed Mar. 09, 2023).

[12] IRS, “IRS Criminal Investivation 2022 Annual Report,” IRS, 2022. [Online]. Available: https://www.irs.gov/pub/irs-pdf/p3583.pdf

[13] J. Z. Weil, “Few crypto gains appear on tax returns. That’s changing — but not this year.,” Washington Post, Dec. 30, 2022. Accessed: Mar. 07, 2023. [Online]. Available: https://www.washingtonpost.com/business/2022/12/29/cryptocurrency-taxes/

[14] F. T. and R. A. C. of Canada, “Penalties for non-compliance,” Dec. 30, 2003. https://www.fintrac-canafe.gc.ca/pen/1-eng (accessed Sep. 15, 2022).

[15] “Worldwide Tax Summaries Online,” Worldwide Tax Summaries Online. https://taxsummaries.pwc.com/ (accessed Jan. 31, 2023).

[16] “Tax Challenges Arising from the Digitalisation of the Economy – Global Anti-Base Erosion Model Rules (Pillar Two) - OECD.” https://www.oecd.org/tax/beps/tax-challenges-arising-from-the-digitalisation-of-the-economy-global-anti-base-erosion-model-rules-pillar-two.htm (accessed Oct. 17, 2022).

[17] “The Latest on the Global Tax Agreement: The EU Adopts Pillar Two,” Tax Foundation, Dec. 15, 2022. https://taxfoundation.org/global-tax-agreement/ (accessed Feb. 06, 2023).

[18] The Law Library of Congress, “Regulation of Cryptocurrency Around the World: November 2021 Update,” The Law Library of Congress, Washington, D.C., 2021–020594, 2021. [Online]. Available: https://hdl.loc.gov/loc.law/llglrd.2021687419

[19] “IMF DATA access to macroeconomic & financial data,” International monetary fund. https://data.imf.org/?sk=388dfa60-1d26-4ade-b505-a05a558d9a42 (accessed Nov. 01, 2022).

[20] “ECSE – Eastern Caribbean Securities Exchange.” https://www.ecseonline.com/ (accessed Feb. 01, 2023).

[21] “Ireland records second-highest level of per capita GDP in EU,” Law Society Gazette Ireland, Ireland, Mar. 25, 2022. Accessed: Feb. 02, 2023. [Online]. Available: https://www.lawsociety.ie/gazette/top-stories/2022/March/ireland-records-second-highest-level-of-per-capita-gdp-in-eu

[22] Chainalysis, “The 2022 Geography of Cryptocurrency Report,” Chainalysis, Oct. 2022.

[23] “Similarweb.” https://lp.similarweb.com/brand-jan-23?utm_medium=ppc&utm_source=adwords&utm_campaign=dmng_search_brand_cross_brand_na&utm_id=18985659097&utm_content=643991718472&utm_term=similar%20web&utm_network=g&utm_group=143023703719&utm_placement=&utm_matchtype=e&utm_adposition=&affiliate_id=similar%20web&qgad=643991718472&qgterm=similar%20web&gclid=EAIaIQobChMI-ZO56pT6_AIVnf_jBx1NCgogEAAYASAAEgIWk_D_BwE (accessed Feb. 03, 2023).

[24] M. Paquet-Clouston, Paquette,Serge-Olivier, Garcia, Sebastian, and Maria José, Erquiaga, “Entanglement: cybercrime connections of a public forum population,” 2022. https://academic.oup.com/cybersecurity/article/8/1/tyac010/6644916 (accessed Jan. 11, 2023).

[25] E. Becht et al., “Dimensionality reduction for visualizing single-cell data using UMAP,” Nat. Biotechnol., vol. 37, no. 1, Art. no. 1, Jan. 2019, doi: 10.1038/nbt.4314.

[26] M. W. Dorrity, L. M. Saunders, C. Queitsch, S. Fields, and C. Trapnell, “Dimensionality reduction by UMAP to visualize physical and genetic interactions,” Nat. Commun., vol. 11, no. 1, Art. no. 1, Mar. 2020, doi: 10.1038/s41467-020-15351-4.

[27] L. McInnes, J. Healy, and J. Melville, “UMAP: Uniform Manifold Approximation and Projection for Dimension Reduction.” arXiv, Sep. 17, 2020. doi: 10.48550/arXiv.1802.03426.

[28] R. Shier, “Statistics: 2.3 The Mann-Whitney U Test.” Mathematics learning support centre, 2004. [Online]. Available: https://www.lboro.ac.uk/media/media/schoolanddepartments/mlsc/downloads/2_3_mann_whitney.pdf

[29] “Cryptocurrency regulations by country,” Thomson Reuters, 2022. [Online]. Available: https://www.thomsonreuters.com/en-us/posts/wp-content/uploads/sites/20/2022/04/Cryptos-Report-Compendium-2022.pdf

[30] “Tax haven ranking shows countries setting global tax rules do most to help firms bend them,” Tax Justice Network. https://taxjustice.net/press/tax-haven-ranking-shows-countries-setting-global-tax-rules-do-most-to-help-firms-bend-them/ (accessed Feb. 06, 2023).

[31] “Corporate Tax Haven Index - 2021 Results,” Tax Justice Network. https://cthi.taxjustice.net/en/ (accessed Feb. 06, 2023).

[32] “Could Puerto Rico Be Your Crypto Tax Haven?,” Gordon Law Group, Nov. 03, 2022. https://gordonlawltd.com/puerto-rico-crypto-tax-haven/ (accessed Feb. 02, 2023).

[33] “Malta becomes the blockchain island after the Parliament passes three Bills that create a regulatory framework for blockchain technology,” Deloitte. https://www2.deloitte.com/ro/en/pages/risk/articles/malta-becomes-the-blockchain-island.html (accessed Feb. 02, 2023).

[34] “Foreign investors exempt from tax on bitcoin profits: El Salvador,” France 24, Sep. 10, 2021. https://www.france24.com/en/live-news/20210910-foreign-investors-exempt-from-tax-on-bitcoin-profits-el-salvador (accessed Feb. 02, 2023).

[35] L. Prodent, “Vietnam Tasks Agencies to Prepare Legal Framework for Cryptocurrencies, Virtual Assets,” Vietnam Briefing News, Apr. 11, 2022. https://www.vietnam-briefing.com/news/vietnam-tasks-government-agencies-prepare-legal-framework-cryptocurrencies-virtual-assets.html/ (accessed Feb. 03, 2023).

[36] R. Browne, “Central African Republic becomes second country to adopt bitcoin as legal tender,” CNBC, Apr. 28, 2022. https://www.cnbc.com/2022/04/28/central-african-republic-adopts-bitcoin-as-legal-tender.html (accessed Feb. 06, 2023).

Comments
0
comment
No comments here
Why not start the discussion?