Understanding The Taxation Of Cryptocurrency In Canada

Cryptocurrency is increasing in popularity these days so more and more taxpayers will need to know what the tax implications are. The tax treatment will depend on several factors, therefore it is important to keep detailed records of all cryptocurrency transactions in order to accurately file your taxes.

Let's take a look at when taxable events occur and how different types of transactions are taxed.

Barter Transactions

The CRA views cryptocurrency as a commodity rather than a currency. When transactions use cryptocurrency rather than legal tender, barter rules apply when determining the value of the transaction.

To determine the value of a barter transaction, the fair market value (FMV) of the good or service being given up in exchange for cryptocurrency dictates what the value of the transaction is. However, if the FMV of the good or service being given up cannot be determined then the FMV of the good or service being exchanged (cryptocurrency) would be the FMV of the transaction. The FMV is the price an arm's length party would pay for the good or service being given up.

Business Income vs Capital Gain

Disposing of a cryptocurrency results in either a business transaction where 100% of the gain or loss is taxable/deductible or a capital transaction where 50% of the gain or loss is taxable/deductible.

The tax treatment will depend on your intentions and whether it was likely you were carrying on a business. The taxation of each individual or business will depend on each specific circumstance.

The following are common signs that you may be carrying on a business:

1. You carry on activity for commercial reasons and in a commercially viable way.
2. You undertake activities in a businesslike manner, which might include preparing a business plan and acquiring capital assets or inventory.
3. You promote a product or service.
4. You show that you intend to make a profit, even if you are unlikely to do so in the short term.

Frequently, businesses are carried on with regular transactions to buy inventory and sell it for a profit which results in business income being generated. When transactions are done infrequently or even just once, they may be considered an adventure or concern in the nature of trade which results in income being fully taxed as business income.

The following need to be considered when determining if a transaction or transactions are an adventure or concern in the nature of trade:

1. whether the taxpayer dealt with the property acquired by him in the same way as a dealer in such property ordinarily would deal with it;
2. whether the nature and quantity of the property excludes the possibility that its sale was the realization of an investment or was otherwise of a capital nature, or that it could have disposed of other than in a transaction of a trading nature; and
3. whether the taxpayer's intention, as established or deduced, is consistent with other evidence pointing to a trading motivation.

As every situation will be different, the decision to treat income as business income or a capital gain will depend on several factors and is determined on a case-by-case basis.

If you are reporting capital gains and losses keep in mind that capital losses can only be used to reduce capital gains, it can't be used to reduce other types of income. These losses can be carried back 3 years or carried forward indefinitely to use against any future capital gains.

Disposing Of Cryptocurrency

The disposition of cryptocurrency leads to a taxable event that will have to be reported on your tax return in the year it was disposed. It is important to keep track of all your transactions so you can determine the adjusted cost base (ACB) of your cryptocurrency when you dispose of it.

Buying Goods And Services In Exchange For Cryptocurrency

It's becoming more common to see businesses accepting cryptocurrency in exchange for goods and services. The CRA considers these transactions to be barter transactions as the goods and services are not exchanged for legal tender.

The buyer would have a taxable event when they exchanged their cryptocurrency for goods or services. The disposition amount would be the value of the cryptocurrency at the time of the transaction less the ACB of the cryptocurrency that was exchanged. This will result in a gain or loss that is either taxed as business income/loss or as a capital gain/loss depending on the buyers' specific circumstances.

Selling Goods And Services In Exchange For Cryptocurrency

On the other side of the transaction discussed above, we have the seller.

When the transaction takes place, the value of the transaction would be the value the seller would normally have sold to a third party for. This is recorded as revenue just as if the goods or services had been sold for legal tender. This also becomes the sellers ACB in the event that it is sold or exchanged.

When the seller goes to dispose of the cryptocurrency for legal tender there is a taxable event for any increase or decrease in value since the seller received it. The gain or loss is calculated as the value of the cryptocurrency at the time of disposition less its ACB. This will result in a gain or loss that is either taxed as business income/loss or as a capital gain/loss depending on the sellers specific circumstances.

