Bitcoin& Cryptocurrency Taxation in Canada – Canadian Tax Lawyer Analysis
Bitcoin &Bitcoin Transactions: The Basics
At bottom, the bitcoin system is a system of digital currency. In particular, a bitcoin functions as a digital asset, serving as a medium of exchange. Like other cryptocurrencies, the bitcoin system relies on cryptography to ensure that transactions remain secure. A bitcoin has no physical form, and it does not provide its owner with any inherent rights to property or another currency. Instead, a bitcoin user installs an application, which acts as a “bitcoin wallet,” on his or her phone, tablet, or computer.
Unlike a traditional online transaction, a bitcoin transaction does not rely on a third party for creation or security. Traditionally, the central bank of a sovereign nation creates currency. For online transactions, a third party, usually a bank or online payment processor, approves or confirms online payments. But the bitcoin system is created by data mining (discussed below) and relies on a peer-to-peer network of computers, which verifies the transaction, transfers bitcoin units, and prevents double dealing. In other words, no centralized authority, governmental or otherwise, controls the bitcoin system.
Bitcoin units come into existence through a process called mining. A person mines for bitcoin by solving complex mathematical problems, which, in turn, processes bitcoin transactions and secures the bitcoin network. These complex problems require bitcoin miners to dedicate extensive computer resources to generate solutions. In essence, bitcoin miners receive bitcoins as compensation for contributing to the integrity of the bitcoin system.
In addition to mining, one can acquire bitcoins by either receiving them as payment for goods or services or purchasing them from a bitcoin exchange. Generally, one accesses a bitcoin exchange online using a personal computer.But one can also gain street-corner access to a bitcoin exchange by using a bitcoin ATM, a machine that physically and functionally resembles a traditional ATM.
A bitcoin ATM is a street-side kiosk, which connects to the Internet and allows users to purchase bitcoins withtraditional currency. The user deposits cash and, in exchange, the bitcoin ATM dispenses areceipt carrying a unique code.The user then enters the code into his or her bitcoin-wallet application, which, in turn, recognizes the newly purchased bitcoins. Alternatively, the user can give the code to a third party as a form of payment.
Canada’s view on Bitcoin& Cryptocurrencies: Is it Money?
Currently, Canadian regulatory authorities posit that digital currency—such as bitcoin and other cryptocurrencies—does not constitute either money or currency. In 2014, the Bank of Canada released a position paper concluding that bitcoin and other cryptocurrencies fail to meet the definition of money.
Likewise, in 2013, an interpretation letter released by the Canada Revenue Agency stated that bitcoin and other digital currencies were not currency for Canadian tax purposes. Instead, the Canada Revenue Agency concluded that a bitcoin was a commodity, like gold or oil. So, the tax rules concerning barter arrangements apply to bitcoin transactions.
Canadian Income-Tax Treatment of Bitcoin and Digital Currency
As mentioned, the Canada Revenue Agency treats bitcoin—and digital currencies generally—as a commodity for income-tax purposes. As a result, bitcoin transactions are subject to the same rules as barter transactions—that is, transactions where one commodity is exchanged for another.
Generally, this means that a gain or loss from a bitcoin transaction will be treated as either (i) income or loss from business or property or (ii) a capital gain or loss. The difference comes with important tax implications. The full amount of business or property income is taxable, while only one-half of a capital gain is taxable. On the flip side, while only one-half of capital losses are deductible, one may fully deduct losses associated with business or investment activity.
For instance, in 2013, the Canada Revenue Agency explained that a vendor, who accepts bitcoin as payment for providing goods or services, must include the fair market value of those goods or services in his or her business income:“Where digital currency is used to pay for goods or services, the rules for barter transactions apply. A barter transaction occurs when any two persons agree to exchange goods or services and carry out that exchange without using legal currency. For example, paying for movies with digital currency is a barter transaction. The value of the movies purchased using digital currency must be included in the seller’s income for tax purposes. The amount to be included would be the value of the movies in Canadian dollars.”
On the other hand, some bitcoin transactions—such as trading, investing, and speculating—may straddle the line between income and capital. Indeed, Canadian courts have churned out a large body of case law wrestling with the ambiguity between investing, which produces a capital gain or loss, and trading, which results in business income or expenses.
Similarly, a person who mines bitcoins may be thought of as either acquiring a capital property or earning business income. If thought of as acquiring a capital property, the miner’s adjusted cost base would be the bitcoin’s fair market value at the time of acquisition. Also, since bitcoin mining demands considerable computing resources, a bitcoin’s adjusted cost base would presumably include the cost of generating the computer power necessary to acquire the coin.The miner thus incurs a capital gain or loss depending on the bitcoin’s value upon disposition.
Alternatively, if thought of as earning business income, the miner’s income is the bitcoin’s fair market value at the time that the miner uncovered the unit. If the miner later sells the uncovered bitcoin for an amount greater than its value on discovery, the excess is also included in business income. Recall, however, that bitcoin mining requires one to devote extensive computing resources to the endeavour. Presumably, these costs should constitute deductible business expenses.
