Introduction: Binance pulls out of Ontario; Ontario-based users must close Binance accounts
The move follows the Ontario Securities Commission's onslaught on cryptocurrency exchanges for their alleged failure to comply with securities law. In the weeks leading up to Binance's departure, the OSC issued statements of allegation against three other cryptocurrency exchanges, Bybit, Poloniex, and KuCoin. The OSC claims that all three cryptocurrency exchanges failed to comply with Ontario's Securities Act. Binance seemingly opted to pull out of the Ontario market altogether, rather than comply with securities law or face regulatory scrutiny.
Binance's departure from Ontario raises Canadian income-tax issues for Ontarians who must close their cryptocurrency-exchange accounts with Binance. More Canadians could face similar tax issues if other cryptocurrency exchanges abandon Canadian markets to avoid securities regulation. This article discusses the Canadian income-tax implications for Canadian taxpayers who have been forced to close a cryptocurrency-exchange account or switch an account from one cryptocurrency exchange to another. This article concludes by offering pro tax tips to Canadian taxpayers engaging in cryptocurrency transactions.
Canadian Income-Tax Implications for Canadian Taxpayers when Forced to Close or Switch a Cryptocurrency-Exchange Account
Any "disposition" of a "property" will potentially trigger tax liability for the Canadian taxpayer who disposed of that property. Canada's Income Tax Act gives a broad definition of the word "property." In particular, for income-tax purposes, "property" includes intangible property, such as cryptocurrency and non-fungible tokens (NFTs).
The Income Tax Act's definition of "disposition" is also quite broad. Basically, a "disposition" occurs whenever a person relinquishes all aspects of property ownership (e.g., possession, control, etc.)-regardless of whether the person does so voluntarily or involuntarily, and regardless of whether the person receives compensation. So, each of the following transactions constitutes a "disposition":
- The sale of a property;
- A gift or donation;
- The redemption or cancellation of a loan;
- The expropriation or confiscation of a property;
- Destruction of a property; and
- Theft, loss, or abandonment of a property.
In the context of transactions involving cryptocurrency, a "disposition" includes a sale of cryptocurrency for fiat currency. It also includes a trade of tokens or coins in one type of cryptocurrency for tokens or coins in another cryptocurrency. By implication, each intermediate crypto trade-e.g., purchasing Bitcoin for the sole purpose of acquiring a trading pair-includes a disposition and will thereby trigger a taxable transaction.
Hence, when forced to close a cryptocurrency-exchange account or switch an account from one exchange to another, a Canadian taxpayer might incur Canadian income-tax liability-depending on what happens to the cryptocurrency within the exchange account upon its closure. For example, if the account closure results in the liquidation of any tokens or coins within the account, the cryptocurrency-for-fiat exchange constitutes a disposition, and any resulting profit is taxed, either as a capital gain or as business income. Likewise, if the account closure results in a crypto-for-crypto exchange (e.g., upon closing the account, you trade the cryptocurrency held within that account to acquire another type of cryptocurrency), the resulting profit will be taxed as a capital gain or as business income.
The income/capital distinction also comes with important tax implications. Canada's Income Tax Act sets out two entirely different tax regimes for business income, on the one hand, and for capital gains, on the other. In sum, if your cryptocurrency transactions attract income treatment, your cryptocurrency-trading profits are fully taxable, and your cryptocurrency-trading losses are fully deductible. If, on the other hand, your cryptocurrency transactions draw capital treatment, only one-half of your gains are taxable, and only one-half of your losses are deductible. Moreover, losses on income account are deductible against any source of income, yet losses on capital account may only offset capital gains.
A taxpayer's motive or intent at the time of acquiring the cryptocurrency is the most important criterion that the Tax Court and the Canada Revenue Agency will consider when determining whether the transaction produced a capital gain or business income. Yet to discern a taxpayer's intention, the Tax Court and the CRA will focus on the objective factors surrounding both the purchase and the sale of the cryptocurrency.
For more information on distinguishing between capital gains and business income in the context of cryptocurrency transactions, please read our "Tax Guide for Crypto & Bitcoin Businesses: Computing Inventory Costs."
Pro Tax Tips - Expert Canadian Tax Guidance from a Canadian Tax Lawyer: Inter-Account Transfer of Cryptocurrency, Record-Keeping, Cryptocurrency Tax Audits, Voluntary Disclosures Program & Solicitor-Client Privilege
If you're an Ontario resident who must close your cryptocurrency account with the cryptocurrency exchange Binance, you might incur Canadian income-tax liability should the account closure result in the liquidation of any cryptocurrency within the account or in a crypto-for-crypto exchange involving any of the account holdings. These transactions constitute a "disposition" under the Income Tax Act, and you'll incur tax on any profit arising from the disposition. You may avoid income-tax liability if you close your cryptocurrency-exchange account without disposing of the cryptocurrency within the account. An inter-account transfer doesn't constitute a "disposition" because the taxpayer does not thereby relinquish ownership of the underlying cryptocurrency. The crypto assets simply flow from one account held by the taxpayer to another account held by the same taxpayer. So, when closing a cryptocurrency account, Canadian taxpayers should, if possible, arrange for a direct transfer of their crypto assets from the soon-to-be-closed account to their new account without liquidating any crypto assets in the interim.
