In early November 2023, the Canada Revenue Agency (CRA) participated in a roundtable with the Association de planification fiscale et financière (APFF), during which they commented on various issues regarding the taxation of cryptocurrencies. The CRA's comments are welcome, as they provide useful administrative guidance in areas of uncertainty for cryptocurrency users and intermediaries.
The CRA was presented with a fact pattern where a taxpayer holding bitcoins in a cryptocurrency wallet for which the taxpayer is the only one to control the private key transfers the bitcoins to a centralized platform for exchanging and lending crypto assets, as a "deposit" of the bitcoins (i.e., a loan of the specific property). The platform offers the taxpayer a variable return of about 4% per year payable in bitcoin in return for the deposit. The platform's terms of service provide that the platform has the right to pledge, sell, or lend the bitcoins, and any profit made from this use of the bitcoins will belong to the platform. The depositor has the right to withdraw up to their bitcoin balance at any time, the withdrawals to be paid from a wallet in which bitcoins from various clients are deposited.
The CRA was asked whether it considers the transfer of bitcoins to the platform to be a "disposition" for tax purposes, such that the taxpayer may realize a gain, loss, capital gain, or capital loss upon the transfer. The CRA was of the view that the taxpayer's deposit with the platform would likely constitute a disposition for tax purposes, since, in the CRA's opinion, it was likely that the ownership of the bitcoins initially belonging to the taxpayer was transferred to the platform, as the platform had acquired the right to use the assets, to derive profits from them, and to dispose of them at its discretion.
The key takeaway from the CRA's position is that terms and conditions of a platform may need to be subject to closer scrutiny by tax advisors for both the platform and its customers. Importantly, whether a disposition has occurred should be determined by reference to the right to possess and use the specific property, and the identity of the person bearing economic risk in relation to the property. As this is an inquiry into the legal substance of an arrangement, a statement in the platform's terms of service that no disposition has occurred should not be sufficient to avoid a disposition.
The prevalence of crypto asset lending platforms that offer a "yield" or return on cryptocurrency deposits has declined over the past 24 months. Early in 2022, the U.S. Securities and Exchange Commission (SEC)1 and the Autorité des marchés financiers du Quebec2 clarified that a crypto asset deposit account is a security and, therefore, must be distributed in compliance with the prospectus and dealer registration requirements of applicable securities law. Later that year, the largest U.S.-based crypto asset lending platforms, Celsius, BlockFi, and Voyager Digital, all filed for insolvency protection.
In Canada, custodial crypto asset trading platforms (CTPs) are regulated as dealers under applicable securities law, and are required to state clearly in their terms of service that the CTP holds crypto assets in trust for the benefit of its clients, separate and distinct from the assets of the CTP. Registered CTPs are also prohibited from pledging, re-hypothecating or otherwise using any crypto assets owned by their clients. In contrast to the crypto asset lending platform terms of service that were the subject of the APFF roundtable discussion, and subject to further analysis regarding the circumstances specific to each CTP, we would not generally expect that a transfer of crypto assets by a client to a CTP governed under such terms of service would constitute a disposition.
In the course of the APFF roundtable, the CRA also discussed taxation of cryptocurrencies in two other instances: (i) a query as to the availability and timing of a loss for tax purposes where when a taxpayer loses access to their cryptocurrency due to a centralized exchange platform falling victim to fraud or theft; and (ii) a query concerning the types of evidence that could help prove that the taxpayer had an account, the balance in that account, and the right to claim a business loss upon the bankruptcy of a cryptocurrency platform where appropriate records cannot be accessed by the taxpayer.
In response to the first question, the CRA provided positive comments indicating that it should be possible for losses to be realized. In response to the second question, the CRA stated that relevant evidence may include: public information about the platform's fraud or bankruptcy; documents confirming account activation; any contracts signed; a copy of any claim filed with the platform's bankruptcy trustee; pleadings from any recovery proceedings initiated by the taxpayer; proof of previously declared crypto-related income and losses; proof that the taxpayer's cryptocurrency had not been disposed of prior to the bankruptcy; precise calculations of the claimed loss; any documentation regarding recovery or compensation; and proof that the taxpayer did not sell their claim to the platform's bankruptcy trustee.
Footnotes
1 Re Blockfi Lending LLC (February 14, 2022), File No 3-20758 (US, SEC).
2 Autorité des marchés financiers c. Technologies Timechain inc., 2022 QCTMF 36
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