Exchanging One Cryptocurrency For Another Cryptocurrency

If you are holding a cryptocurrency such as Bitcoin and want to exchange it for Ethereum, then the barter transaction rules apply once again since neither side of the transaction involves legal tender. The FMV of the transaction is the Canadian dollar value of the cryptocurrency received, in this case Ethereum.

The exchange will either lead to a business income or loss or a capital gain or loss depending on your activities.

Charging GST/HST

Businesses that are GST/HST registered still need to collect and remit GST/HST for transactions where cryptocurrency is received as payment. The GST/HST collected on the transaction is based on the FMV of the cryptocurrency received at the time of the transaction. Be sure to keep all documentation for determining the FMV that GST/HST was based on.

Cryptocurrency Staking

If you own cryptocurrency that uses the proof of stake model to validate transactions, then you can participate in cryptocurrency staking. Ethereum, Cardano, Solana are examples of cryptocurrencies you can stake.

A staking pool allows you, along with others that hold the same cryptocurrency asset as you to combine forces to increase the chances that you will receive rewards from staking your cryptocurrency. Once you find a pool and stake your cryptocurrency, you can receive staking rewards when the pool validates transactions.

Receiving Staking Rewards

When you receive rewards for staking your cryptocurrency you then need to identify how the income will be taxed. There are two possibilities to consider when looking at the taxation from receiving staking rewards.

First, as the owner of the cryptocurrency that has been staked, you receive the rewards due to the ownership of the cryptocurrency being staked, then it can be viewed that the rewards you receive from staking are similar to receiving investment income.

Second, staking cryptocurrency can also be viewed as providing a service as this is how the cryptocurrency validates transactions which could be viewed as business income. This doesn't automatically result in the rewards being considered business income, other criteria need to be considered. You will need to consider how much time and attention you are spending on investing in cryptocurrency to earn income from it and whether your operation demonstrates entrepreneurship by taking on risk and pursuing profit.

Either way, if you earn investment income or business income from cryptocurrency staking, they are both fully taxable and would need to be reported at their fair market value in Canadian dollars at the time you received the staking reward.

For example, if you received $100 worth of cryptocurrency from staking, then you would report $100 as either business income or investment income on your income tax return. The adjusted cost base (ACB) of the staking rewards would be zero as the units awarded were issued at no cost to you.

Disposing Of Staking Rewards

Determining how to report the income from disposition again comes down to your intentions when purchasing the cryptocurrency. If you meet the conditions of carrying on a business as discussed above, then the income from disposing your cryptocurrency may be considered business income and be fully taxable. On the other hand, if you don't meet the conditions of carrying on a business then income from your cryptocurrency disposition may be considered capital gains and taxed at 50%.

If you've reported the income from receiving staking rewards as either investment income or business income as in the previous section, you can increase the ACB of the cryptocurrency, so you don't get taxed twice on the same income. So, for example, if you now sell the cryptocurrency you received from staking for $1,000, the ACB would be $100 and you would report either business income or capital gain of $900.

Ultimately, whether you've received staking rewards or have disposed of them, each case is different, and taxation depends on the specific case of each taxpayer.

Cryptocurrency Mining

Cryptocurrency is mined using powerful computers to solve complex mathematical problems. The miners that run these computers get compensated in the cryptocurrency they are mining. Depending on the extent of their activities, mining can be considered either a hobby or a business and the cryptocurrency they receive will either be considered a capital gain or business income.

If a miner is considered to be operating a business, then expenses related to operating that business can be deducted against the income earned from mining.

Cryptocurrency miners should keep records of the following costs:

1. mining hardware;
2. mining pool fees;
3. electricity costs along with details of the operating time of your mining hardware, and;
4. costs for maintaining mining equipment during the year.

In addition, if mining income is considered business income, any cryptocurrency held at the end of the year would be reported as inventory and when the cryptocurrency inventory is sold for legal tender there will be either business income or loss on the sale. Inventory valuation is discussed below.

Is Cryptocurrency Considered Inventory Or Capital Property?

In order to file your tax return, you will need to determine if cryptocurrency should be reported as capital property or inventory. If it is capital property, then it needs to be reported at its ACB so that capital gains/losses can be determined when it's sold. If cryptocurrency is determined to be inventory, the next step is to determine if the business is an adventure or concern in the nature of trade. See the Business Income vs Capital Gain section above to read more about an adventure or concern in the nature of trade.

