Introduction: The Starting Point of the Taxation of Employment Income
Every person resident in Canada must pay income tax on the taxable income for each taxation year. Section 3 of the Canadian Tax Act sets out five main sources of income: office, employment, business, property, and capital gains/losses. In this article, we will discuss the Canadian income tax consequences for an employee who receives wages or salary in cryptocurrency such as bitcoin or ETH.
What is Included in Employment Income?
The starting point for determining what is included in employment income for tax purposes is section 5 of the Canadian Income Tax Act which sets out what must be included in employment for tax purposes and when employment income must be reported for Canadian tax purposes.
Subsection 5(1) of the Canadian Income Tax Act states that a taxpayer's employment income is salary, wages, and other remuneration, including gratuities, received by the taxpayer in a given taxation year. This section is quite broad because it states that employment income doesn't have to always come directly from the employer. In other words, if there is an employment relationship and an income receipt, then the income received will have to be included in the calculation of one's employment income. For example, let's suppose that there is a Canadian tax lawyer, working for a large Canadian tax law firm, and the employer invites all of his or her employees to the company's annual retreat. In such circumstance, the CRA may consider the retreat as taxable benefit if the cost is more than $150 per person. Therefore, generally speaking, if a taxpayer receives an amount or benefit that has some connection with his or her employment, it is good practice to assume that it may be a taxable employment benefit unless your experienced Canadian tax lawyer indicates otherwise based on taxation case law or the Canadian Tax Act.
When is Employment Income Included in Income?
Subsection 5(1) of the Canadian Tax Act provides that the recognition event for tax purposes is the receipt during the taxation year. In accounting terms, this timing for recognition is commonly referred to as the "cash basis" of income recognition. This means that employment income is reported in the taxation year in which it is received. This is opposite to the general accounting recognition rule for business revenue where the timing for recognition is on an "accrual basis", which means that revenue is recognized when the earning process is completely or substantially finished, regardless of when the funds are received.
Taxation of Non-Cash Benefits?
Section 6 clarifies what is taxable under section 5 of the Canadian Tax Act. It states that benefits connected to employment income are also generally taxable as employment income. The main provision is paragraph 6(1)(a) which states that the "value of board, lodging and other benefits of any kind whatever received or enjoyed by the taxpayer or by a person who does not deal at arm's length with the taxpayer, in the year in respect of, in the course of, or by virtue of the taxpayer's office or employment" must be included in the employment income. As a result of this paragraph, any non-cash benefits may have to be included in the employment income if an employee receives benefits in the course of employment. For example, if a Canadian tax law firm provides a $100 allowance to a Canadian tax lawyer employee to join the gym, then this is normally part of employment income by virtue of the aforementioned paragraph. Generally speaking, and employment benefit is any economic advantage that can be measured in monetary terms that one receives during one's employment.
Therefore, since the sections mentioned above in the Canadian Tax Act are written in broad manners, the rule of thumb is to assume that any benefit that connects to the employment relationship is taxable as employment income unless stated otherwise in the Canadian Tax Act or tax case law.
Taxation of Cryptocurrency Paid or Received as Wage or Salary?
At present there is no case law that specifically deals with the taxation of cryptocurrency wages. However, we can assume what would happen based on the application of the sections of the Canadian Income Tax Act mentioned above. Section 5(1) of the Tax Act states that an employee's employment income is the salary, wages, and other remuneration, including gratuities, received by the employee in the taxation year. Therefore, if cryptocurrencies are received as part of an employee's salary, wages and other remuneration, then the fair market value of the cryptocurrency at the time of receipt should be included in the employment income. The cryptocurrency received as part of the employee's salary, wages, and other remunerations will then have a cost base to the employee equal to the fair market value at the time of receipt. When the employee disposes the cryptocurrency in the future, the taxable income or capital gain on the disposition will be the fair market value at the time of disposition minus the cost base. However, the initial fair market value upon receipt is taxable as employment income even if not converted to fiat currency at that time.
For employment income, the employer bears the responsibility of withholding and remitting source deductions from employment income. These deductions include Canada Pension Plan contributions, Employment Insurance premiums and income tax withholding. This amount will of course vary depending on how much the employee earns. Therefore, if an employer is paying an employee with cryptocurrency as part of the employee's salary, wage, and other remunerations, then the employer must make a correct valuation by determining the fair market value of the cryptocurrency at the time of payment. Since CRA does not accept cryptocurrency the remittance amount will have to be made in Canadian dollars.
Pro Tax Tips: Rule of Thumb: Assume that If Amount Received is Connected to Employment, Then It is Taxable Unless Stated Otherwise
As explained above, the rule of thumb is to assume that any amount received that is connected to one's employment is taxable as employment income unless stated otherwise in relevant authorities. Characterizing whether an employment relationship exists can sometimes be a tricky exercise, because employment characterization is not set out in the Canadian Tax Act. It requires interpreting various case laws and performing a comprehensive factual analysis. If you are unsure whether the income you received, whether cryptocurrency any other assets, must be reported under the employment income source, consider contacting our Toronto Income Tax Lawyers.
Why is Characterizing a Business or Employment Relationship Important?
The distinction between employment and business relationships is important for tax purposes. For example, the scope of deductions available is vastly different. Generally speaking, an employee is very limited in the tax deductions that he or she can claim. On the other hand, if an individual is operating a business, he or she will have a broader spectrum of expenses that may be claimable. Another example is related to withholding of tax. For employment income, an employer has the responsibility of withholding and remitting source deductions from employment income. In contrast, generally speaking, there is no withholding requirements associated with business income.
Are There Exceptions Where an Employment Benefit Will Not Be Taxable to the Employee?
There are limited number of cases contained in the Canadian Tax Act where an employment benefit will not be taxable to the employee. In addition to statutory exceptions, courts have also developed a common law test called the primary beneficiary test to determine whether an employee has received a taxable employment benefit. If you would like to know whether your income falls into one of the exceptions, consider consulting with one of our experienced Toronto Tax Lawyers.
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.