In these heady days of cryptocurrency investment, the market can seem like a gold rush: offering promise, but at the expense of predictability. The taxation of cryptocurrencies is no different. In this article, a collaboration between the Fintech Team at EKB and Alexander Demner at Thorsteinssons LLP, we consider the tax implications for cryptocurrency investment in Canada.
"In this world nothing can be said to be certain, except death and taxes."
Digital Currency or Taxable Commodity?
Despite its name, cryptocurrency's status as a "currency" remains very much in question. In 2013, the Canada Revenue Agency (the CRA) took the position that Bitcoin and other cryptocurrencies are not currencies and should instead be viewed as commodities.
Virtual currencies, such as Bitcoins, are not considered to be a currency issued by a government of a country, such as American dollars. As such, they are generally treated as a commodity for purposes of the Income Tax Act.
To date, no country has recognized a cryptocurrency as a form of domestic legal tender. However, there are strong signs that this may change in the near future.
Assuming the CRA's characterization of cryptocurrencies is correct, what are the tax implications of their being treated as commodities? Among other things, it means that people using crypto to buy goods and services are undertaking "barter" transactions in the eyes of the CRA. Thus, a value (in Canadian dollars) has to be determined for both ends of the transaction (i.e., the crypto as well as the item bought/sold). In other words, accepting Bitcoin as payment does not exempt merchants from recognizing income on a sale. Similarly, those who swap crypto for merchandise would need to report income or a capital gain (or loss) on the disposition of their crypto asset.
Perhaps less obviously, the barter analysis also likely applies to "crypto-for-crypto" trades. That is, the crypto world is largely centered around a few well-known bellwether coins like Bitcoin and Ethereum, which can be traded through intermediaries for legal tender (or "fiat" currency as it is known in the crypto world). There are also a large number of smaller cryptocurrencies, sometimes called "alt-coins", which for the most part can only be purchased with one of the more established coins or tokens (like the aforementioned Bitcoin or Ethereum). Barter treatment means that each alt-coin purchase, or even a Bitcoin for Etherum trade, potentially creates a taxable event. This is at odds with the commonly held myth that crypto-investors only need to compute realized income or gains when "cashing out" in crypto-for-fiat trades.
Internet Anonymity: A False Hope?
Cryptocurrency investors in Canada may feel that they enjoy relative anonymity, with minimal detection risk by the CRA. A glance across the border at our American neighbours, however, reveals the steps that taxation authorities can take to investigate crypto-holders.
In United States v Coinbase Inc., the IRS brought a successful petition against Coinbase, a digital currency wallet and platform for trading digital currencies, to release: (1) the name, taxpayer ID number, address and birth date of account holders; (2) account records (including transaction activity and account balances); and (3) periodic account statements or invoices, for all accounts with at least one transaction of USD$20,000 in any one transaction type (i.e., buy, sell, send, or receive) during any of 2013, 2014, or 2015. The IRS brought the petition on the basis that, while Coinbase boasted 5.9 million customers served and more than $6 billion in transactions, only 800-900 taxpayers reported dispositions involving properties related to Bitcoin in the 2013 through 2015 years.
It doesn't take much imagination to picture the CRA – which has similar investigative powers – to make a similar request of Canadian cryptocurrency exchanges. Conceivably, such enforcement action could also extend to Canadian entities who have undertaken an Initial Coin Offering (ICO) or Initial Token Offering (ITO), or have otherwise facilitated crypto-transactions. In our increasingly globalized world, we may even see the CRA attempt to reach beyond our borders and request data from foreign institutions or governments.
Mining can be Taxing
Crypto-miners potentially face a markedly different tax treatment than passive investors. Although there is no court decision on point (and may not be for years to come), there is a significant risk that miners – whether rewarded based on proof of work or proof of stake – must pay full income tax rates on all profits realized. In dedicating significant time, energy, and resources towards maximizing return from crypto-mining activities, miners could be characterized as engaged in a business. The result: income tax of up to 49.8% (in 2018) on any profits realized by B.C.-resident individuals. Passive investors in crypto could be subject to tax at only half that rate as realizing capital gains, rather than business income.
The CRA has also commented that accepting cryptocurrencies as payment for goods or services can require the vendor to collect and remit GST/HST, based on the fair market value of the crypto received. As the Government of Canada does not yet accept Bitcoin (or other cryptocurrencies) as payment – contrary to what some recent telemarketing scams would have you believe –GST remitters would need to make an equivalent Canadian dollar remittance on any cryptocurrency transactions attracting GST (to the extent not offset by input tax credits). The GST consequences to those disposing of crypto is currently uncertain, and it is anticipated that that the CRA will provide their administrative views on that topic in the near future.
The cryptocurrency world is replete with vagaries and uncertainties. Investors and traders face a veritable tax minefield in undertaking digital currency transactions. Holding assets outside Canada (even mere backup copies held in cold storage) may give rise to "specified foreign reporting" obligations – investors be warned, circumventing these obligations may result in draconian penalties. Suffering a theft or loss of crypto may result in the doubly-punitive outcome of economic loss coupled with tax penalization. Each of those, and many others, are nuanced issues in a fluid and ever-evolving industry. Professional tax advice is always strongly recommended.
The Future is Regulated
Increasing scrutiny from all types of regulators, including tax authorities, seems inevitable for the crypto sector. While this may diminish some of the potential profits when compared to the early boom days of crypto, it will likely add structure, transparency and legitimacy over the long term. Industry participants are well served to stay up to date on developments, as the CRA addresses the topics discussed above and others. As Ben Franklin said, however, they should not expect the government to fail to ask for its share of any profits.
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.