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Introduction: Cryptocurrency Tax Planning & The Rise of Crypto-Specialist Family Offices and Asset Management Firms
Many Canadian cryptocurrency investors and traders seek crypto tax planning options allowing them to legally reduce the Canadian income tax burden of their cryptocurrency-based income. The demand has given rise to a plethora of family offices and asset-management firms purporting to specialize in cryptocurrency and digital investments.
Yet many of the most popular family offices and asset-management firms, such as Jake Caver's Digital Ascension Group and its affiliate Digital Wealth Partners, are based in the US.
As a result, the investment products and financial services that these US-based firms offer may not contemplate the many Canadian crypto tax pitfalls that await Canadian cryptocurrency investors—especially those who haven't first obtained cogent tax advice from a top Canadian crypto-tax lawyer.
This article briefly discusses a few Canadian tax traps that tend to undermine the financial products and investment services that these US-based family offices and asset-management firms typically offer to Canadian cryptocurrency investors. It concludes by offering pro tax tips from our expert Canadian crypto-tax lawyers.
Canadian Tax Traps for Canadian Investors Seeking Financial Products from US-Based Crypto-Management Firms
Our experienced Canadian crypto-tax lawyers have consulted with numerous Canadian cryptocurrency investors who sought to have their digital assets managed by US-based, crypto-specialist family offices such as Jake Caver's Digital Ascension Group and its affiliate Digital Wealth Partners.
These US-based family offices and crypto-management firms offer several seemingly appealing financial products and services, such as low-rate loans that are secured by the investor's own cryptocurrency portfolio.
These loans effectively allow investors to access the cash value of their cryptocurrency portfolio on a tax-free basis. (Without the loan, an investor who needed cash would have had to sell some cryptocurrency—and thereby trigger tax on that sale.)
These US-based family offices and crypto-management firms also offer managed crypto portfolios, insurance policies for investors' cryptocurrency holdings, and crypto wallets with enhanced security features.
A common trend is that the US-based family office or crypto-management firm will accept a Canadian cryptocurrency investor as a client only if that Canadian person or entity meets the definition of "accredited investor" under the US's Securities Act of 1933 and satisfies various other requirements.
To meet these requirements, the Canadian cryptocurrency investor must typically incorporate a US-based limited liability corporation (i.e., a US LLC) and transfer the investor's own cryptocurrency portfolio to the US LLC.
Yet this required structural setup may prove unworkable from a Canadian tax perspective. For instance, as mentioned above, one of the key products that these US-based family offices and crypto-management firms offer is access to low-rate loans secured by the investor's own cryptocurrency portfolio.
In the case of a Canadian investor, the family office or crypto-management firm will advance the funds to the Canadian investor's US-based LLC, which puts up as collateral the crypto portfolio that the LLC acquired from the Canadian investor. To access the funds, the Canadian investor must draw those funds from the LLC. This leads to tax inefficiency on the Canadian side.
When the loan must be routed through a corporate entity, it converts what would otherwise have been a tax-free loan into a taxable dividend, a taxable income inclusion as a shareholder benefit under subsection 15(1) of Canada's Income Tax Act, or a taxable income inclusion as a shareholder loan under subsection 15(2) of Canada's Income Tax Act.
Another problem is that, when the Canadian investor transfers the investor's cryptocurrency portfolio to the US-based LLC, the transfer triggers a deemed disposition at fair market value under subsection 69(1) of Canada's Income Tax Act. As a result, the Canadian cryptocurrency investor has essentially accelerated the Canadian tax payable on the gain that had accrued on the crypto portfolio.
Moreover, the Canadian cryptocurrency investor cannot avoid the deemed disposition by electing for a tax-deferred rollover under section 85 of Canada's Income Tax Act. A section 85 rollover is available only if the transferee is a "taxable Canadian corporation," which basically refers to a corporation that is a Canadian tax resident.
In other words, you cannot use the section 85 rollover if you transfer assets to a corporation that is a non-resident for Canadian tax purposes. The problem is that an LLC incorporated in the US will always be a non-resident of Canada for tax purposes.
Under Article IV(3) of the US-Canada tax treaty, if a corporation is incorporated in the US, that corporation, regardless of where its management occurs, is deemed to be a tax resident of the US. And subsection 250(5) of Canada's Income Tax Act will consequently deem that corporation to be a non-resident of Canada. As a result, the Canadian investor who transfers cryptocurrency to a US-based LLC cannot use the section 85 rollover to avoid the deemed disposition and the resulting Canadian tax liability.
Another problem may arise in relation to the managed crypto portfolios offered by the US-based family offices or crypto-management firms. If these managed portfolios generate a yield, it may trigger the FAPI rules under Canada's Income Tax Act.
FAPI (or Foreign Accrual Property Income) refers to passive income that a Canadian-resident taxpayer earns through a "controlled foreign affiliate." If the FAPI rules apply, the Canadian shareholder must report and pay Canadian tax on the passive income that the controlled foreign affiliate earned during the tax year—even if the foreign affiliate has yet to distribute that income in the form of a dividend.
