Cryptocurrencies and the CRA
In the distant past, the wild west of 2016, cryptocurrencies were a novelty; for the use of those with a particular distaste of central banks, or a desire to visit society’s seedy underbelly without leaving their living room.
However, even as cryptocurrency becomes respectable, it is still nearly uncharted waters for tax purposes. The Canada Revenue Agency has provided little guidance so far in how cryptocurrency should be treated, primarily outlining that cryptocurrency is not, in fact, a “currency”, but a commodity. Exchanges of cryptocurrency, then, are exchanges of one good for another, without using money as a medium of exchange: so-called “barter transactions”.
In CRA’s defence, it can take years for taxpayers to be audited and proceed through appeals to court, resulting in delay between new technologies and binding legal interpretations. In the case of rapidly growing industries, CRA has little commercial practice to use as a guide for administrative policies either. In the interim, cryptocurrencies are left to be interpreted through general principles of tax law, rather than specific rules or examples.
With the optimism characterizing cryptocurrency markets in early 2017 fading, it is an appropriate time to discuss the tax implications of what can go wrong with crypto: the tax treatment of crypto losses, and the risk of penalties relating to bitcoin transactions.
Cryptocurrency – Investment or Business Income
If you purchase cryptocurrency as an investment, its price rises, and you sell it, you have received a capital gain in the amount of the difference in the year you sell the coin. If you purchase cryptocurrency and the price collapses, this creates a “capital loss”.
However, if you are actively trading cryptocurrencies, the CRA may claim that you are running a business. This would mean that all cryptocurrency gains are treated as business income, and the amount you have profited is fully taxable.
This highlights the importance of keeping reasonable records of your coin purchases; not doing so makes it easy for CRA to assume that you are running a business, therefore making all of your income taxable rather then one half.
Mining cryptocurrency is the use of computers to solve the extraordinarily complex math problems which facilitate bitcoin transfers, leaving the solver with a fraction of the value themselves. If you mine cryptocurrency, rather than speculate, it may result in business income rather than capital gains.
The flip side is that, if the price of the currency you are mining falls, resulting in you losing money, you can at least reduce your taxable income by the amount of the loss.
One of the key considerations is whether the operation has a reasonable expectation of profit. This is somewhat circular, as actually turning a profit makes it more challenging to call an activity a hobby, and resulting in losses makes it difficult to maintain that your “business” is really a business, allowing you to claim losses.
CRA Penalties and Cryptocurrency
There are many penalties spelled out in the Income Tax Act, from criminal sanctions to non-filing penalties to arcane provisions such as penalties for the use of electronic equipment to hide sales. Here, we will focus on Gross Negligence Penalties, in which the CRA proves that someone reduced their tax burden intentionally or in circumstances “amounting to gross negligence”.
While bitcoin operates through blockchain, a living spreadsheet making transactions difficult to track, the lack of a paper trail does not make you audit-proof, even if some may believe it does. Living off the avails of a crypto-fuelled business may sound like a foolproof plan to avoid CRA, but as we have discussed in previous posts, lack of access to receipts and other records does not prevent CRA from coming after you, and may even prevent you from launching an effective response. This applies more readily to businesses using cryptocurrency, but CRA has tools to track down individuals hiding investments as well.
Given their clandestine nature, and their inherent suitability to avoiding authorities, CRA may presume that any undisclosed cryptocurrency holdings, gains, or losses were intentionally suppressed. Even though CRA must prove gross negligence themselves, at the CRA level, they will often assume that revenue was unreported intentionally or because of gross negligence. Should you receive payment for goods or services in cryptocurrency, this is truer still. While CRA usually impose gross negligence penalties on businesses underreporting their revenue, we find it difficult to imagine them not doing so where a business operates using cryptocurrency.
Where you or an intermediary hold cryptocurrency “offshore”, in a foreign jurisdiction, you may be required to report these holdings to CRA, and risk being liable for aggressive penalties if you don’t report.
Whether you are looking for a safer way to reduce your taxes while still complying with the Income Tax Act, a way to cash out funds locked in a server while avoiding penalties, or to set up your crypto-business in a tax efficient manner, consider reaching out to Rosen Kirshen Tax Law. Like a supercomputer decoding blockchain transaction, Rosen Kirshen Tax Law uses its superhuman processing power to decipher the Income Tax Act, leaving you with more money in your pocket. Contact us today!
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a lawyer.