A cryptocurrency-trading business that lacks proper records will fare poorly during a CRA cryptocurrency tax audit. If selected for a cryptocurrency tax audit by the Canada Revenue Agency, a Canadian cryptocurrency trader will typically receive a 13-page cryptocurrency-audit questionnaire, which includes over 50 questions on a range of topics, such as:
- The timeline of owing or using cryptocurrency;
- The source of the cryptocurrencies purchased;
- The use of third-party exchange wallets;
- The source of funds used to purchase cryptocurrency;
- Transaction record-keeping practices of the taxpayer;
- Participation in initial coin offerings (ICOs);
- Whether any cryptocurrency holdings generate passive income for the taxpayer (e.g., Node, Masternodes, Supernodes, etc.);
- Participation in cryptocurrency mining (including questions about the sort of mining hardware used and energy expenses related to mining);
- Acceptance of cryptocurrency as payment for goods or services;
- The frequency of cryptocurrency transactions; and
- The time spent studying cryptocurrency markets.
The taxpayer must also turn over bank-account statements and any other records allowing the Canada Revenue Agency's tax auditor to verify the taxpayer's answers.
Cryptocurrency traders must therefore keep records of their cryptocurrency transactions. If you use a cryptocurrency exchange, you should periodically export your transaction information to avoid losing it. Notably, Ontario-based users of Binance should export their Binance account records before losing all access on December 31, 2021. You should also maintain the following records about your cryptocurrency transactions:
- The date of each transaction;
- Any receipts for purchasing or transferring cryptocurrency;
- The value of the cryptocurrency in Canadian dollars at the time of the transaction;
- The digital-wallet records and cryptocurrency addresses;
- A description of the transaction and of the other party (e.g., the other party's cryptocurrency address);
- The exchange records;
- Records relating to any accounting and legal costs; and
- Records relating to any software costs for managing your tax affairs.
If you mine cryptocurrency, you should keep the following records in addition to your cryptocurrency-transaction records:
- Receipts for purchasing cryptocurrency-mining hardware;
- Receipts for expenses associated with your cryptocurrency-mining operation (e.g., power costs, mining-pool fees, maintenance costs);
- Records about your cryptocurrency-mining operation (e.g., hardware specifications, hardware operation time); and
- The mining pool details and records.
Our Certified Specialist Canadian tax lawyer can provide advice about record-keeping and proper reporting of your cryptocurrency profits to ensure that CRA doesn't fault you for misrepresenting the information in your tax returns. You may, for example, benefit from a tax memorandum examining whether your cryptocurrency profits should be reported as capital gains or as business income or as a blend of both.
The Ontario Securities Commission isn't the only Canadian administrative agency that has been targeting cryptocurrency exchanges. In March 2021, the Canada Revenue Agency obtained a Federal Court order requiring the Canadian cryptocurrency exchange Coinsquare to identify all Canadian customers that held cryptocurrency accounts with a value of $20,000 or more during the period from 2014 to 2020 or that held cryptocurrency accounts with total deposits over $20,000 since the account's creation. Coinsquare must also list its 16,500 largest Canadian cryptocurrency-account holders by trading volume, and Coinsquare must release the cryptocurrency-transaction records for each affected taxpayer.
These developments should definitely concern Canadian taxpayers with unreported profits from cryptocurrency transactions. If you filed Canadian income-tax returns that omitted or underreported your cryptocurrency profits, you risk facing not only civil monetary penalties, such as gross-negligence penalties, but also criminal liability for tax evasion.
You may qualify for relief under the CRA's Voluntary Disclosures Program (VDP). If your VDP application qualifies, the CRA will renounce criminal prosecution and waive gross-negligence penalties (and may reduce interest). A voluntary-disclosure application is time-sensitive, however. The CRA's Voluntary Disclosures Program will reject an application-and thus deny any relief-unless the application is "voluntary." This essentially means that the VDP must receive your voluntary-disclosure application before the CRA contacts you about the non-compliance you sought to disclose. Our experienced Canadian tax lawyers have dealt with many Canadian taxpayers involved with cryptocurrency and can carefully plan and promptly prepare your voluntary-disclosure application. A properly prepared disclosure application not only increases the odds that the CRA will accept your disclosure but also lays the groundwork for a judicial-review application to the Federal Court should the CRA unfairly deny your disclosure.
To determine whether you qualify for the Voluntary Disclosures Program, schedule a confidential and privileged consultation with one of our expert Canadian tax lawyers. Solicitor-client privilege prevents the Canada Revenue Agency from learning about the legal advice that you received from your Canadian tax lawyer. Yet your communications with an accountant remain unprotected. So, if you seek tax advice but want to keep that information away from the CRA, you should first approach a Canadian tax lawyer. If an accountant is needed, your Canadian tax lawyer can retain the accountant on your behalf and extend legal privilege.
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.