Canadian Tax Rules For Cryptocurrency Businesses

This is the final part of our three-part series. You can find parts one and two below. 

Part 1: Canadian Securities Regulations For Cryptocurrency Businesses

Part 2: Canadian Anti-money Laundering Regulations For Cryptocurrency Businesses

Cryptocurrencies are booming around the world, including Canada. For instance, the world’s first directly backed Bitcoin Exchange Traded Fund (ETF) was approved in Canada earlier this year, demonstrating a shift in regulations and investor demand.

Following these significant milestones, we see value in examining the current regulatory framework surrounding cryptocurrencies in Canada. Sia Partners’ Mini-Series on Canadian Cryptocurrency Regulations covers rules concerning Canadian entities, focusing on securities rules, anti-money laundering (AML) and taxing policies for virtual currencies.

For more information on the securities rules concerning Canadian businesses dealing with cryptocurrencies, please refer to the first piece of our Mini-Series: Canadian Securities Regulations For Cryptocurrency Businesses

Moreover, if you’re interested in learning more about AML requirements for businesses dealing with cryptocurrencies, please refer to the second piece of our Mini-Series: Canadian Anti-money Laundering Regulations For Cryptocurrency Businesses

The Canadian federal tax authority, the Canada Revenue Agency (CRA), has established high-level guidelines concerning the characterization of certain payment tokens such as Bitcoin or Ethereum and the possible implications of income and sales tax when transacting with assets of this nature. However, the rules are not comprehensive enough nor clear, to fulfil one’s tax obligations in the past-faced landscape of digital assets. Nonetheless, the Canadian federal government has made substantial progress to address the gaps in the taxation system, particularly concerning the sales tax implications of certain “virtual payment instruments”, yet plenty of work remains to be done to consolidate the crypto space.

Cryptocurrencies and Income Tax

The CRA states, despite its nomenclature, that a cryptocurrency is not considered a “currency” for income tax purposes. Using this logic, a cryptocurrency is more similar to a commodity (even though it is an “intangible”), the value of which will vary based on various external factors predominantly driven by investor activity and a basic supply and demand curve. Based on this view, cryptocurrencies could be analogized as the virtual equivalent of a precious metal such as gold or silver. This type of characterization, if appropriate, could have completely different tax implications under the Canadian tax law as compared to “regular” cash (or any foreign currency) transactions. In general, the CRA has been silent on its view regarding cryptocurrencies or digital assets other than payment tokens (Bitcoin, Ethereum). Therefore, the references stated below involving “cryptocurrencies” are generally limited to the payment tokens unless otherwise indicated. 

Taxing Rules for Cryptocurrency Acquisition

The main question regarding tax is whether the initial acquisition of any cryptocurrency is a taxable event that might trigger a Canadian income tax liability to the entity acquiring the cryptocurrency. The right answer depends on the manner, purpose, and circumstances in which the cryptocurrency is acquired.

In the case where a cryptocurrency is acquired through “mining” activities of commercial nature, the current administrative CRA guidelines state that the acquirer will be required to report business income for that specific year in accordance with the value of the mined cryptocurrency. Therefore, the mined cryptocurrency will be treated as “inventory” of the business. Such a holder will have a variety of tax issues distinct from the acquisition of cryptocurrency to non-mining activities and must be reviewed on a case-by-case basis.

The acquisition of cryptocurrencies as a simple speculative investment, just like physical gold or any publicly traded security, is in general not taxable to the entity acquiring the cryptocurrency. Nonetheless, the said acquisition will determine the holder’s “cost” in that specific cryptocurrency for Canadian tax purposes, which is appropriate in determining the tax consequences that will be realized later when the cryptocurrency would either be sold or exchanged.

Understanding a Holder’s Tax Cost in Cryptocurrency

Once any valid cryptocurrency has been acquired, it will be relevant to determine its cost for tax purposes, which is an essential concept for settling the future income tax consequences on an eventual transfer or disposition of the cryptocurrency.

In the case of purchasing cryptocurrency in exchange for Canadian currency, the cost of the cryptocurrency for income tax purposes will be equivalent to the total of cash paid, including any other directly related acquisition expenses. On the other hand, in the case of usage of foreign currency, the crypto holder will be required to convert that specific currency into the Canadian-dollar equivalent at the applicable rate, conforming to the Canadian tax rules.

Nonetheless, cryptocurrencies can obviously be acquired through multiple alternative means, including commercial business transactions or other forms of “barter” exchanges. The distinctive facts surrounding such acquisition could have meaningful differences concerning the determination of the holder’s tax cost consequent to the acquisition of cryptocurrency.

Tax on Disposition of Cryptocurrency

Any entity will realize taxable income (or loss) on a possible disposition of cryptocurrency. This includes any sale of the specific cryptocurrency for cash and the usage of the cryptocurrency to pay for goods or services, or as consideration under any contractual rights or obligations (i.e., a “barter transaction”).

In the case where the holder’s cryptocurrency has a value - at the time of its disposition - more than its tax cost, it will be vital to determine if the holder should report that excess as being on capital account (i.e., a capital gain) or the proceeds should be stated as business income. This is a significant distinction for tax purposes.

In general, the concepts of buying and selling of a commodity can be considered as being on capital account unless it is carried out in the case of a business of buying and selling such commodities, or this type of activity otherwise amounts to an “adventure or concern in the nature of trade”. This is determined case-by-case requiring a detailed review of the crypto holder’s dealings with such commodities.

If an entity acquires any cryptocurrency as payment for goods or services in the usual course of the entity’s business (even if the entity is not, per se, in the business of buying and selling cryptocurrencies as part of a speculative investment business), there is a possibility that any appreciation realized, when that entity sells the cryptocurrency, will be fully taxable as business income. As stated before, this type of issue should be reviewed on a case-by-case basis.

From a tax perspective, calculating gains and losses on cryptocurrencies can be a tedious task, and Canadian cryptocurrency entities should be ready to deal with higher levels of scrutiny. Moreover, the CRA punishments for unreported gains can range from significant financial penalties to criminal charges of tax evasion for crypto entities. Thus, obtaining professional help when dealing with digital currencies is a strategic and necessary course of action for Canadian businesses.

As Sia Partners, we employ a team of former regulators, with extensive experience in interpreting rules and guidance published by local and international regulatory and oversight bodies. Sia Partners remains current on all tax requirements applicable to cryptocurrency businesses and can provide you with the best compliance solution in line with your business plans. Given significant penalties for non-compliance, working with our team can add crucial value to your business.