Canada: Tax Assistance

Introduction: ITC Record-Keeping Requirements for Canadian Businesses Dealing in Non-Fungible Tokens

Many artists, musicians, and content creators have turned to non-fungible tokens as a new way of monetizing their work. A non-fungible token, or NFT, is basically a unique digital asset that depends on blockchain technology to track ownership. Anything digital can be converted into an NFT—e.g., a digitized picture, song, poem, or this very article. The underlying blockchain allows the public to verify who owns a specific non-fungible token and to track transfers of ownership. As a result, an NFT permits you to create, sell, buy, and own unique digital artifacts.

Unlike cryptocurrency, each non-fungible token bears unique attributes. This is why non-fungible tokens are called "non-fungible." Cryptocurrency, on the other hand, is fungible—trading one Bitcoin for another gets you exactly the same thing. Yet each NFT is like an original piece of art. If you trade one for another, you don't end up with the same thing. Non-fungible tokens have therefore garnered attention as a new medium for commercializing digitized art and music.

The profit generated from creating and selling non-fungible tokens constitute business income for self-employed NFT artists and NFT content creators in Canada. As a result, self-employed Canadian NFT artists and Canadian NFT content creators must report their earnings as business income in accordance with subsection 9(1) of Canada's Income Tax Act.

What's more, commercial NFT sales may also give rise to GST/HST obligations. Although a cryptocurrency-trading business constitutes a supply of financial services, which is exempt from GST/HST, commercial NFT sales remain a taxable supply. Under Canada's Excise Tax Act, financial services don't bring about GST/HST obligations, and a "financial service" includes the purchase or sale of a "virtual payment instrument," which refers to a "property that is a digital representation of value, that functions as a medium of exchange, and that only exists at a digital address of a publicly distributed ledger." So, fungible cryptocurrency, like Bitcoin, Ethereum, or Chainlink, falls squarely within the definition of a "virtual payment instrument." Yet NFT artwork doesn't. As a representation of a piece of art or music, a non-fungible token doesn't serve as a "digital representation of value" and doesn't "function as a medium of exchange." Hence, if earning $30,000 or more in gross revenue, a self-employed Canadian NFT artist or content creator must register for a GST/HST number, charge GST/HST on non-fungible tokens sold in Canada, collect that GST/HST, and pay it to the Canada Revenue Agency.

The benefit of registering for GST/HST is that the Canadian NFT artist or content creator may claim input tax credits (ITCs), which reduce the net GST/HST payable to the Canada Revenue Agency. An input tax credit allows a GST/HST registrant to offset the amount of GST/HST payable to the CRA by the amount of GST/HST that the registrant paid to its own business vendors.

Canada's Excise Tax Act imposes rigorous crypto record-keeping requirements upon registrants who claim ITCs. Unsurprisingly, the Canada Revenue Agency invokes its most aggressive tactics when auditing groups that the CRA's tax auditors perceive as most likely to retain poor records—groups such as those who create, trade, and sell non-fungible tokens or other blockchain-based assets. When auditing the ITC claims of a Canadian NFT artist or content creator, the CRA's GST/HST crypto auditors will check not only whether the taxpayer possesses supporting documents but also when the taxpayer actually received those supporting documents. Canadian NFT artists, NFT content creators, and NFT dealers who fail to meet the Excise Tax Act's record-keeping requirements will lose all impugned input tax credits. So, Canadian NFT artists, NFT content creators, and NFT dealers who routinely keep poor records will find themselves facing a large GST/HST bill when the CRA's tax auditors are through

This article examines the ITC record-keeping requirements for GST/HST registrants engaging in commercial sales of non-fungible tokens. Before discussing the Excise Tax Act's record-keeping requirements for input tax credits, this article first reviews Canada's GST/HST system. It then concludes by offering pro crypto tax tips for Canadian NFT artists, NFT content creators, and NFT dealers from our expert Canadian NFT and crypto tax lawyers.

Canada's GST/HST System: A Summary

Section 165 of Canada's Excise Tax Act imposes GST/HST on "every recipient of a taxable supply made in Canada." A "taxable supply" essentially refers to any commercial activity, and it captures most business transactions—e.g., sale of goods or services; barter transactions; licensing or leasing arrangements; etc.

