Canada: Bitcoin Taxation Basics

Last Updated: March 23 2018
Article by Vern Krishna

Every new technology brings with it tax nightmares for tax­ payers, and the inevitable disputes with the Canada Revenue Agency. As we approach tax filing season, Canadians who have engaged in buying or selling, or have used, cryptocurrencies must decide how to report their transactions. Virtual currencies are on the minds of tax collectors around the world, and the CRA is on a mission to increase its revenue intake. As tax litigation with the CRA is slow and arduous, taxpayers should maintain detailed evidence of their transactions for many years.

Cryptocurrencies incorporate technology, currency, math, economics and social dynamics. Australian entrepreneur Craig Wright (aka Satoshi Nakamoto) is reputed to be the shadowy creator of Bitcoin, a multi­ faceted, highly technical and difficult to trace asset that may quite possibly be a pyramid scheme. The price is highly volatile and can fluctuate up and down by several thousand per cent. Bitcoin, for example, has hit over US$20,000 and as low as US$5,000 - just in 2018. The selloff of cryptocurrencies in February saw the market lose as much as US$100 billion in value in a single day. Such volatility triggers substantial gains and losses, which have significant tax consequences.

For tax purposes, virtual currencies are considered "property," rather than currency. Trading a Bitcoin for another digital coin would be taxable since it would be considered a sale of property for cash, which the tax­ payer then uses to buy the other cryptocurrency. In­ come from creating Bitcoin through the mining process would also be taxable for the producer.

How would gains and losses on cryptocurrency trading be taxed? Realized gains and losses on the currencies may be on account of capital or income, which would trigger substantially different tax consequences when a person buys or sells cryptocurrency or uses it to purchase goods and services. Depending on how taxpayers report their gains and losses, the transactions would also have a significant impact on government revenue.

The distinction between capital gains and income is superficially simple. Cap­ital gains derive from sale or realization of the investments. Income derives from trading, or the periodic yield of an investment. The distinction is often put in the form of an analogy. Capital is likened to the tree or the land, and income to the fruit or the crop. The tree is the capital that produces a yield (the fruit), and income is the profit that derives when we sell the fruit

However, the analogy is less than perfect. An "investment" is an asset or property that one acquires with the intention of holding it or using it to produce income. Thus, an investment is a means to an end. Where a taxpayer acquires property with an intention to trade it - that is, to purchase and resell the property at a profit - any gain or loss from the trade is business income or loss.

But the uncertainty does not stop with intention. Where a taxpayer has a secondary intention to trade, any gain or loss resulting from the trade is considered business income (or loss). Therefore, a taxpayer who claims that a gain is a capital gain must show two things: that his primary intention at the time of entering into the transaction was to make an investment; and that he had no secondary intention at that time to trade in the particular property.

Both intention and secondary intention to trade are questions of fact, and the trier of fact will draw inferences from the taxpayer's conduct on a balance of probabilities. However, courts often use secondary intention as a surrogate for testing the taxpayer's credibility, which is always an important issue in tax cases.

The nature of the under­ lying property, rather than the expectation of profit, can be important in characterizing gains and losses. All investors hope, albeit some­ times unrealistically, that their investments will in­ crease in value. However, the mere expectation of profit is not, by itself, sufficient to characterize a transaction as on account of income or capital. Certain types of assets - typically, those that cannot possibly provide any investment yield - are suspect as "trading assets," and any gain or loss from them would usually be income gains or losses.

These are early days for the definitive legal characterization of gains and losses from cryptocurrency transactions. Taxpayers with losses will want to claim their transactions as business losses, so that they can claim the entire loss. Taxpayers with gains will probably want to report (if they report at all) their transactions as capital gains, so that only one-half will be taxable. The determination of the character of gains and losses will be determined by the tax courts after prolonged litigation and extensive costs. We can reasonably expect the resulting disputes and litigation to extend over 10 to 12 years before we get appellate guidance on the law. Hence, at the very least, people should maintain their trans­ action reports from crypto­ currency exchanges or record every transaction in de­tail. Ultimately, the burden is always on the taxpayer to prove her case.

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.

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