Introduction: Related-Party Cryptocurrency Transactions & Derivative Tax Liability under Section 160 of Canada's Income Tax Act
Section 160 of Canada's Income Tax Act is a tax collection tool. It thwarts taxpayers attempting to hide assets from a Canada Revenue Agency tax collector by transferring those assets to friends or relatives or related corporations.
Section 160 captures a broad range of transactions, including transactions involving non-fungible tokens (NFTs) and transactions involving cryptocurrency such as Bitcoin (BTC), Bitcoin Cash (BHC), Litecoin (LTC), Ethereum (ETH), Chainlink (LINK), Dash, Zcash (ZEC), and Ripple (XRP). As a result, if you receive cryptocurrency, non-fungible tokens (NFTs), or other blockchain-based assets from a related party-e.g., a spouse, a child, a business partner, or a trust or corporation in which you have an interest-that has outstanding tax debts, section 160 allows the CRA's tax collectors to pursue you for that person's tax debt. (Your derivative crypto-tax liability is capped at the fair market value of the transferred asset at the time of transfer, and it is reduced by the value of what you paid in consideration for that asset. We detail the mechanics of section 160 in the following section.)
This article examines the derivative crypto-tax liability under section 160 of Canada's Income Tax Act. And it offers pro tax tips from our top Canadian crypto-tax lawyers on avoiding and disputing section 160 assessments.
The Mechanics of Section 160 of Canada's Income Tax Act
Section 160 is a notoriously harsh rule: It offers no due-diligence defence, it applies even if the transaction wasn't motivated by tax avoidance, and it catches transferees who don't even realize that they're receiving property from a tax debtor (e.g., see: Canada v Heavyside, 1996 CanLII 3932 (FCA), at para 3). In addition, section 160 doesn't contain a limitation period. So, the Canada Revenue Agency can assess you under the rule years after the purported transfer.
Section 160 applies if all the following four conditions are satisfied:
- A property was transferred. The language of section 160 contemplates a broad range of transfers: it covers situations where a tax debtor "transferred property, either directly or indirectly, by means of a trust or by any other means whatever."
- At the time of the transfer, the transferor owed a tax debt to the Canada Revenue Agency.
- The recipient was, at the time of the transfer, one of the following: (a) the transferor's spouse or common-law partner (or a person who has since become the transferor's spouse or common-law partner); (b) a person who was under 18 years of age; or (c) a person with whom the transferor was not dealing at arm's length-e.g., a trust or corporation in which the transferor has an interest.
- The recipient paid the transferor less than fair market value for the transferred property.
In other words, section 160 will catch a transaction whereby you received cryptocurrency, non-fungible tokens (NFTs), or other blockchain-based assets from a related party with outstanding tax debts, and you didn't provide full consideration-e.g., a gift of cryptocurrency or NFTs.
When section 160 applies, the transferor and the recipient both become "jointly and severally" liable for the transferor's tax debt. In particular, the recipient becomes independently liable for the transferor's tax debt at the time of the transfer. This means that the Canada Revenue Agency can now pursue both the original tax debtor and the derivative tax debtor for the tax debt. In fact, even if the original tax debtor is later discharged from bankruptcy and thereby released from the underlying tax debt, the derivative tax debtor remains liable to the CRA until the tax debt is fully repaid (e.g.: Canada v Heavyside, ibid.)
That said, the transferee's derivative tax liability under section 160 is capped at the fair market value of the transferred property. Moreover, the recipient's liability is reduced by the amount of any consideration that the recipient provided for the property. For example, a tax debtor owns cryptocurrency and NFTs valued at $500,000 and owes $1 million in tax debt to the CRA. If the tax debtor gifts the cryptocurrency and NFTs to her son, the son's liability under section 160 is $500,000-i.e., the value of the digital assets. (If the gifted the cryptocurrency and NFTs subsequently increase in value to $2 million, the derivative tax liability is still limited to the $500,000 value at the time of transfer.) If, on the other hand, the son purchased the digital assets from the tax debtor for $250,000, the son's liability under section 160 is $250,000-i.e., the value of the digital assets minus the purchase price.
Subsection 160(3) governs how payments apply to discharge the joint liability. A payment by a taxpayer who has inherited liability under section 160 will reduce both debts-that is, this payment reduces not only the tax debt of the jointly liable third-party taxpayer but also the tax debt of the original tax debtor. But an ordering rule governs a payment by the original tax debtor. The original tax debtor must first pay off all tax debts exceeding the joint debt. That is, the original tax debtor must first pay off all tax debts belonging solely to the original debtor.
Continuing from our previous example: the original tax debtor owes $1 million in taxes, and the joint debtor became jointly liable for $500,000 under section 160.
- If the joint debtor pays off the full $500,000 joint debt, that payment extinguishes the joint debtor's section 160 liability, and it reduces the original tax debtor's liability by $500,000.
- If the original tax debtor pays $500,000, then that payment would only suffice to cover the $500,000 tax debt belonging solely to the original debtor. As such, the payment reduces the original tax debtor's amount owing by $500,000, but the joint debtor's liability remains unchanged at $500,000.
