Introduction – Cryptocurrency: Global Challenges, Regulations and the Tax Implications Associated with the Seizure of Crypto Assets
In May 2021, electric car manufacturer Tesla Inc. announced its decision to stop accepting Bitcoin as payment. According to CBC, Tesla's announcement sparked a decline in cryptocurrency prices. In June 2021, China announced its decision to ban all financial institutions and payment companies from providing services related to cryptocurrency transactions. According to CBC, China's announcement to "crack down on cryptocurrencies" exacerbated the decline in cryptocurrency prices. In addition, according to CBC, the Bank of Canada's Federal Reserve hinted that it may launch a challenge "declaring that crypto works against the public good". Further, according to CBC, while many investors are worried about potentially losing their digital investments, others have already "lost more than half their investments" due to the ongoing decline in the crypto market.
According to CBC, Tesla's Inc.'s announcement sparked a "nearly $1 billion US wipe off of the market capitalization in the crypto sector". CBC explains, Tesla Inc. announcement played a significant role in cryptocurrency's drop by 54% "from a record high of $64,895 hit on April 14", which is the first monthly decline since November 2018. In addition, according to CBC, China's announcement exacerbated the decline in Bitcoin which was initially sparked by Tesla's decision to stop accepting Bitcoin as payment. CBC explains, by mid-May, Bitcoin experienced more than a 50% drop and "it hit a three-and-a-half month low of $30,066" which was at its lowest since January 2021. According to CNBC, by the end of June, Bitcoin hit a monthly low of $28,908. Further, CBC explains, Bitcoin's decline negatively impacted other crypto assets including ether (a coin that is limited to Ethereum blockchain network) which recently dropped to its weakest level since late January 2021.
According to CBC, Bitcoin, which was already under pressure by Tesla and China's announcements, experienced a peak loss of over 50%. Other cryptocurrency, such as Dogecoin, suffered even a bigger loss "in percentage terms", however, CBC explains, the loss was greater for investors who "bought at margin". According to CBC, buying at margin is a "process where investors borrow from their broker to invest but are required by lenders to pay back part of what they owe if the value of their stake falls below a certain level". According to CBC, some investors who bought at margin "are forced to sell into a falling market", unless they have excess funds to cover their loan amount upon demand for repayment. CBC referred to the CNBC business news service which reported that margin calls have also heightened "volatility in the unregulated global crypto market" where some investors borrow from their broker "at ratios of 100 to 1". That is, investors borrow $100 for every $1 of their own money to purchase their investments. While this kind of leverage investment can potentially be lucrative when markets are rising, yet margin traders risk losing all of their investments in a declining market. According to CBC, although Canadian brokerages do not offer these types of margins, "in a global market everyone suffers the consequences".
In June 2021, according to CBC, El Salvador, which uses the US dollar as its currency, became the first country to declare cryptocurrency as a "legal tender". CBC elaborates, El Salvador's President, Nayib Bukele, announced that the "government will guarantee the convertibility to the exact value in dollars at the moment of the transaction". In this context, CBC explains, some Salvadorians who recently negotiated their salaries in Bitcoin may regret their decision due to the recent decline in Bitcoin.
In addition, in June 2021, the Bank for International Settlements (BIS) released its "Central Bank Digital Currencies: An Opportunity for Monetary System" report (the "BIS Report") shedding light to the ongoing challenges of the cryptocurrency market. According to CBC, the BIS Report presents that central banks "will begin to issue their own digital coins" and they may even take action to discourage the use of cryptocurrencies. CBC pointed to the BIS Report's conclusion which states that "innovations such as cryptocurrencies, stablecoins and the walled garden ecosystems of big techs all tend to work against the public good elements that underpins the payment system".
According to The Jerusalem Post, the Knesset, which is the legislature of Israel, joined the global trend of "creating NFT – a non-fungible token" for Israel's new President Isaac Herzog, in honor of his inauguration. Simply put by Forbes Media, NFTs are digital assets that represent objects (i.e., music, art and videos) that can be bought and sold online and are often encoded using the same software as cryptocurrency. The Jerusalem Post explains, certain NFTs are becoming popular worldwide with an "NFT of the original World Wide Web code recently sold for $5.4 million". According to The Jerusalem Post, the Knesset, is the "first parliament in the world to create an NFT" yet NFTs ongoing global success could attract others to join the trend of "creating NFT". For example, according to The Jerusalem Post "artist Mike Winkelmann recently sold an NFT for a record price of $69.3 million". The Knesset reflects how government officials are becoming increasing involved into NFTs and cryptocurrency.
