Written by Matthew Peters and Martin A.U. Sorensen
Are you contemplating the acquisition of a cryptocurrency such as Bitcoin or Litecoin? The reasons for, and circumstances surrounding, such acquisitions vary widely, including "crypto-mining" activities, buying and selling for speculative investment purposes, and as a means of facilitating the purchase and sale of goods, services or other transactions.
The technology underlying digital currencies may offer the benefits of increased privacy and reduction of intermediaries (and associated transaction fees) normally associated with cash transactions. However, the acquisition, holding and disposition of a cryptocurrency (regardless of how anonymous it may seem) has Canadian tax implications. Any potential holder of a cryptocurrency must understand the applicable Canadian tax landscape, including the transactions that trigger a taxable event, and ensure that it is fully compliant with its tax reporting and paying obligations.
The use of the term “cryptocurrency” in this blog is restricted to virtual currencies (e.g., Bitcoin) that are created through a “mining” process over a decentralized network. These cryptocurrencies can generally be bought and sold on specialized exchanges and are increasingly being accepted as payment in lieu of fiat currency in a wide variety of commercial transactions.
Beyond the scope of this article are business-specific virtual “tokens” or “coins” that are created, issued and sold exclusively for use on a platform operated by the creator of the token/coin. While tokens/coins are rapidly proliferating in the marketplace, the unique nature of any particular token/coin (including the manner in which it is issued and the rights/entitlements that it affords its owner) does not easily accommodate broad legal generalizations and must be considered on a case-by-case basis.
Starting Point…Commodity, not Currency
The Canada Revenue Agency (CRA) currently takes the position that, despite its nomenclature, a cryptocurrency is not a “currency” for income tax purposes. Rather, cryptocurrency is akin to a commodity (albeit an intangible, “virtual” thing), the value of which will fluctuate based on external factors that are driven largely by investor sentiment and basic supply/demand. In other words, think of cryptocurrency for income tax purposes as being the virtual equivalent of a precious metal such as gold or silver.
By acquiring and transacting in cryptocurrencies you are, under current the CRA’s most recent interpretation of Canadian tax law, transacting in commodities. This is a critical threshold concept that has significantly different income tax implications compared to “normal” cash (even foreign currency) transactions.
The CRA’s administrative position has not been tested in a Canadian court and many in the Canadian tax community have suggested that alternative legal characterizations (e.g., currency, commodity, personal property) may be more practical and appropriate, at least in certain situations.
Acquisition of Cryptocurrency—A Taxable Event?
Typically, the first question asked regarding the taxation of cryptocurrencies is whether the acquisition of the cryptocurrency is a taxable event that potentially triggers a Canadian income tax liability to the person acquiring the cryptocurrency. The answer depends on the manner, purpose and circumstances in which the cryptocurrency is acquired.
If the cryptocurrency is acquired through “mining” activities that are of a commercial nature (i.e., mining carried out generally for business purposes or in connection with a business), the CRA’s current published administrative position is that the acquirer will be required to report business income for the year determined with reference to the value of the mined cryptocurrency. For this purpose, the mined cryptocurrency will generally be treated as inventory of the business. Such a holder will have a myriad of tax issues that are distinct from the acquisition of cryptocurrency from non-mining activities, which are not addressed in this blog and must be reviewed on a case-by-case basis.
The acquisition of cryptocurrency as a pure speculative investment, similar to physical gold or a publicly-traded security, is generally not a taxable event to the person acquiring the cryptocurrency. However, the acquisition of the cryptocurrency establishes the holder’s “cost” for tax purposes and sets the stage for the tax consequences that will be realized down the road when the cryptocurrency is eventually sold.
This is to be contrasted with the acquisition of a cryptocurrency as consideration for the provision of goods or services or as compensation for some other right of payment. In such cases, the acquisition of the cryptocurrency (or, more accurately, the sale of the underlying good/service or the right to receive payment) is a taxable event for Canadian income tax purposes, similar to any other sale of goods, services or right of payment that is satisfied in fiat currency. Moreover, the person acquiring the cryptocurrency will generally realize another taxable event when he/she subsequently disposes of the cryptocurrency.
What is My Cost in the Cryptocurrency?
