Canadian Cryptocurrency Tax Trap: Poor Record-Keeping will Leave You at the CRA’s Mercy: Record-Keeping Requirements for Canadian Cryptocurrency Traders & Investors – Canadian Tax Guidance from a Canadian Tax Lawyer

Introduction – The CRA Targets Taxpayers Who Keep Poor Records

The Canada Revenue Agency isn’t shy about pursuing a tax audit. But the CRA invokes its most aggressive tactics when auditing groups that CRA tax auditors perceive as most likely to retain poor records or lack internal controls—groups such as those who use, trade, and invest in cryptocurrency. Canadian cryptocurrency users are often shocked when they receive the CRA’s 13-page tax-audit questionnaire about their transactions involving cryptocurrency such as Bitcoin (BTC), Bitcoin Cash (BHC), Litecoin (LTC), Ethereum (ETH), Chainlink (LINK), Dash, Zcash (ZEC), and Ripple (XRP). In addition, Canada’s Income Tax Act requires all Canadian taxpayers—including Canadian cryptocurrency users—to maintain adequate books and records.

This article examines the record-keeping requirements for Canadian cryptocurrency traders and investors.  After reviewing the Income Tax Act’s record-keeping requirements and the CRA’s tax-audit powers, this article identifies the specific records that cryptocurrency users should maintain.  It concludes by offering pro tax tips from our top Canadian crypto-tax lawyers for Canadian cryptocurrency traders and investors.

Tax Record-Keeping Requirements: Section 230 of Canada’s Income Tax Act

Section 230 of Canada’s Income Tax Act effectively requires every Canadian taxpayer to maintain adequate books and records. The record-keeping requirement applies to every person who carries on a business or who is required to pay income tax or collect income tax (or pay or collect any other amount, such as interest, penalties, or vicarious tax liability under section 160 of the Income Tax Act). The books and records must suffice to enable one to determine the amount of income tax payable (or to determine any amount that should have been deducted, withheld, or collected). The taxpayer must keep these records at a residence or place of business in Canada.

Section 230 also imposes a general six-year retention period. That is, a taxpayer must retain books, records, and supporting documents for at least six years after the end of the last tax year to which those documents relate. In practice, this rule means that you must typically retain records for considerably longer than six years. For example, suppose that you purchased various cryptocurrency units in 2016 and sold them in 2022. Your 2016 records concerning the cryptocurrency purchase will relate to the 2022 taxation year in which you made the sale. So, you must retain the 2016 purchase records for at least the six years following 2022—that is, until at least 2028!

The failure to maintain records is a summary-conviction criminal offence under section 238 of the Income Tax Act. Anyone who fails to comply with the above-mentioned record-keeping requirements may face a minimum fine of $1,000 (up to a maximum of $25,000), plus up to 12 months’ imprisonment. In addition, the Canada Revenue Agency may levy gross-negligence penalties. Our experienced Canadian litigation tax lawyers can assist you if you have been charged with an Income Tax Act offence.

The CRA’s Income-Tax Audit Powers & Cryptocurrency Tax-Audit Questionnaire

Of course, Canada’s Income Tax Act not only requires you to maintain records but also entitles the CRA to examine those records. Sections 231.1 and 231.2 of Canada’s Income Tax Act govern the Canada Revenue Agency’s tax audit and information-gathering powers. These rules empower the CRA’s income-tax auditors to:

• inspect, audit, or examine any document belonging to a taxpayer or to any other person;
• examine the property belonging to a taxpayer or to any other person;
• enter any premises to examine documents or property; and
• require any person—including banks and accountants—to provide any information or document.

These tax-audit rules also allow the CRA to issue a requirement for information, which is essentially a letter demanding that a taxpayer (or any relevant third party—including accountants, since they don’t have legal privilege) release specified documents or information. If the taxpayer refuses, the Canada Revenue Agency can, under section 231.7 of the Income Tax Act, pursue a court order forcing the taxpayer’s compliance.

The CRA typically begins a cryptocurrency tax audit by issuing a letter notifying the taxpayer about the pending audit, the tax years or reporting periods under audit, and the general subject matter of the audit. These letters often include the cryptocurrency tax-audit questionnaire.

The Canada Revenue Agency’s cryptocurrency tax-audit questionnaire includes over 50 questions on a range of topics, such as:

• The timeline of owing or using cryptocurrency;
• The types of cryptocurrencies purchased or sold—e.g., Bitcoin (BTC), Bitcoin Cash (BHC), Litecoin (LTC), Ethereum (ETH), Chainlink (LINK), Dash, Zcash (ZEC), Ripple (XRP), Monero (XRM), Zcash (ZEC), Dash (DASH), Grin (GRIN), Komodo (KMD), Verge (XVG), Plasma, OmiseGo, Tether (USDT), etc.;
• The use of third-party exchange wallets (e.g., Coinbase, Binance, etc.);
• The source of funds used to purchase cryptocurrency;
• Transaction record-keeping practices of the taxpayer;
• Participation in initial coin offerings (ICOs);
• Whether any cryptocurrency holdings generated passive income for the taxpayer (e.g., blockchain or cryptocurrency liquidity mining and yield farming, proof-of-stake mining, etc.);
• Participation in cryptocurrency proof-of-stake validation (staking or forging) or cryptocurrency proof-of-work validation (mining), including questions about the sort of proof-of-work mining hardware used and energy expenses related to mining;
• Acceptance of cryptocurrency as payment for goods or services;
• The frequency of cryptocurrency transactions; and
• The time spent studying cryptocurrency markets.

The taxpayer must also turn over bank-account statements and any other records allowing the CRA to verify the taxpayer’s answers to the cryptocurrency tax-audit questionnaire.

