In these heady days of cryptocurrency investment, the market can seem like a gold rush – offering promise, but at the expense of predictability. Cryptocurrency taxation is no different, and this article considers the tax implications for cryptocurrency investment in Canada.
As Benjamin Franklin said, "in this world nothing can be said to be certain, except death and taxes".
Digital currency or taxable commodity?
Despite its name, cryptocurrency's status as a currency remains in question. In 2013 the Canada Revenue Agency (CRA) took the position that bitcoin and other cryptocurrencies are not currencies and should instead be viewed as commodities:
Virtual currencies, such as Bitcoins, are not considered to be a currency issued by a government of a country, such as American dollars. As such, they are generally treated as a commodity for purposes of the Income Tax Act.
To date, no country has recognised a cryptocurrency as a form of domestic legal tender. However, there are strong signs that this may change in the near future.
Assuming that the CRA's characterisation of cryptocurrencies is correct, what are the tax implications of them being treated as commodities? Among other things, it means that people using cryptocurrencies to buy goods and services are undertaking so-called 'barter' transactions in the eyes of the CRA. Thus, a value (in Canadian dollars) must be determined for both ends of the transaction (ie, the cryptocurrency as well as the item bought or sold). In other words, accepting bitcoin as payment does not exempt merchants from recognising income on a sale. Similarly, those that swap cryptocurrency for merchandise are required to report income or a capital gain (or loss) on the disposition of their crypto asset.
The barter analysis also likely applies to so-called 'crypto-for-crypto' trades. That is, the cryptocurrency world is largely centred around a few well-known bellwether coins, such as bitcoin and ethereum, which can be traded through intermediaries for legal tender (so-called 'fiat' currency). There are also a large number of smaller cryptocurrencies, sometimes called 'alt-coins', which can mostly be purchased only with one of the more established coins or tokens (eg, bitcoin or ethereum). Barter treatment means that each alt-coin purchase, or even a bitcoin-for-etherum trade, can create a taxable event. This is at odds with the commonly held myth that crypto-investors need only compute realised income or gains when cashing out in crypto-for-fiat trades.
Internet anonymity: a false hope?
Cryptocurrency investors in Canada may feel that they enjoy relative anonymity, with minimal risk of detection by the CRA. However, a glance at their US neighbours reveals the steps that the tax authorities can take to investigate crypto-holders.
In United States v Coinbase Inc the Internal Revenue Service (IRS) brought a successful petition against Coinbase, a digital currency wallet and platform for trading digital currencies, to release:
- account holders':
- names;
- taxpayer ID numbers;
- addresses; and
- dates of birth;
- account records (including transaction activity and account balances); and
- periodic account statements or invoices for all accounts with at least one transaction of US$20,000 in any one transaction type (ie, buy, sell, send or receive) between 2013 and 2015.
The IRS brought the petition on the basis that, while Coinbase boasted 5.9 million customers and more than US$6 billion in transactions, only 800 to 900 taxpayers reported dispositions involving properties relating to bitcoin between 2013 and 2015.
The CRA, which has similar investigative powers to the IRS, could make a similar request of Canadian cryptocurrency exchanges. Such enforcement action could also extend to Canadian entities that have undertaken an initial coin offering or initial token offering, or have otherwise facilitated crypto-transactions. In an increasingly globalised world, the CRA may even attempt to reach beyond Canadian borders and request data from foreign institutions or governments.
Crypto-miners may face a markedly different tax treatment than passive investors. Although there have been no court decisions on this subject (and may not be for years to come), there is a significant risk that miners – whether rewarded based on proof of work or proof of stake – must pay full income tax rates on all profits realised. In dedicating significant time, energy and resources towards maximising return from crypto-mining activities, miners could be considered to be engaged in a business. As a result, any profits realised by British Columbia-resident individuals would be subject to income tax of up to 49.8% in 2018. Passive cryptocurrency investors could be subject to tax at only half that rate as realising capital gains, rather than business income.
The CRA has also commented that accepting cryptocurrencies as payment for goods or services can require the vendor to collect and remit goods and services tax/harmonised sales tax (GST/HST), based on the fair market value of the cryptocurrency received. As the Canadian government does not yet accept bitcoin (or other cryptocurrencies) as payment, GST remitters must make an equivalent Canadian-dollar remittance on any cryptocurrency transactions attracting GST (to the extent not offset by input tax credits). The GST consequences for parties disposing of cryptocurrency is currently uncertain, though it is expected that the CRA will provide its administrative views on the topic in the near future.
The cryptocurrency world is replete with vagaries and uncertainties. Investors and traders face a veritable tax minefield in undertaking digital currency transactions. Holding assets outside Canada (even mere back-up copies held in cold storage) may give rise to specified foreign reporting obligations, and circumventing these obligations may result in severe penalties. Further, suffering a theft or loss of cryptocurrency may result in both economic loss and tax penalisation. Each of those outcomes, and many others, are nuanced issues in a fluid and ever-evolving industry. Therefore, professional tax advice is strongly recommended.
Increasing scrutiny from all types of regulator, including the tax authorities, seems inevitable for the cryptocurrency sector. While this may diminish potential profits when compared to the early days of cryptocurrencies, it will likely add structure, transparency and legitimacy in the long term. Industry participants should remain up to date on developments as the CRA addresses these topics. However, as Ben Franklin said, they should not expect the government to fail to ask for its share of any profits.
For further information please contact Alexander Demner at Thorsteinssons LLP by telephone (+1 604 689 1261) or email ([email protected]). The Thorsteinssons LLP website can be accessed at www.thor.ca.
This article is a collaboration between the Fintech Team at Edwards, Kenny & Bray LLP and Alexander Demner at Thorsteinssons LLP.
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