In May, Bloomberg reported that the "Bank of Israel is testing Ethereum tech" in a recently launched internal digital trial. Israel's central bank issued a statement explaining that its digital payment system could potentially create a positive impact on the country's economy by way of "simplifying payment processes while providing security to both parties in a transaction", Bloomberg reported. According to Coindesk, some believe that central bank digital currencies will create "efficient and inexpensive infrastructure for cross-border payments". In addition, Coindesk reports, Sweden's Riksbank and the European Central bank are among some of the banks that are "actively researching and developing their own digital currencies in preparation for expected launches" within the next five years. In contrast, Coindesk explains, the US Federal Reserve is adopting a "more cautious approach" with regards to launching its own digital currencies.
Despite the ongoing challenges of the cryptocurrency market, CBC sheds light on some of the benefits associated with digital money issued by central banks. CBC explains, unlike cryptocurrencies, which could potentially "rise and fall unpredictably", the value of digital money issued by central banks "are known". In addition, CBC explains, unlike stablecoins, digital money issued by central banks "can be spent anywhere as a legal tender". CNBC defines Stablecoins as "cryptocurrencies pegged to an underlying asset". Further, both CBC and the BIS Report seem to suggest that digital coins issued by central banks could potentially have many of the advantages of cryptocurrency "without the disadvantages". For example, according to CBC, while digital money issued by central banks "eliminate the role of an intermediary" when investors transfer money, they also "protect privacy while maintaining the integrity of the payment system and law enforcement". However, CBC explains, long-time crypto holders will likely disagree with the above-mentioned benefits associated with central banks issuing digital money. According to CBC, unlike cryptocurrency, transactions and payments made by digital money issued by central banks could potentially be traceable by governmental authorities for various reasons including, but not limited to, law enforcement and taxation.
Related to that, according to Block Crypto Inc., on July 7, 2021, Israel's Minister of Defense, signed a seizure order for crypto wallets which are presumed to be associated with Hamas operatives. According to Block Crypto Inc., the crypto wallets include a list of "84 addresses for Bitcoin, Tether, Ether and Dogecoin, among others". Block Crypto Inc. explains that the National Bureau for Counter Terror Financing "attributes most of these wallets to seven Palestinian nationals it associates with Hamas" However, some of the crypt wallets "remain anonymous". Block Crypto Inc. explains, Hamas is a terrorist Islamic group that controls the Gaza Strip. According to Block Crypto Inc., the "European Union, United States, and Israel have all designated Hamas or its affiliates as terrorist organizations". According to Block Crypto Inc., Israel's Minister of Defense issued a statement indicating that "any individual who claims ownership of any or all of The Property [namely, the 84 crypto addresses], may make their claims and submit them in writing to the Head of the National Bureau for Counter Terror Financing". Further, Block Crypto Inc. explains that "this is not the first time that Hamas has been identified as using crypto to gather donations". For example, Block Crypto Inc. reports, in 2019 an Israeli not-for-profit organization attempted to cease Hamas' use of Coinbase and in 2020 the US Department of Defense and Department of Justice exposed a "massive seizure operation that hit cryptocurrency wallets owned by Hamas, Al-Qaeda and ISIS".
In early June 2021, US government officials recovered the "majority of a multimillion-dollar ransom payment" in Colonial Pipeline hack, CBC reported. According to CBC, this ransom recovery was the first seizure undertaken by a "specialized ransomware task force created by the Biden administration's Justice Department". This reflects the increasingly aggressive approaches government authorities are implementing to deal with "the growing and increasingly destructive ransomware attacks" that are targeting many industries worldwide, including, but not limited to, the crypto market, CNN reports.