Yet while GST/HST is levied on the recipient of the property or service (the purchaser), the person who makes the supply (the vendor) bears the obligation of actually collecting the tax and remitting it to the Canada Revenue Agency. In particular, a Canadian business earning $30,000 or more in worldwide annual gross revenues must register for a GST/HST number and begin charging GST/HST on its goods and services. Failure to do so is subject to tax penalties plus interest and possible prosecution for crypto tax evasion.

Registered suppliers participating in the supply chain may recoup the GST/HST that they paid to their own business vendors by claiming those amounts as input tax credits. The ultimate consumer, however, cannot claim input tax credits and hence cannot recover the GST/HST paid to retailers or other suppliers. Thus, in most cases, only the final consumer bears the GST/HST burden. Businesses collect GST/HST on sales, but since they receive a full input tax credit for GST/HST paid on their own purchases, businesses remit only the difference to the Canada Revenue Agency.

The Excise Tax Act exempts various businesses from the obligation to collect GST/HST. For example, a Canadian business earning less than $30,000 in annual gross revenue qualifies as a "small supplier." And under paragraph 240(1)(a) of the Excise Tax Act, a small supplier need not register for—and thus need not collect—GST/HST. (This doesn't apply to a taxi business or to commercial ride-sharing services like Uber and Lyft. A taxi driver or commercial ride-share driver must register for GST/HST, regardless of the amount of gross annual revenue the driver earns.)

A financial-services business is another example of a business that need not charge or collect GST/HST. The Excise Tax Act's definition of a "financial service" captures various transactions involving a "financial instrument"—e.g., securities, insurance policies, precious metals, commodities options, etc. In June 2021, Canada's Parliament extended the definition of a "financial instrument" to include a "virtual payment instrument," which refers to "property that is a digital representation of value, that functions as a medium of exchange and that only exists at a digital address of a publicly distributed ledger." Fungible cryptocurrency—like Bitcoin (BTC), Ethereum (ETH), or Tether (USDT)—falls squarely within the definition of a virtual payment instrument. As such, cryptocurrency trading is exempt from GST/HST because it qualifies as a financial-services business.

But the definition of virtual payment instrument doesn't catch non-fungible tokens. NFT artwork, for instance, often consists of a digital representation of a piece of art or music, not a "digital representation of value." As such, it arguably doesn't "function as a medium of exchange." So, although a cryptocurrency-trading business qualifies as a GST/HST-exempt supply of financial services, commercial NFT sales remain a taxable supply under Canada's Excise Tax Act.

Claiming Input Tax Credits: ITC Requirements for GST/HST-Registered NFT Artists, NFT Content Creators & NFT Dealers

A registered supplier who paid GST/HST to one or more of its own business vendors may claim those payments as input tax credits, thereby reducing the supplier's net GST/HST payable to the Canada Revenue Agency. Thus, if a GST/HST-registered NFT artist or content creator paid GST/HST to business vendors, the artist or content creator may claim those amounts as input tax credits. Examples of amounts claimable as ITCs include the GST/HST payable on commercial rent, the GST/HST payable on professional fees charged by Canadian crypto tax lawyers or accountants, the GST/HST payable on internet-service fees, and the GST/HST payable on cell-phone fees (to the extent that the internet use and cell-phone use were business related).

Yet a GST/HST registrant must meet certain criteria to qualify for the ITC claim itself. For instance, the registrant must have been a GST/HST registrant during the reporting period in which the GST/HST was paid or became payable to the business vendor, who must also be registered for GST/HST. Moreover, the registrant cannot claim an input tax credit unless the GST/HST was payable on a business expense (as opposed to a personal expense).

In addition, a business cannot claim ITCs unless that business makes "taxable supplies." This phrase includes taxable sales and services, and it includes zero-rated supplies (e.g., exports), but it excludes exempt supplies. In other words, a business cannot claim ITCs if it makes only exempt supplies. For example, a cryptocurrency-trading business, which qualifies as a GST/HST-exempt supply of financial services, cannot claim input tax credits. Other examples of exempt supplies include health care, educational services, and long-term residential rent.