Record-Keeping Practices for Canadian Cryptocurrency Traders & Investors

Canadian cryptocurrency users who lack proper records will be at the CRA’s mercy during a cryptocurrency tax audit. For example, when a taxpayer’s dismal record-keeping precludes a Canada Revenue Agency tax auditor from using the standard (generally, more reliable) tax-audit techniques, the tax auditor will employ an indirect method of income verification. The tax auditor may, for instance, compare your household budget and expenditures with data collected by Statistics Canada, or review the deposits appearing on your bank-account statements, or estimate the growth of your net worth over a specified period.

The problem is that indirect-income-verification methods don’t give accurate results, and, when used by a CRA tax auditor, these methods typically lead to wildly inflated income-tax assessments. The Canada Revenue Agency’s advantage lies in the fact that, under Canada’s income-tax system, the taxpayer has the initial onus of rebutting the CRA’s assumptions. In other words, a cryptocurrency user’s lack of records will ultimately benefit the Canada Revenue Agency. Without adequate record-keeping, a cryptocurrency trader or investor will find it difficult to rebut the CRA’s indirect-income-verification methods unless the cryptocurrency user seeks assistance from a knowledgeable Canadian crypto-tax lawyer, who can poke holes in the tax auditor’s analysis, thereby forcing the CRA to adopt a more reasonable method—a method based, for instance, on a blockchain-forensics analysis.

Hence, cryptocurrency traders and investors should maintain records of all their cryptocurrency transactions. The same is true for any business that accepts cryptocurrency as payment for goods and services. In particular, you should maintain the following records about your cryptocurrency transactions:

• The date of each transaction;
• The transaction ID (i.e., TxID or Tx Hash);
• Any receipts for purchasing or transferring cryptocurrency;
• The value of the cryptocurrency in Canadian dollars at the time of the transaction;
• The digital-wallet records and cryptocurrency addresses;
• A description of the transaction and of the other party (e.g., the other party’s cryptocurrency address);
• The exchange records;
• Records relating to any accounting and legal costs; and
• Records relating to any software costs for managing your tax affairs.

If you mine cryptocurrency, you should keep the following records in addition to your cryptocurrency-transaction records:

• Receipts for purchasing cryptocurrency-mining hardware;
• Receipts for expenses associated with your cryptocurrency-mining operation (e.g., power costs, mining-pool fees, maintenance costs);
• Records about your cryptocurrency-mining operation (e.g., hardware specifications, hardware operation time); and
• The mining-pool details and records (e.g., mining-pool contracts).

If you use a cryptocurrency exchange, you should periodically export your transaction information to avoid losing it. Ideally, you should also use offsite or cloud storage to back up your documents and computer files. Many Canadians lost all their cryptocurrency-transaction records when the Canadian cryptocurrency-exchange QuadrigaCX went bankrupt and turned out to be nothing more than a Ponzi scheme.

You should also maintain a copy of any formal legal opinions that you received from your top Canadian crypto-tax lawyer. For instance, our expert Canadian crypto-tax lawyers can prepare a tax memorandum examining whether your cryptocurrency profits should be reported as capital gains, as business income, or as a blend of both. This confidential and privileged document can prove invaluable by ensuring that the CRA doesn’t fault you for misrepresenting the information in your tax returns.

Pro Tax Tips: Protecting Your Rights During a Cryptocurrency Tax Audit

The CRA’s tax auditors enjoy significant information-gathering powers. And courts respect these powers. As a result, if you’re the subject of a CRA cryptocurrency tax audit, you won’t find much legal support for simply ignoring the tax auditor’s requests for information.

That said, you need not answer every question posed by a CRA tax auditor. The Federal Court of Appeal confirms that the Canada Revenue Agency “does not have the power to compel a taxpayer to answer questions at the audit stage”: MNR v Cameco Corporation, 2019 FCA 67, at para 28. (The 2021 federal budget proposed to override the Cameco decision by amending section 231.1 of Canada’s Income Tax Act. The proposal would have allowed the Canada Revenue Agency to compel a taxpayer to answer questions “orally or in writing, in any form specified by the [CRA tax auditor].” But this proposed amendment was ultimately cut from the final draft of Bill C-30, the Budget Implementation Act, 2021, No. 1., which received royal assent and became law on June 29, 2021. So, at the moment, the Cameco decision still stands.)

Yet while you need not answer a CRA tax auditor’s questions during a cryptocurrency tax audit, you should understand that the tax auditor may draw an unfavourable inference when you refuse to answer questions. The CRA is also free to make assumptions and to assess tax on the basis of those assumptions. Moreover, during a Tax Court appeal, the knowledgeable Canadian litigation tax lawyer for the taxpayer bears the onus of rebutting any assumptions made by a CRA tax auditor. In other words, whether you face a cryptocurrency tax audit or any other form of tax audit, you must pick your battles. Otherwise, you may find yourself facing a slew of outlandish assumptions.

Fortunately, Canadian cryptocurrency users can generally avoid these problems through early engagement of an experienced Canadian crypto-tax lawyer, who can advise you of your rights, determine when it may actually help your case to answer a tax auditor’s questions, prepare you or other potential witnesses for the tax auditor’s questions, and ensure that your responses to the Canada Revenue Agency’s cryptocurrency tax-audit questionnaire are accurate, relevant, clear, and succinct.

About the Author

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Kevin Persaud

Kevin Persaud is a tax lawyer and Senior Associate at Rotfleisch & Samulovitch. He has assisted start-up businesses, resident and non-resident business owners, corporations, and cryptocurrency traders with tax planning, will and estate planning, voluntary disclosures, and tax disputes, including tax audits, tax objections, and tax litigation.

Learn more about Kevin Persaud