Although cryptocurrencies have existed since Bitcoin emerged in 2009, this medium of exchange has experienced a massive surge in popularity in recent months. Offering a wide range of opportunities (and risks), cryptocurrencies have inspired a great deal of confusion due to their unique properties. To better understand the potential tax impacts that cryptocurrency may have on you and your business, it is important to ask the right questions – and get answers you can trust.
At a high level, the blockchain is a digital ledger that keeps track of all the transactions in a way that’s decentralized, distributed, consensus-based and immutable. Blockchain technology was first established through Bitcoin, which utilizes miners as a way to verify transactions. Miners maintain the digital ledger, being rewarded through units of cryptocurrency. Verifying transactions is a process commonly known as the consensus protocol. When a block is confirmed and posted on the blockchain, the miners are rewarded with units of cryptocurrency.
Given the rise of more efficient and scalable consensus protocols, the use of mining isn’t the only way that the digital ledgers are maintained. Other emerging protocols such as proof-of-stake remove the need for mining through a process known as staking. In the staking process, transactions are verified through locking up an amount of your coins, which are then used to prove those coins are in fact yours through advanced computer algorithms. By participating in this system, you are rewarded with cryptocurrency, which is relatively comparable to that of a dividend issuance.
Unfortunately, there is no real guidance related to tax or financial reporting of cryptocurrencies. Those who own a business are likely to have many questions for their accountants. Should I incorporate? How do I handle GST/HST when dealing with cryptocurrency? How do I account for the cryptocurrency related income I have earned? For those currently involved in cryptocurrency, these standard business concerns are not being properly addressed. With that in mind, here is a closer look at some of the key tax issues related to mining and cryptocurrencies.
Is mining a business or hobby?
For individuals or corporations mining cryptocurrencies, there is uncertainty surrounding whether this is considered a business or a hobby from the CRA’s perspective. If it’s considered a hobby, the only associated tax implication relates to the capital gains incurred on cryptocurrency that was mined. However, if it’s considered to be a business activity, all income earned from mining will be subject to tax. To determine which circumstance would apply to you or your business, the criteria the CRA has established for defining a business (as opposed to a hobby) need be applied.
How do you structure a cryptocurrency business?
If you are involved in mining cryptocurrencies, it may be beneficial to consider a business structure other than a sole proprietorship. Sole proprietors claim any income associated with mining activities as self-employed income, while partnerships split earnings and expenses between two or more individuals. In this situation, partners would only claim their portion of income as income from mining. Under either of these options, you could potentially increase tax savings by simply incorporating your business. By incorporating your cryptocurrency business, you are able to reduce the amount of personal liability. Given that all income earned from mining is not necessarily needed personally, the ability to defer portions of income can result in large tax savings. Additionally, you are able to receive a portion of Part IV tax back through the payment of dividends. Dependent on the situation, incorporation could save you large sums of tax dollars.
Mining pools are one of the options that many individuals and corporations in mining have considered. Dependent on each individual case, participation in a mining pool could result in classification as a joint venture or a partnership. The key difference between the two stems from the longevity of the activity, yielding arguments from both sides. This is highly specific to each individual case, and improper classification could result in penalties or unnecessary tax expenses.
GST and HST
If you’re in the mining business, it is likely that you are spending money and paying GST/HST to earn income. If your business is making taxable supplies, you can voluntarily register for GST/HST, charge GST/HST and recoup the GST/HST paid on expenses. One of the main things to consider is whether the mining of cryptocurrency is going to be considered a taxable supply from an excise tax perspective. There are two ways to determine if it’s taxable in advance: look at the available GST/HST exemption provisions or tackle it from the view of whether the cryptocurrency you’re receiving is “consideration” for providing the service of mining. However, if cryptocurrency doesn’t meet the definition of consideration, there may be no GST/HST implications.
When discussing cryptocurrency related tax implications, we stress the fact that no formal guidance has been issued from the CRA. As such, we use our professional judgement to form conclusions on similar interpretations. With all the uncertainty currently surrounding cryptocurrencies, it always pays to seek expert advice and make informed, strategic decisions to avoid penalties.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.