Moreover, according to IFC, Kazakhstan has signed a new taxation law to tax cryptocurrency mining effective January 1, 2022. IFC explains, while the new law is "expected to generate billions in the national currency", businesses are speaking out against the taxation of cryptocurrency mining. According to IFC, many businesses are opposed to the new taxation law and are concerned about its impact on the future of the mining industry in Kazakhtan. Cryptocurrency mining activities are subject to taxation under regular Canadian tax law rules. However, determining whether your cryptocurrency mining activities constitute a business or a hobby for Canadian income tax purposes, and the method of reporting profits, is complex tax law matter. Our top Canadian tax lawyers can help identify your Canadian obligations, and tax planning opportunities, with respect to cryptocurrency mining. Visit our firm's website to read more on Crypto Currency Taxation – Income Tax Implications of Mining.
The IFC reports sheds light on the fact that governmental authorities across the world are focusing their attention on "the regulation of the cryptocurrency market" as in the example above whereby China is banning the cryptocurrency market and has ordered its banks to cease facilitating cryptocurrency transactions. In addition, IFC reports, while South Korea precisely designed a comprehensive set of rules for exchanges within the crypto market, Canada issued notices to "several exchanges [Poloniex and KuCoin] for failing to comply with regulations within time". However, with Canada "implementing stricter regulations out of concern for bitcoin's energy impact, miners are getting ready to leave the country for other sources of power", Coindesk reports. In addition, Bitmex and Binance are among the cryptocurrency exchanges leaving Canada because of its new securities regulations. It is important to realize that potential tax implications could arise if the departure of cryptocurrency exchanges requires conversion of any coin into any other coin or into fiat in order to transfer to another exchange. For example, the disposition of cryptocurrency will trigger a taxable event that must be reported, pursuant to Canada's Income Tax Act, which could potentially give rise to a capital gain or business income. Yet while it is uncertain whether stricter restrictions and the regulation of the cryptocurrency market and the cryptocurrency mining industry will be effective, IFC explains, governmental authorities are becoming increasingly eager to maintain control over their currencies.
Concerns Associated with Cryptocurrency: Global Challenges, Regulations and the Tax Implications Associated with the Seizure of Crypto Assets
There are significant concerns and challenges associated with the cryptocurrency market, including specific cryptocurrency tax concerns. Specifically, mentioned previously, Tesla reversed its decision to accept Bitcoin payments, China announced its decision to ban all financial institutions and payment companies from providing services related to cryptocurrency transactions, and central banks, such as The Bank of Israel, are issuing their own digital coins while discouraging the use of cryptocurrencies. While many investors and traders are worried about potentially losing their digital investments, others have already lost a substantial portion of their digital investments. Some cryptocurrency traders are forced to sell their investments in a declining crypto market because of margin calls. Furthermore, as previously mentioned, the Bank of Canada's Federal Reserve and central banks are hinting that they may "take action to discourage crypto's use". Yet, even if central banks and Canada's Federal Reserve take action to discourage the use of cryptocurrencies, it is unclear how efficient or effective their actions will be in discouraging the use of cryptocurrency. In addition, despite the volatile nature of the cryptocurrency market, it is uncertain whether the value of digital money issued by central banks would potentially exacerbate volatility in other markets or even its own market. It is important to realize that any changes in crypto holdings, including coin to coin changes, have tax implications even if carried out in reaction to market changes.
Some governments around the world seem to be focusing their attention to the regulation of various aspects of cryptocurrency. For example, Kazakhstan is set to tax cryptocurrency mining, Israel ordered the seizure of a list of crypto wallets, and China is banning all practices related to cryptocurrencies. Yet, it is unclear whether stricter restrictions and regulations of the cryptocurrency market and the taxation of cryptocurrency mining will give governmental authorities control over their currencies.
Further, as previously mentioned, Israel's Minister of Defense, signed a seizure order for crypto wallets which are presumed to be associated with Hamas operatives. Similarly, USA Today recently reported that US government officials recovered the "majority of $4.4 million cryptocurrency ransom payment in Colonial Pipeline hack". These examples shed light on the domestic powers available to governmental authorities in context of cryptocurrency transactions and the cryptocurrency market. While some governmental authorities are becoming increasing eager to maintain control over their currencies, others have the ability and desire to seize cryptocurrency where they deem it to be appropriate.