Canada's Excise Tax Act also imposes stringent record-keeping requirements. Paragraph 169(4)(a) of the Act precludes a registrant from claiming an input tax credit "unless, before filing the return for which the credit is claimed, the registrant has obtained sufficient evidence in such form containing such information as will enable the amount of the input tax credit to be determined, including any such information as may be prescribed." Notably, the provision requires the registrant to obtain documentary evidence "before filing" the GST/HST return claiming the ITC. Put differently: the registrant must not only obtain documents supporting the ITC but also obtain those records before attempting to claim the ITC.

The Input Tax Credit Information (GST/HST) Regulations lay out the exact records that a registrant must obtain to substantiate its input tax credits. In most cases, a registrant must obtain the following information:

• The name of the supplier who charged the GST/HST underlying the input tax credit;
• The total amount paid or payable to that supplier;
• The amount of GST/HST paid or payable to that supplier (In other words, the supporting document should identify the GST/HST as a separate line item.);
• The date on which the GST/HST was paid or became payable;
• The supplier's GST/HST registration number;
• The terms of the payment; and
• A description sufficient to identify each supply—that is, each service or good.

This information will generally appear on invoices, receipts, and contracts, all of which the registrant claiming the ITC should retain.

But credit-card statements, bank-account statements, and cancelled cheques don't include the above-listed details. They might indicate that a payment was made, yet they don't establish whether the payment included GST/HST. As a result, GST/HST-registered NFT artists, content creators, or dealers must ultimately supplement their credit-card statements, bank-account statements, and cancelled cheques with invoices, receipts, and contracts.

Pro Tax Tips – Input Tax Credits: Verifying Your Suppliers to Protect Yourself from Tax Fraud & Defending Your ITC Claims in a GST/HST Audit by CRA

The Canada Revenue Agency's GST/HST auditors routinely deny ITCs because of insufficient supporting documents. And CRA tax auditors tend to more frequently audit industries in which participants keep notoriously poor records, which is often the case with those who create, trade, and sell non-fungible tokens and other blockchain-based assets. By failing to meet the Excise Tax Act's record-keeping requirements, a GST/HST registrant engaging in commercial sales of non-fungible tokens will lose all impugned input tax credits and may face a large GST/HST bill (plus, interest and potential gross-negligence penalties).

In most cases, to support their input-tax-credit claims, GST/HST-registered NFT artists, NFT content creators, and NFT dealers should obtain documents containing all of the following information:

• The name of the supplier who charged the GST/HST underlying the ITC;
• The total amount paid or payable to that supplier;
• The amount of GST/HST paid or payable to that supplier;
• The date on which the GST/HST was paid or became payable;
• The supplier's GST/HST registration number;
• The terms of the payment; and
• A description sufficient to identify each supply.

The GST/HST-registered NFT artist, content creator, dealer should also confirm that the supplier possesses a valid GST/HST registration number. The CRA's tax auditors will deny your ITCs if you cannot produce a valid GST/HST registration number for your supplier—even if you can prove that you did in fact pay GST/HST to that supplier. Unfortunately, principles of equity don't apply in Canadian cryptocurrency tax disputes, so neither the CRA nor the courts are very sympathetic to the fact that your supplier may have fraudulently charged you for GST/HST.

To protect yourself from crypto tax fraud, you should therefore confirm the validity of your supplier's GST/HST registration number before paying the supplier any amount that you intend to claim as an input tax credit. You can confirm a supplier's GST/HST registration number by using the GST/HST registry search on the Government of Canada's website (https://www.canada.ca/en/revenue-agency/services/e-services/e-services-businesses/confirming-a-gst-hst-account-number.html). You should also keep a record showing that you searched the CRA's GST/HST registry (e.g., taking a screenshot capturing the search result and the date upon which you performed the search).

Our experienced Canadian NFT-tax lawyers can advise Canadian NFT artists, NFT content creators, and NFT dealers on protecting their businesses from GST/HST fraud and on ensuring that their input-tax-credit claims withstand the scrutiny of the Canada Revenue Agency's GST/HST auditors.