Ultimately, courts assess a wide range of factors when deciding whether to characterize a transaction’s gains or losses as on an account of capital or income. Applied to bitcoin transactions, these factors may include:
- frequency of transactions - a history of extensive buying and selling of bitcoins or of a quick turnover of properties;
- period of ownership - the bitcoins are usually owned only for a short period of time;
- knowledge of bitcoin markets - the taxpayer has some knowledge of or experience in the bitcoin markets;
- knowledge of bitcoin markets - the taxpayer has some knowledge of or experience in the bitcoin markets;
- relationship to the taxpayer’s other work - bitcoin transactions form a part of a taxpayer's ordinary business;
- time spent - a substantial part of the taxpayer's time is spent studying the bitcoin markets and investigating potential purchases;
- financing - bitcoin purchases are financed by some form of debt; and
- advertising - the taxpayer has advertised or otherwise made it known that he is willing to purchase bitcoins.
Bitcoin, Digital Currency, and the Goods and Services Tax/Harmonized Sales Tax
In 2013, the Canada Revenue Agency voiced its opinion that, if they receive bitcoins or digital currencies in exchange for their goods and services, commercial sellers of goods and services must collect Goods and Services Tax/Harmonized Sales Tax (“GST/HST”):“In those transactions where a taxable supply of a good or service is made and the consideration for that supply is Bitcoins, the consideration for the supply is deemed to be equal to the fair market value of the Bitcoins at the time the supply is made for the purposes of determining the GST/HST payable for the supply.”
In addition, while not offering firm guidance, the Canada Revenue Agency hinted at its view of whether a purchase of bitcoin using Canadian currency would be exempt from GST/HST under the Excise Tax Act. Generally, the Excise Tax Act exempts from GST/HST the supply of financial services, which includes “the exchange, payment, issue, receipt or transfer of money.” But, since the Canada Revenue Agency asserts that bitcoin does not meet the definition of money, the Agency would likely insist that the exemption does not apply to a bitcoin purchase.
Still, Canada Revenue Agency has yet to provide guidance on several vital questions on the GST/HST implications of bitcoin transactions. For instance, neither Parliament, the Canada Revenue Agency, nor a Canadian court has yet to answer the following:
- Is bitcoin mining a “taxable supply” for the purpose of subsection 165(1) or 123(1) of the Excise Tax Act?
- Are bitcoin traders required to collect and remit Goods and Services Tax/Harmonized Sales Tax?
- What method should we use to value bitcoins for the purpose of subsection 165(1) of the Excise Tax Act?
- Are fees relating to bitcoin transactions a part of “the value of the consideration” for a taxable supply under subsection 165(1) of the Excise Tax Act?
Tax Scam Warning
You should be aware of a new scam. The scammer, pretending to be an agent of the Canada Revenue Agency, will call a victim. The scammer tells the victim that he or she owes a tax debt, which the victim must repay to avoid prosecution. The scammer then directs the victim to pay the tax debt using bitcoins. In particular, the scammer directs the victim to the nearest bitcoin exchange, where the victim must exchange cash for bitcoins and deposit the funds into the scammer’s anonymous digital wallet.
The Canada Revenue Agency will never ask for a payment in bitcoins. If you receive a suspicious phone call and the speaker claims to be with the Canada Revenue Agency, you should verify the call’s legitimacy. You should obtain the Canada Revenue Agency’s true phone number, call the Agency, and ask about the status of your account. If you have other tax concerns and do not want to contact CRA directly, you can contact our Canadian tax law office and we will assist you. In contrast, you should not attempt to verify the call’s legitimacy by calling a phone number provided by the suspicious caller: You will likely end up speaking with the scammer’s accomplice, who will take steps to reinforce the original scam.
While Canadian authorities reject bitcoins as constituting money, a person who receives bitcoins as payment for goods or services may still have tax obligations. The recipient may need to report the bitcoin payment as income on his or her tax return. Similarly, he or she may need to collect and remit GST/HST on behalf of the purchaser.
You might think that the purported anonymity of a bitcoin transaction will allow you to safely keep this income hidden from the government. But this is false. Recent news reports have revealed that some bitcoin exchanges willingly reveal their customer data to local authorities even without a warrant. In addition, tax authorities themselves adopt methods aimed at cracking the bitcoin system. For instance, the Internal Revenue Service allegedly purchased software that can unveil a bitcoin user’s identity. The software analyzes a bitcoin transaction and traces bitcoin units to their source. In other words, it follows a bitcoin as it moves from one bitcoin wallet to another. Designers of the software claim that the program has already garnered information on 25% of bitcoin users, who account for about 50% of all bitcoin activity.
If you failed to fulfil the Canadian tax obligations arising from your bitcoin transactions,you may qualify for the Voluntary Disclosures Program. This program gives you a second chance to correct your taxes without prosecution or penalty from the Canada Revenue Agency. To learn whether you qualify, please speak with one of our top Canadian tax lawyers today.
"This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. 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."