Once a cryptocurrency has been acquired, it will be important to determine its cost for Canadian tax purposes, which is a fundamental concept for determining the future income tax consequences on an eventual disposition of the cryptocurrency.
Where a cryptocurrency is purchased in exchange for Canadian currency, the cost for income tax purposes of the cryptocurrency will be equal to the amount of such cash paid, plus any directly related acquisition expenses. If foreign currency is used, the holder will generally be required to convert the foreign currency into the Canadian-dollar equivalent at the applicable rate pursuant to normal tax rules.
Things become a bit trickier if a cryptocurrency is acquired as payment for goods or services or pursuant to other contractual rights/obligations. The CRA generally treats such exchanges as a barter transaction, resulting in the recipient of the cryptocurrency obtaining a tax cost in such cryptocurrency equal to the fair market value of the goods/services/rights that were given up in exchange for the cryptocurrency. This may not always line up exactly with the fair market value of the cryptocurrency at the time of the barter transaction.
Another type of transaction that is becoming increasingly prevalent is the acquisition by a person of one cryptocurrency (“crypto #1”) in exchange for a different cryptocurrency (“crypto #2”). Based on the CRA’s general administrative position, this will likely be regarded as a barter transaction involving the exchange of one commodity for another commodity. The person will be considered to have acquired crypto #1 with a tax cost equal to the fair market value of the crypto #2 given up in exchange, computed as of the time of the barter transaction. The additional wrinkle in this scenario is that the person acquiring crypto #1 will also be considered to have disposed of crypto #2 and will be required to report any income/gain in respect of crypto #2 for Canadian income tax purposes (the person will therefore need to know his/her tax cost in crypto #2, which is dependent on the manner in which crypto #2 was originally acquired by such person).
Tax on Disposition of Cryptocurrency
You will realize taxable income (or loss) on an eventual disposition of a cryptocurrency. This includes a sale of the cryptocurrency for cash as well as the use of the cryptocurrency to pay for goods or services or as consideration under other contractual rights/obligations.
If the cryptocurrency has a value at the time of its disposition that is in excess of its “cost” as described above, it will be critical to determine whether the holder should report such excess as being on capital account (i.e., a capital gain) or whether the proceeds should be reported as business income. This is a material distinction for tax purposes.
Generally, the buying and selling of a commodity can be regarded as being on capital account unless it is either carried out in the course of a business of buying and selling such commodities or such buying and selling amounts to an “adventure or concern in the nature of trade”. This is a factual, case-by-case determination requiring a detailed review of the nature of your dealings with the commodities in question.
If a person acquires cryptocurrency as payment for goods or services in the normal course of the person’s business (even if the person is not, per se, in the business of buying and selling cryptocurrencies as part of a speculative investment business), there is a risk that any appreciation realized at the time the person disposes of the cryptocurrency will be fully taxable as business income. Again, this issue is fact-dependent and should be reviewed on a case-by-case basis.
Can I Hold a Cryptocurrency in My RRSP?
Canadian tax law restricts the type of investments can be held in deferred investment plans (e.g., RRSPs and TFSAs). While “currency” and certain types of commodities are eligible investments for such purposes, cryptocurrencies appear to fall outside of these parameters, at least based on the CRA’s current published administrative practice. Accordingly, unless such cryptocurrencies are held through a registered mutual fund corporation or trust (or through a publicly-listed company) the shares/units of which are already eligible investments for a deferred investment plan, it does not appear that a cryptocurrency can currently be directly held through a deferred investment plan.
This discussion focuses on the fundamental Canadian income tax issues relating to the acquisition, holding and disposition of cryptocurrency based on the CRA’s current published administrative position that cryptocurrency is a commodity. Should the CRA’s administrative position evolve to treat cryptocurrencies in any given situation as a “currency”, a security, personal property, a “tax nothing” or otherwise, such characterization could have a domino effect on every aspect of the relevant tax analysis. Transacting in cryptocurrencies also gives rise to unique sales tax implications that must be considered based on the facts relating to any particular transaction. Holders and prospective holders of cryptocurrency will need to ensure that all potentially relevant Canadian tax issues are considered and to stay on top of evolving legal trends and administrative interpretations.
Special thanks to articling student Rehman Mir for his assistance with preparing this article.