FREQUENTLY ASKED QUESTIONS

Question: I'm a self-employed Canadian NFT artist, and my business consists of creating and selling non-fungible tokens to other Canadians. I've heard that commercial NFT sales are exempt from GST/HST. Is that correct?

Answer: No. Although a cryptocurrency-trading business constitutes a supply of financial services, which is exempt from GST/HST, commercial NFT sales remain a taxable supply. Under Canada's Excise Tax Act, financial services don't bring about GST/HST obligations, and a "financial service" includes the purchase or sale of a "virtual payment instrument," which refers to a "property that is a digital representation of value, that functions as a medium of exchange, and that only exists at a digital address of a publicly distributed ledger." This definition catches fungible cryptocurrency, but it doesn't catch non-fungible tokens, such as NFT artwork. As a representation of a piece of art or music, a non-fungible token doesn't serve as a "digital representation of value" and doesn't "function as a medium of exchange." Hence, if earning $30,000 or more in gross revenue, a self-employed Canadian NFT artist or content creator must register for a GST/HST number, charge GST/HST on non-fungible tokens sold in Canada, collect that GST/HST, and pay it to the Canada Revenue Agency.

Question: What is an input tax credit?

Answer: An input tax credit (or ITC) is a credit that a GST/HST-registered supplier may claim to reduce the supplier's net GST/HST payable to the Canada Revenue Agency. The amount of the ITC essentially equals the GST/HST that the supplier incurred on its own inputs (i.e., on its own business expenses).

Question: I'm a self-employed Canadian who operates a cryptocurrency-trading business, which is registered for GST/HST. Can I claim input tax credits?

Answer: No. A business cannot claim ITCs unless that business makes "taxable supplies." This phrase includes taxable sales and services, and it includes zero-rated supplies (e.g., exports), but it excludes exempt supplies. In other words, a business cannot claim ITCs if it makes only exempt supplies. A cryptocurrency-trading business qualifies as a GST/HST-exempt supply of financial services. So, it doesn't qualify for input tax credits.

Question: I'm a self-employed Canadian who operates an NFT-trading business, which is registered for GST/HST. Can I claim input tax credits?

Answer: Yes, but only if you satisfy all the criteria. First,you must have been registered for GST/HST during the crypto tax reporting period in which the GST/HST was paid or became payable to your vendor. Second, you cannot claim an input tax credit unless the GST/HST was payable on a business expense (as opposed to a personal expense). Third, you must obtain documentary evidence substantiating your input tax credits before filing the GST/HST return in which you claim those ITCs. In most cases, to support their input-tax-credit claims, GST/HST-registered NFT artists, NFT content creators, and NFT dealers should obtain documents containing all of the following information:

• The name of the supplier who charged the GST/HST underlying the input tax credit;
• The total amount paid or payable to that supplier;
• The amount of GST/HST paid or payable to that supplier (In other words, the supporting document should identify the GST/HST as a separate line item.);
• The date on which the GST/HST was paid or became payable;
• The supplier's GST/HST registration number;
• The terms of the payment; and
• A description sufficient to identify each supply—that is, each service or good.

Invoices, receipts, and contracts will usually be the source of this information. To confirm whether your blockchain-based business qualifies for input tax credits, contact one of our expert Canadian NFT-tax lawyers today.

Question: I understand that, to qualify for input tax credits, I must obtain certain supporting documents. I typically pay my business vendors by credit card or cheque. Can I use my credit-card statements, bank-account statements, and cancelled cheques as supporting documents for my ITC claims?

Answer: To satisfy the supporting-document requirements, you must (at a minimum) produce evidence showing that your vendor charged you GST/HST. This information won't appear on your credit-card statements, bank-account statements, and cancelled cheques. Although credit-card statements, bank-account statements, and cancelled cheques might indicate that you made a payment, they don't establish whether the payment included GST/HST. So, by themselves, credit-card statements, bank-account statements, and cancelled cheques won't support your ITCs. You must ultimately supplement the credit-card statements, bank-account statements, and cancelled cheques with other documents, such as invoices, receipts, and contracts. For advice on ensuring that your ITC claims withstand the scrutiny of the Canada Revenue Agency's GST/HST auditors, consult one of our experienced Canadian crypto-tax lawyers today.