Introduction

In the ever-evolving landscape where digital assets play a vital role in corporate, commercial, and financial spheres, the transfer of cryptocurrency as part of different transactions has become commonplace. This includes instances where digital assets are pledged as collateral for loans or transferred through crypto lending agreements.

Scenario 1: Collateral for loans

Certain borrowers are keen on leveraging their substantial digital asset portfolios to secure fiat currency loans. The process of pledging crypto assets as collateral in secured loan transactions can take various forms.

Sometimes, the terms of the loan may necessitate the borrower to pledge digital assets by entering into a custodial agreement. This agreement designates a custodian to assume possession and control of the pledged digital collateral.

Depending on the custodial agreement's terms, the Canada Revenue Agency ("CRA") may assert that a disposition of assets has occurred, resulting in potential capital gains or losses for the individual pledging the digital collateral.

Under such agreements, custodians generally assume legal interest in the collateral. The key determination as to whether there has been a disposition is if the terms of the agreement indicate that the custodian also receives beneficial ownership.

Pursuant to subsection 248(1) of the Income Tax Act (Canada) (the "Act"), the definition of "disposition" includes, under paragraph (c), "any transfer of the property to a trust or, where the property is property of a trust, any transfer of the property to any beneficiary under the trust, except as provided by paragraph (f) or (k)." The application of paragraphs (f) or (k) can be described as an exception to the rule where there was a mere change in legal ownership of the trust without any change in beneficial ownership.

Generally, a custodial relationship is considered to be a trust relationship where the assets are held by the custodian for the benefit of the borrower. This arrangement may be considered a bare trust for tax purposes in which legal title is transferred to the trustee (the custodian) and beneficial ownership is held by the beneficiary (the borrower).1 If this is the case when digital assets are pledged, then there will be no disposition under paragraph (c) as there is only a change in legal ownership and no change in beneficial ownership. However, if there is a change in beneficial ownership under the term of the agreement, the custodial arrangement can result in a disposition under the Act.

Digital assets can also be pledged as collateral for a loan where there is no custodial agreement or trust relationship. In a traditional asset collateral arrangement, the pledge of securities may not be treated as a disposition under the Act. Pursuant to subsection 248(1) of the Act, a "disposition" excludes, under paragraph (j), "any transfer of the property for the purpose only of securing a debt or a loan, or any transfer by a creditor for the purpose only of returning property that had been used as security for a debt or a loan." Accordingly, where digital assets are pledged as collateral in a non-custodial, secured loan transaction, there should be no taxable disposition if there has been no transfer in beneficial ownership.

Under the definition of "disposition" in subsection 248(1) of the Act, the CRA may scrutinize whether the transfer of digital assets pursuant to a custodial or non-custodial agreement constitutes a disposition for tax purposes, raising intriguing questions about the tax implications.

Scenario 2: Lending agreements

A recent CRA roundtable commentary addressed a hypothetical scenario where a taxpayer transfers bitcoin to a centralized cryptoasset exchange and lending platform in exchange for a variable return under a lending agreement.2 The platform, holding the bitcoin in its own name, retained the right to pledge, sell, lend, or otherwise transfer or use the bitcoin at its discretion without informing the taxpayer.3

As the bitcoin was not held in a custodial agreement, in trust for the taxpayer as beneficial owner, the beneficial interest in the deposited bitcoin was transferred to the exchange.

Based on the limited facts presented, the CRA indicated that a disposition has likely occurred for purposes of the Act.4 The CRA did not cite to a specific paragraph of the Act to support this position, but referred generally to the definition of "disposition" under subsection 248(1).

This roundtable may create unexpected tax consequences for the taxpayer from the bitcoin transfer agreement.

Implications

The definition of "disposition" in subsection 248(1) of the Act adds complexity to understanding the tax consequences of transferring digital assets. The CRA emphasized that determinations regarding a crypto disposition require consideration of the events, transactions, or transfers and all relevant facts, contractual clauses, and applicable private law.5

The unintended tax consequences highlighted in these scenarios underscore the importance of carefully considering the terms of lending arrangements and maintaining comprehensive record-keeping in the fast-paced and unpredictable realm of digital asset transactions.

Conclusion

As the nature of crypto transfers often leads to unexpected consequences, participants must exercise caution and diligence. The challenge of tracking crypto asset movements underscores the need for meticulous record-keeping. In this rapidly evolving market where decisions must be made nearly at the same speed as your internet connection, thoughtful consideration is imperative before entering into alternative arrangements concerning digital assets.

Footnotes

1 Although not defined in the Act, the CRA describes a bare trust for income tax purposes as a trust arrangement under which the trustee can reasonably be considered to act as agent for all the beneficiaries under the trust with respect to all dealings with all of the trust's property. A trustee can reasonably be considered to act as agent for a beneficiary when the trustee has no significant powers or responsibilities, the trustee can take no action without instructions from that beneficiary and the trustee's only function is to hold legal title to the property. In order for the trustee to be considered as the agent for all the beneficiaries of a trust, it would generally be necessary for the trust to consult and take instructions from each and every beneficiary with respect to all dealings with all of the trust property. Bare trusts are now subject to new trust reporting rules for tax years ending after December 30, 2023. Accordingly, a bare trust is required to file a T3 return annually (unless specific conditions are met) and complete a Schedule 15 annually (unless it is a listed trust). A bare trustee is required to register for a trust number. In the case of custodial relationships, crypto custodians should consider whether a bare trust relationship exists and adhere to the reporting requirements. More information can be found here: Government of Canada "New trust reporting requirements for T3 returns filed for tax years ending after December 30, 2023," (December 1, 2023) online: < >.

2 Association de Planification Fiscale et Financière, "2 November 2023 APFF Roundtable, – Q. 10 Disposition on bitcoin transfer to platform" (November 2, 2023).

3 Ibid.

4 Ibid.

5 Ibid.

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.