In the past decade, we have seen the creation and massive expansion of what is commonly referred to as "cryptocurrency". Cryptocurrencies are essentially digital "currencies" that operate through blockchain technology as a medium of exchange and do so independently from centralized banks. Cryptocurrencies are regulated by encryption techniques that control the number of "units" and use their own networks of users to verify transfers between parties. The use of cryptocurrencies has become widespread, with over 1,600 different types existing worldwide. However, the regulation of cryptocurrencies has not kept up with this growth and questions now arise as to how cryptocurrencies should be treated under the law. The following discussion identifies several relevant legal issues currently faced by the holders, traders, and issuers of cryptocurrencies.
Securities Law – Are Cryptocurrency Issuers Selling Securities?
This issue impacts both issuers and purchasers of cryptocurrency, as issuers of securities in Canada must comply with the requirements of securities legislation, which includes filing comprehensive disclosure documents with securities regulators. The test in Canada to determine if a cryptocurrency coin offering is a "security" is whether the offering creates an investment contract. An investment contract exists when there is: (1) an investment of money (2) in a common enterprise (3) with the expectation of profit (4) to come significantly from the efforts of others. Issuers should also note that "free" offerings which require one to promote the offering via social media may nonetheless trigger securities law. Those issuers have an incentive to promote the offering as an investment, suggesting the token will increase in value.
Anti-Money Laundering – Do I Have to Record-keep and Report Cryptocurrency Sales?
Cryptocurrencies can facilitate money laundering since traders of the commodity are able to remain totally anonymous. In order to combat money laundering, Canada's Proceeds of Crime (Money Laundering) and Terrorist Financing Act requires money services businesses ("MSB") to comply with reporting and record-keeping requirements. However, Canada's Act does not currently include virtual currencies within the definition of MSBs. As a result, amendments have been proposed that, if accepted, would include cryptocurrencies and make their dealers subject to customer due diligence, recordkeeping, monitoring, and other reporting requirements.
Taxation – How is my Cryptocurrency Taxed?
When filing your tax returns, those with significant cryptocurrency "wallets" may ask themselves: is cryptocurrency treated as property or as currency? This question requires one to consider how cryptocurrencies are treated under the Income Tax Act and the Excise Tax Act. The answer in both the U.S. and Canada is that cryptocurrencies are treated as commodities, similar to an investment in stocks, as cryptocurrency is not a government-issued currency. This means that an individual's cryptocurrency portfolio would be fully taxed as business or property income, depending on the nature of their involvement in the cryptocurrency market. This also means that those who experience a loss of value in their cryptocurrency wallet may be eligible to deduct such losses as business expenses or may be able to claim capital losses to be used to off-set future capital gains.
Treating cryptocurrency as a commodity also means that all cryptocurrency transactions are considered barter transactions. The result is that the value of any goods and services bought using cryptocurrency must be included within the seller's income for tax purposes. There is also an obligation to collect and remit Goods and Services Tax (GST) on the fair market value of goods and services bought with cryptocurrency.
Family Property – How is my Cryptocurrency Wallet Valued Upon Separation?
Given that cryptocurrency is treated as a commodity and not currency for taxation purposes, one may also ask how it would be treated in the event of a separation. The general conclusion is that cryptocurrency would be valued and divided in accordance with the rules regarding family property. However, this is a complex issue, as there would be difficulty in valuation, as some cryptocurrencies have an associated CAD or USD price, while others only have a value relative to a larger cryptocurrency. Furthermore, given the volatility in cryptocurrency values, parties ought to mutually agree to a specific time of valuation, as the value at the date of petition may alter significantly from the date of adjudication.
Will & Estates – Can I Leave my Cryptocurrency Wallet to a Beneficiary of my Estate?
Whether someone is drafting their will or considering how to deal with an estate, questions may arise as to how a cryptocurrency wallet will be treated. In Canada, because cryptocurrencies are a taxable commodity, they may form a part of the assets of an estate. However, the real issue in leaving digital currencies to a beneficiary is how they will be accessed after one's passing. All cryptocurrency accounts are protected by a private key and would be inaccessible and inactive without it. The simple way to address this issue is to ensure that the wallet is declared as an inheritable asset and to entrust the private key to the advisor of the estate, with specific instructions on how to access the account.
Conclusion
As this post has hopefully illustrated, there are a myriad of legal issues concerning both the purchase and sale of cryptocurrency as well as with the business of offering cryptocurrency. The lawyers at McKercher LLP have experience assisting both cryptocurrency issuers and regular investors with understanding the legal implications of their cryptocurrency.
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.
