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The Canadian Revenue Agency (CRA) wants to tax your cryptocurrency holdings, and they have the legal right to do it. Cryptocurrencies may be new and innovative, but they are not unregulated. Existing rules and regulations apply. What follows is a look at how existing tax laws likely apply to cryptocurrency holdings. This area is complex, and the stakes are high, so please consult a professional for specific direction. The following is not legal advice or tax advice.
How does the CRA classify cryptocurrency
The CRA does not consider cryptocurrencies to be legal currency. This point was made clear clear in a published fact sheet in 2013. According to the CRA, when cryptocurrencies are being used to pay for goods or services, the “rules for barter transactions” apply, and when they are bought and sold like a commodity for investment purposes, the rules for securities transactions apply.
The tax must be calculated each time you sell any cryptocurrency
Each time you sell a cryptocurrency, the CRA wants you to calculate the gain or the loss, and they want all these calculations in Canadian dollars. This is true even when you are trading between cryptocurrencies and not using dollars or any other national currency. It is also true when you are using a cryptocurrency to purchase other goods or services. The calculation is made by taking the amount received when you dispose of the cryptocurrency and subtracting the cost incurred to obtain the cryptocurrency. Making these calculations is extremely onerous especially if you buy and sell across multiple exchanges and use different wallets. Fortunately, there are a few different online services that can make the calculation for you such as Coin Taxes.
Despite how onerous this requirement is, the same rule applies to someone who trades stocks or foreign currencies. If you were to trade a number of silver coins for a gold one, you would be expected to calculate the value of the silver coins at the time you exchanged it for the gold coin and subtract from that amount the cost when you acquired it (the “cost base”). The net sum of those calculations over the year will give you the taxable profit or loss from selling these commodities. This calculation is only required when you sell. If you purchased some cryptocurrency coins and HODL’ed onto them, even if they have increased in value dramatically, that increase will not be taxable until you do something with those coins.
For someone who is mining a cryptocurrency, the CRA has not put out a directive on how to value mined coins. There is guidance that comes through a letter written by the CRA in 2014 in response to an individual that was inquiring about valuing their mined coins. This letter is helpful in determining the CRA’s position but it only reflects their opinion at the time of its writing, and it does not carry the weight of a public directive. The response in the letter was a reiteration of the CRA’s inventory valuation methods. It states that you can perform the “valuation of each item in the inventory at the cost at which it was acquired or its fair market value at the end of the year, whichever is lower.” You may also perform a “valuation of the entire inventory at its fair market value at the end of the year.” Allowing a business to choose either the lower of the cost or the market value of the inventory gives important flexibility to any person or company holding inventory. In the case where the market value of mined coins increases over a tax year, the miner can value the inventory at cost and defer the tax implications of the increase in market value to the time when they sell the coins. In the case where the market value of mined coins decreases below the cost of mining them during a tax year, the miner can value the coins at market value and receive the tax benefit of the loss of value.
The Internal Revenue Service (IRS) took a different position. Their Revenue Bulletin 2014-16 recommends a treatment much closer to the valuation used with securities or foreign currencies. They state that the “fair market value of the virtual currency as of the date of receipt is includible in gross income.” I could find nothing official from the CRA endorsing an approach similar to that of the IRS for mined cryptocurrency; however, there are online commentaries from Canadian tax professionals that espouse such an approach. I have also heard similar valuation recommendations from professionals during cryptocurrency and taxation discussion panels in Canada. The IRS approach does not allow for the same flexibility at that offered by the CRA but depending on a situation there could be advantages to it. This is a grey where specific advice from a professional is recommended.
when buying and selling cryptocurrencies like commodities or shares
Money made when buying and selling commodities or shares can be put into either of two categories: 1) income or 2) capital. It is up to the taxpayer when filing to declare the money in either category. Each is taxed differently with different advantages. Taxpayers must choose wisely as the CRA has rules about what should go where and any decision could have long-term consequences.
capital or income
Why does the distinction matter?
The distinction is hugely important because you only have to pay tax on 50% of your net capital gains whereas you must pay tax on 100% of your net income. At first, it seems like capital gains are the way to go, but on the flip side, only 50% of capital losses are deductible as opposed to 100% of income losses. In addition, capital losses are for the most part only deductible against capital gains. A narrow exception to this is upon death where the estate can deduct unused capital losses against general income. Capital losses can be carried backward three years and carried forward indefinitely, so eventually, upon death or otherwise, capital loss deductions do get used, but it may take a while before they reduce your tax bill. Contrast this with income losses which in most cases can be used in the year they occur.
How is the distinction made?
In a nutshell, capital is something that is used to produce income. Think of a commercial apple orchard. The trees and the land are considered capital. This capital is used to produce fruit which is sold and produces income for the business. If an orchard sells a number of its trees, the profit would be capital gains, not business income. This set up holds true as long as the orchard is in the business of selling fruit. The fun comes when things change. If the orchard becomes a tree farm instead or if they are selling both fruit and trees or transitioning from one to the other, then the designation becomes tricky and a number of determinations need to be made, such as, just how many trees they need to sell before they are considered to be in the business of selling trees and not fruit.
How to determine if someone is “in the business of” doing something
Canada’s Income Tax Act defines business as “a profession, calling, trade or undertaking of any kind.” Most people with cryptocurrency holdings would not fit under this part of the definition, but it goes on to say that a business also includes “an adventure or concern in the nature of trade.” This is the tricky part as it seems almost tailor-made for the wild ride of buying and selling cryptocurrency.
Two questions need to be asked of every owner of cryptocurrency. 1). Are you in the business of trading cryptocurrencies? If the answer is no then, 2). does what you are doing qualify as being involved in an adventure or concern in the nature of trading cryptocurrencies? There are a set of factors for each of these questions that the CRA and Tax court will consider when answering these questions. There is considerable overlap between the two sets and I outlined each below with reference to the interpretive source.
In the business of trading (Vancouver Art Metal Works case)
- Frequency of the transactions
- Duration of the holdings
- Intention to acquire for resale at a profit
- Nature and quantity of the securities held
- Time spent on the activity
Adventure or concern in the nature of trade (CRA Directive)
- The Taxpayer’s conduct: is the taxpayer behaving in a way that would be expected of a dealer in such a property?
- The nature of the property: is the value to the owner primarily speculative or does the property in question have other value such as consumption value?
- Tax payer’s intention: does the taxpayer intend to invest long term or to realize a profit in the short term?
None of the factors of either test are determinative, and there is no clear combination of factors that will always bring one classification over another. However, the volume of trades, as well as their frequency, are always examined carefully in the case law. In addition, another important question is: Does this individual receive compensation for trading cryptocurrency on behalf of others and do they advertise their services publicly? These factors speak to the individual’s conduct being similar to what we would expect from a professional trader.
Determining your tax situation if you hold cryptocurrency is a daunting task. For the technical part of calculating your taxable gains or losses across exchanges and wallets, there are online services to make that easier or at least doable. Here is a link to one: Cointaxes. For the determination between capital or income, the criteria can be a guide, but it comes down to the facts of your situation and a best guess at how the CRA will be applying the law. Professionals are the best at making those guesses. I hope this article was a helpful start.