Criminals continue to increase the use of cryptocurrency
According to the Financial Transactions and Reports Analysis Centre of Canada (Fintrac), criminals are expected to continue using cryptocurrency to hide their assets from traditional banking systems. A recent report from the federal agency highlighted ongoing efforts to gather strategic intelligence on how virtual assets are being used for money laundering and terrorist financing.
The report revealed that money laundering in the crypto space often involves transferring funds obtained through fraud and ransomware attacks. It also emphasized the challenges posed by unregistered money services, which make it harder to detect financial crimes through conventional channels. Sarah Paquet, director of Fintrac, acknowledged the agency's work in an ever-changing landscape of new technologies, financial products, and global events. The report also noted a rise in money laundering incidents associated with underground banking and an increase in individuals and entities suspected of operating unregistered money services. The report highlighted the prevalence of underground banking facilitated by unregistered money services among international actors seeking to evade sanctions or engage in illicit activities, including terrorist financing.
As Canada's financial intelligence unit and supervisor of anti-money laundering and anti-terrorist financing efforts, Fintrac identifies funds linked to illicit activities by analyzing data from various sources, such as insurance companies, banks, money services businesses, securities dealers, real estate brokers, and casinos. According to Fintrac's 2022-2023 disclosures, the three most common activities associated with the identified illicit funds are drugs (31%), fraud (25%), and crimes against persons (13%).
Income from illegal activities is still taxable
It may come as a surprise to many that income from illegal activities, such as theft, fraud and drug sales, is subject to taxation. The Canada Revenue Agency (CRA) intentionally tax audits taxpayers convicted of criminal behavior and estimates, if necessary, the income they believe has been earned from these illegal activities.
For Canada cryptocurrency tax purposes, the CRA is not concerned with how the income was obtained or what kind of business was conducted; their focus is solely on whether the income was reported as required by tax law. For the purposes of the administration and enforcement of the Tax Act, the CRA often audits a taxpayer alone or in conjunction with another law enforcement agency, such as the RCMP. But, while the CRA does recommend taxpayers for criminal prosecution based on crypto tax fraud specifically, it will generally proceed with a civil tax audit regardless of the legality of the actual business that the taxpayer is engaged in, either in conjunction with or separate from any criminal investigation that is not income tax or GST/HST related. Therefore, receipt of crypto from illegal activities must be reported as taxable income.
Crypto transactions are taxable
Crypto transactions, such as barter transactions or the buying and selling using conventional currency, are both taxable. When Canadian taxpayers use cryptocurrencies to pay for goods or services in a barter transaction, they must include the fair market value of the received goods in their income for tax purposes if the CRA considers their crypto activities to be business activities. This ensures that the complete value of the goods or services received is accounted for in the taxpayer's income.
For instance, imagine a Canadian taxpayer who owns a retail store and buys a product with a fair market value of $20 using BTC worth $20. Since BTC and other cryptocurrencies are not recognized as official currency, the $20 value of the product is used for tax purposes to ensure that the entire value of the product sold during the transaction is included in the store owner's income for the year, rather than the value of the Bitcoin at the time of sale.
The gains from trading cryptocurrencies can be considered either business income or capital gains. The Tax Court of Canada frequently references the Federal Court of Appeal's decision in Vancouver Art Metal Works Ltd. v. Canada, [1993] 2 FC 179, when distinguishing between income earned on account of capital and income earned through a business or trade. In this case, the Federal Court of Appeal recognized that such a determination depends heavily on the specific facts of each case and identified five factors that can assist in this analysis:
- The frequency of the transactions
- The duration of the holdings
- The intention to acquire the securities for resale at a profit
- The nature and quantity of the securities
- The time spent on the activity
The CRA has published materials that align with many of these factors. Generally, a portfolio with a high volume of transactions and short holding periods, combined with active involvement by its owner, can indicate a trade or business in buying and selling securities. The intention to resell at a profit and the specific securities involved are also crucial factors, as is the knowledge and education related to securities.
When taxpayers argue that a given disposition should be considered on account of capital rather than income, they are essentially asserting that they disposed of a capital asset. Capital assets are defined by their ability to generate income through use or ownership rather than their potential for resale at a profit in the future. Therefore, securities that do not produce passive returns, such as dividends or coupon payments, are generally seen as less capital in nature than securities like Canadian bank stocks.
Courts have increasingly emphasized the taxpayer's subjective intention, whether to acquire securities for resale at a profit or for long-term investment, as the most crucial factor from the Metal Works case, with the other factors serving to objectively support the taxpayer's stated intention.
Pro tax tips – consult with a tax lawyer to confirm the proper characterization of crypto gains
The preference of a taxpayer for earning business income or capital income is determined by their individual circumstances. While one taxpayer might benefit from maximizing losses through business losses, another might seek to lower their taxable income through capital income. It is crucial that taxpayers consult with an experienced Canadian cryptocurrency tax lawyer to confirm th classification of their income accurately reflects their intentions and actions. In addition, if a taxpayer failed to report crypto income from his or her illegal activities, the voluntary disclosure application would be the ideal solution which offers full penalty relief and partial interest relief along with criminal prosecution exemption from unreported tax.
FAQ:
Is income from illegal activities taxable?
Yes. The CRA is not concerned with how the income was obtained or what kind of business was conducted. Their focus is solely on whether the income was reported as required by tax law. Therefore, income from criminal activities must be reported.
What is the tax consequence of a crypto barter transaction?
According to the CRA's current stance, any exchange of cryptocurrency for goods, services, or another commodity is treated as a barter transaction under the Income Tax Act and Excise Tax Act. This means that using cryptocurrency as a payment method has significant tax consequences for Canadian businesses and cryptocurrency users, affecting how they report their tax liabilities. When a seller accepts cryptocurrency as payment for goods or services, the proceeds of the transaction are considered to be the fair market value of the cryptocurrency received at the time of the transaction.
How should gains from crypto transactions be considered as business income or capital gain?
Case law indicates it depends on the subjection intention of the crypto trader when he or she acquired the crypto, which is reflected by the following factors:
- The frequency of crypto transactions
- The duration of the holdings
- The nature and quantity of the cryptocurrency
- The time spent on the activity
- The circumstances that were responsible for the sale of the cryptocurrency