Hence, Canada's FAPI rules may require a Canadian cryptocurrency investor to immediately pay Canadian tax on any investment income that the US LLC earns from the managed cryptocurrency portfolios—even if the LLC doesn't actually distribute those earnings as a dividend.
Pro Tax Tips & Expert Canadian Crypto-Tax Lawyer Tax Guidance
This article demonstrates a few of the many potential tax traps that Canadian cryptocurrency investors may face if they pursue financial products and services offered by US-based crypto advisors without first seeking tax-law advice from a knowledgeable Canadian crypto-tax lawyer. Now, this isn't to say that every Canadian cryptocurrency investor will necessarily run into the exact same problems. Nor do we claim that these structures never make sense from a Canadian tax perspective.
The previously discussed tax traps simply illustrate the need to carefully analyze the implications of these financial products in light of your objectives and circumstances. Moreover, your Canadian crypto-tax lawyer may identify modifications that preserve the investment value of the financial product while allowing you to avoid the Canadian tax traps.
If, for instance, the US crypto-management firm allows the Canadian investor to use a Canadian corporation (instead of a US-based LLC), the initial portfolio transfer may qualify for a tax-deferred rollover under section 85 of the Income Tax Act, and the Canadian investor need not accelerate the Canadian tax payable on the crypto portfolio's accrued gains.
The point is that Canadian cryptocurrency-related tax planning demands expert legal advice from a Certified Specialist in Taxation Canadian crypto-tax lawyer. Our elite Canadian crypto-tax lawyers can advise on the Canadian tax implications of the products and services that these US-based crypto-specialist family offices and crypto-management firms offer, and we can devise tax-planning solutions that are tailored to your specific circumstances and goals.
For tax-planning solutions that account for your specific circumstances and facilitate your goals, consult one of our knowledgeable Canadian crypto-tax lawyers today.
Frequently Asked Questions
I live in Canada and hold a large cryptocurrency portfolio. I'm interested in having my digital assets managed by US-based, crypto-specialist family offices such as Jake Caver's Digital Ascension Group and its affiliate Digital Wealth Partners. What are the Canadian tax implications of the financial products and services that these types of firms offer?
Our Canadian crypto-tax lawyers have consulted with numerous Canadian cryptocurrency investors who sought to have their digital assets managed by US-based, crypto-specialist family offices such as Jake Caver's Digital Ascension Group and its affiliate Digital Wealth Partners.
A common trend is that the US-based family office or crypto-management firm will accept a Canadian cryptocurrency investor as a client only if that Canadian person or entity meets the definition of "accredited investor" under the US's Securities Act of 1933 and satisfies various other requirements. To meet these requirements, the Canadian cryptocurrency investor must typically incorporate a US-based limited liability corporation (i.e., a US LLC) and transfer the investor's own cryptocurrency portfolio to the US LLC.
Yet this required structural setup may prove unworkable from a Canadian tax perspective. For instance, one of the key products that these US-based family offices and crypto-management firms offer is access to low-rate loans secured by the investor's own cryptocurrency portfolio. In the case of a Canadian investor, the family office or crypto-management firm will advance the funds to the Canadian investor's US-based LLC, which puts up as collateral the crypto portfolio that the LLC acquired from the Canadian investor.
To access the funds, the Canadian investor must draw those funds from the LLC. But this leads to tax inefficiency on the Canadian side. When the loan must be routed through a corporate entity, it converts what would otherwise have been a tax-free loan into a taxable dividend, a taxable income inclusion as a shareholder benefit under subsection 15(1) of Canada's Income Tax Act, or a taxable income inclusion as a shareholder loan under subsection 15(2) of Canada's Income Tax Act.
Another problem is that Canada's FAPI rules may require the Canadian shareholder to immediately recognize the US LLC's crypto-related investment income as taxable income, even if the entity doesn't actually distribute those profits as a dividend.
Now, this isn't to say that every Canadian cryptocurrency investor will necessarily run into the exact same problems. Nor do we claim that these structures never make sense from a Canadian tax perspective. The Canadian tax traps simply illustrate the need to carefully analyze the implications of these financial products in light of your objectives and circumstances. For tax-planning solutions that account for your specific circumstances and facilitate your goals, consult one of our knowledgeable Canadian crypto-tax lawyers today.
What is FAPI? And why should I be concerned about the FAPI rules if I hold a yield-generating cryptocurrency portfolio through my US-based LLC?
FAPI (or Foreign Accrual Property Income) refers to passive income that a Canadian-resident taxpayer earns through a "controlled foreign affiliate." If the FAPI rules apply, the Canadian shareholder must report and pay Canadian tax on the passive income that the controlled foreign affiliate earned during the tax year—even if the foreign affiliate has yet to distribute that income in the form of a dividend.
Hence, Canada's FAPI rules may require you to immediately pay Canadian tax on any investment income that your US-based LLC earns from a yield-generating cryptocurrency portfolio—even if the LLC has yet to actually distribute those earnings to you as a dividend.
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.