Significantly, there are Canadian tax implications to governmental authorities confiscating cryptocurrencies about which our experienced Canadian tax crypto lawyers can advise. Governmental authorities may attempt to seize cryptocurrency wallets and information relating to cryptocurrency transactions in order to identify tax evading taxpayers, encourage compliance with Canada's tax system and collect taxes on unreported income. In addition, government officials could potentially use confiscated cryptocurrencies to trace and investigate other crypto wallets and their holders. It is important to realize that there are also tax implications associated with the seizure of cryptocurrency assets. For example, seized crypto can give governmental authorities guidance in context of enacting and implementing stricter regulations surrounding the taxation of cryptocurrency. As well, the seizure of cryptocurrency can potentially lead cryptocurrency holders and traders to escape their tax obligations by avoiding certain countries that are implementing restrict regulations. From a Canadian tax point of view, a seizure of cryptocurrency assets is considered a disposition and under Canada's Income Tax Act such taxable event must be reported on the crypto holder's income tax returns, which could potentially give rise to a capital or income gain or more likely a loss.
The Taxation of Cryptocurrency in Canada
Under Canada's Income Tax Act, any income from cryptocurrency transactions is characterized as business income or as a capital gain. As well, losses involving cryptocurrency transactions are treated as business losses or capital losses. Taxpayers must establish whether a cryptocurrency transaction results in income or capital for income tax purposes. When cryptocurrency is used to purchase goods and services, the Canada Revenue Agency will treat the transaction as a "barter transaction" for income tax purposes. A "barter transaction" occurs when good are exchanged or services are carried out without the use of legal currency. However, the use of the cryptocurrency to acquire goods or services will be considered to be a disposition for income tax purposes giving rise to a gain or loss.
In addition, where a taxable property or service is exchanged for cryptocurrency, GST/HST that applies to the property or services is determined based on the fair market value of the cryptocurrency at the time of the exchange.
Pro Tax Tips – The Tax Implications of Cryptocurrency
Canada has yet to enact legislation—tax or otherwise—dealing expressly with cryptocurrency or cryptocurrency transactions. Likewise, Canadian courts have yet to decide upon a tax issue relating to cryptocurrency or cryptocurrency transactions.
If you have questions concerning the tax treatment of cryptocurrency or cryptocurrency transactions or the potential tax implications associated with governmental authorities confiscating cryptocurrency contact one of our top Canadian tax lawyers for tax guidance. Our Certified Specialist in Taxation Canadian tax lawyer has extensive experience in dealing with cryptocurrency taxation.
If you or your business have unreported income, or wrongly reported as capital gains instead of business income, earned through cryptocurrency transactions, you may qualify for relief through CRA's voluntary-disclosures program (VDP). Voluntary disclosures, also known as tax amnesty, are a complex area of law that requires detailed analysis and advice from an experienced Canadian tax lawyer. Consider contacting our certified specialist in taxation Canadian tax lawyer for appropriate tax guidance with respect to a possible voluntary disclosure application.
The purpose of the Voluntary Disclosures Program is the avoidance of "tax evasion and aggressive tax avoidance" to ensure a tax system that is responsive and fair for all Canadians. Canada's Voluntary Disclosures Program promotes compliance with the law and allows taxpayers, including corporations, the opportunity to voluntarily (1) correct inaccurate or incomplete information; and/or (2) disclose to the CRA information which was not previously reported. Canadian taxpayers who have unreported income may be eligible for penalty relief and partial interest relief under Canada's Voluntary Disclosures Program. A valid Voluntary Disclosures Program application must:
- Be "voluntary";
- Be "complete";
- Include payment of the estimated taxes owing. A taxpayer who is not capable of making such payment at the time of the application may request consideration for a "payment arrangement";
- Include information pertaining to income tax that is at least one year past due;
- Include information pertaining to GST/HST for at least one reporting period that is past due.
To qualify for the relief under the Voluntary Disclosures Program, the taxpayer must submit a complete application to the program and meet its above-mentioned requirements. If you have unreported income or would like appropriate tax planning to reduce your tax burden please contact our tax law office for tax guidance from one of our top Canadian tax lawyers.