If the business is not an adventure or concern in the nature of trade, then inventory can be valued at either:

1. The lower of cost or FMV at the end of the year for each inventory item.
2. FMV at the end of the year for all inventory at the end of the year.

Once you choose one of these methods to value inventory it needs to be used consistently each year.

However, if a business is an adventure or concern in the nature of trade then inventory has to be valued at the purchase price of the inventory.

Foreign Income Verification Statement (T1135)

If you own cryptocurrency or have an interest in a partnership that holds cryptocurrency you will need to consider whether it is specified foreign property and requires form T1135 to be filed. Foreign property holdings over $100,000 need to be reported to the CRA on the T1135 form so if you have cryptocurrency holdings situated, deposited, or held outside Canada over $100,000 or combined with other foreign property the total is over $100,000 then you will need to make sure the T1135 is filed with CRA. Foreign property held in an RRSP or TFSA does not need to be reported.

In addition, if you have an interest in a partnership that holds cryptocurrency outside Canada it would need to be considered with any other foreign property to determine if form T1135 needs to be filed with your tax return. However, if the partnership was a specified Canadian entity and held foreign property, then the entity itself would file the T1135. A partnership is considered a specified Canadian entity when the total amount of the income or loss attributed to non-resident partners is less than 90% of the total income or loss of the partnership.

It's important to consider cryptocurrency when determining if you have over $100,000 in foreign property as the penalties for not filing a T1135 can be substantial.

Superficial Losses

Just like investing in stocks, cryptocurrency transactions can result in superficial losses. A superficial loss occurs when both of the following criteria are met:

1. You or someone affiliated with you buys or has the right to buy identical property during the 30-day period before and after the date of sale.
2. You or someone affiliated with you still owns or has the right to buy identical property 30 days after the sale date.

In total, there are 61 days where you or an affiliated person cannot buy or have the right to buy identical property during that period. This is to prevent cryptocurrency owners from realizing losses so they can be applied against gains and then repurchase the same cryptocurrency to regain their prior position. There are some situations (listed here) where the superficial loss rules would not apply.

However, if you do have a superficial loss, it is added to the ACB of the identical property you purchased within the 61 days so when you dispose of that property the ACB is increased by the amount of the superficial loss. This only applies if you are the person who purchased or had the right to purchase the identical property. If an affiliated person bought or had the right to buy the identical property, then the superficial loss cannot be added to the ACB of the new property.

Recordkeeping

As with anything tax related, you should keep records of the details of each cryptocurrency transaction. All information should be kept for 6 years after the tax year it applies to in case the CRA request it in the future.

You should be documenting the following information for all cryptocurrency transactions.

1. date of the transaction;
2. value of the cryptocurrency in Canadian dollars at the time of the purchase or sale;
3. records of exchange transactions;
4. description of transactions and public addresses of the other parties;
5. records from your cryptocurrency wallet;
6. software costs for tracking your cryptocurrency transactions;
7. transaction fees, and;
8. accounting and legal costs.

The CRA monitors cryptocurrency transactions to ensure income is being reported and taxes are being paid on these digital assets. Having detailed records of your transaction to support income reported on your tax returns could prevent you from incurring interest and penalties if the CRA inquires about your cryptocurrency activity.

Did You Forget To Report Cryptocurrency Income?

One final note, if taxpayers have had cryptocurrency transactions that were not reported on their tax returns, the CRA has a Voluntary Disclosure Program (VDP) that can provide relief from prosecution as well as interest and penalty relief to taxpayers who correct returns with missing or incomplete information. Relief is more favourable to taxpayers that made an unintentional error than those that were intentionally trying to avoid paying tax.

Visit our personal tax services and plans pages to learn more about how we can assist you in reaching your goals. They provide an overview of our services, including information on the benefits and features of each. Feel free to contact us if you have any questions about our services.

Disclaimer

The author takes reasonable care to make sure the information on this blog is complete at the time it was posted. The information may not be comprehensive or current and is provided for general information purposes only.

This blog is not meant to be used as an alternative to professional advice. You should always consult with a professional to obtain advice on your specific situation.

‍