- But if the original tax debtor had paid $750,000, that payment would suffice to both reduce the original tax debtor's amount owing by $750,000, and reduce the joint debtor's liability by $250,000.
In other words, before her tax payments discharge the joint debt, the original tax debtor must first pay off all tax arrears that are solely her own.
Section 325 of the Excise Tax Act contains a similar set of rules relating to GST/HST debts. That is, while section 160 of the Income Tax Act covers transfers by a person with income-tax debts, section 325 of the Excise Tax Act covers transfers by a person with GST/HST debts.
Pro Tax Tips: Avoiding & Responding to Derivative Crypto-Tax Assessments under Section 160
If you have outstanding tax debts and transfer cryptocurrency, non-fungible tokens, or other blockchain-based assets to your friends and relatives in an attempt to keep assets away from the Canada Revenue Agency, you've exposed your friends and relatives to CRA collections action. And even if you're not attempting to dodge CRA tax collectors, section 160 may rear its ugly head. Likewise, you may incur derivative crypto-tax liability if you receive cryptocurrency, NFTs, or other blockchain-based assets from a related party with outstanding tax debts. If you plan on entering a blockchain transaction with a related party, including a transaction involving a trust, and either you or that party has tax debts (or might later be reassessed for a prior tax year), consult one of our expert Canadian crypto-tax lawyers for advice on reducing your exposure to a derivative crypto-tax assessment under section 160.
If you receive a notice of assessment under section 160 of the Income Tax Act or under section 325 of the Excise Tax Act, you may challenge both the merits of the assessment itself and the underlying tax debt by filing a notice of objection within the prescribed time limit. In addition, you may challenge the underlying tax debt even if the original tax debtor failed to do. If the original tax debtor did in fact challenge the debt yet failed to lower the amount, you may still challenge the underlying tax debt-and you may raise independent arguments.
A notice of objection prompts the CRA's administrative dispute-resolution process, and the Canada Revenue Agency's Appeals Division will assign an appeals officer to review the merits of your objection. If the CRA's appeals officer renders an unfavourable decision, you may continue the dispute by filing a notice of appeal to the Tax Court of Canada. (In the alternative, you may effectively bypass the CRA's Appeals Division and appeal directly to Tax Court if the Appeals Division hasn't rendered a decision within 90 days from the date that you filed your objection.)
But you have only a limited amount of time to object to the section 160 assessment. Generally, you must file a notice of objection within 90 days from the date on the derivative-tax assessment, and you must appeal to the Tax Court of Canada within 90 days from the date of a notice of confirmation from the CRA's Appeals Division. If you fail to meet the 90-day deadline, you might qualify for an extension, but you must apply for the extension within one year and 90 days from the date on the assessment or confirmation. You may also apply for an extension of time to file a notice of appeal to the Tax Court of Canada, but those extensions are much harder to obtain. If you don't exercise your appeal rights within the statutory deadlines, you'll be personally stuck with the derivative crypto-tax debt even if the original tax debtor goes bankrupt.
Fortunately, Canadian cryptocurrency users can generally avoid these problems through early engagement of an experienced Canadian crypto-tax litigation lawyer. Speak to our Certified Specialist in Taxation Canadian tax lawyer today. Our experienced Canadian tax lawyers thoroughly understand this area of law, and we can ensure that you deliver a forceful, thorough, and cogent objection to the Canada Revenue Agency or appeal to the Tax Court of Canada.
Frequently Asked Questions
Question: I owe a large income-tax debt to the Canada Revenue Agency. But most of my assets are in cryptocurrency, and I plan on transferring my cryptocurrency to my son as a means of protection from CRA tax collectors. This shouldn't pose a problem, correct?
Answer: You'll expose your son to derivative tax liability under section 160 of Canada's Income Tax Act. Section 160 is a tax collection tool, and it aims to thwart taxpayers who attempt to hide assets from Canada Revenue Agency tax collectors by transferring those assets to friends or relatives. If you transfer your cryptocurrency to your son, section 160 will allow the CRA's tax collectors to pursue your son for your income-tax debts. Your son's derivative tax liability under section 160 is capped at the fair market value of the transferred cryptocurrency, and his derivative tax liability will be reduced by the amount, if any, that he paid to you for the cryptocurrency.
Question: I recently received a notice of assessment for derivative tax liability under section 160 of the Income Tax Act. The assessment relates to cryptocurrency, non-fungible tokens, and other blockchain-based assets that I received from my spouse. I want to dispute this assessment in the Tax Court of Canada. What should I do now?
Answer: Even if you want to take the dispute to Tax Court, you must first file a notice of objection with the Canada Revenue Agency's Appeals Division. The objection itself must be filed within 90 days of the date on the section 160 assessment. After filing your objection, you must first allow at least 90 days to elapse, and you may then file a notice of appeal with the Tax Court of Canada. As with other forms of litigation, tax litigation is subject to numerous procedural rules governing almost every aspect of the lawsuit-including specific deadlines, acceptable evidence, settlement negotiations, and the contents of pleadings. Consult one of our expert Canadian crypto-tax litigation lawyers who can simplify the tax-litigation process, prepare your case for Tax Court, and represent you before the Tax Court during the hearing or settle your appeal with the Crown and the CRA before a hearing.
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.