Canadian NFT Artists & The Tax Man: The Canadian Tax Implications of Creating and Selling Blockchain Non-Fungible Tokens (NFTs) – Canadian Tax Guidance from a Canadian Tax Lawyer

Introduction: Blockchain Non-Fungible Tokens or NFTs: The New Medium for Digital Artists and Content Creators

Non-fungible tokens (NFTs) have quickly become a new medium through which artists, musicians, and content creators can monetize their work. In March 2021, musician and artist Grimes sold a collection of digital art as non-fungible tokens for almost $6 million. In September 2021, the auction house Sotheby’s sold a 107-piece set from the Bored Ape Yacht Club collection—consisting of thousands of NFTs, each corresponding to a cartoon ape with unique colour schemes, facial expressions, and outfits—for a whopping $24 million.

A non-fungible token, or NFT, is basically a unique digital asset that relies on blockchain technology to track ownership. Anything digital can be converted into an NFT—e.g., a digitized picture, song, poem, or even this very article. Blockchain technology allows the public to verify who owns a specific non-fungible token and to track transfers of ownership. As a result, an NFT permits you to own, buy, and sell unique digital items. Because it relies on blockchain technology to track ownership, an NFT is like cryptocurrency, such as Bitcoin (BTC), Ethereum (ETH), or Litecoin (LTC). But unlike cryptocurrency, each NFT holds unique characteristics. This is why non-fungible tokens are called “non-fungible.” Whereas cryptocurrency is fungible—trading one Bitcoin for another gets you exactly the same thing—each NFT is like an original piece of art. If you trade an original Picasso for a Rembrandt, you don’t end up with the same thing. The same holds true for NFTs. As such, non-fungible tokens have unsurprisingly garnered the most excitement and attention for their utility in commercializing digitized art and music.

In addition, NFTs allow an artist or musician to program a resale royalty directly into the NFT, thereby prompting commissions beyond the first point of sale. Facilitated by blockchain technology, this royalty could in principle continue forever. This enables the artist or musician to generate continuing revenue for future sales of an artistic work or song—generating even greater revenues as the art or the artist increases in popularity.

The creation and sale of blockchain NFTs by Canadian taxpayers invoke a number of Canadian tax issues. And without proper NFT-tax guidance from an experienced Canadian NFT-tax lawyer, Canadian NFT artists and content creators will find themselves unsure about how to properly report their income to the Canada Revenue Agency.  The article aims to educate Canadian NFT artists and Canadian NFT content creators about their Canadian tax obligations. It outlines both the income-tax obligations and the GST/HST obligations of self-employed NFT artists and NFT content creators in Canada. The article concludes by offering pro tax tips from our top Canadian NFT-tax lawyers for Canadian taxpayers who create non-fungible tokens for sale.

Canadian Income-Tax Implications for Self-Employed NFT Artists & NFT Content Creators

NFT Art Sales as a Source of Taxable Business Income

Canada’s Income Tax Act distinguishes between various sources of income: income from an office or employment, business income, income from property (or investment income), and capital gains. Different income-tax rules apply to different sources of income. Business income and investment income, for instance, are each fully taxable in Canada. Yet only one-half of a capital gain is included in taxable income.

The profit generated from creating and selling non-fungible tokens will typically qualify as business income for self-employed NFT artists and NFT content creators in Canada. The same is true for royalties on copyright NFTs. A copyright NFT is a blockchain arrangement whereby an artist, author, or musician issues non-fungible tokens, thereby selling a percentage of the rights to a created work. As a result, the owner of the non-fungible tokens receives a corresponding proportion of any royalty payments on the underlying work. Although a royalty payment may constitute passive investment income in other circumstances, it produces active business income for the artist, author, or musician who created the royalty-paying copyright NFT and issued it to the public.

As a result, self-employed NFT artists and NFT content creators must report their earnings as business income in accordance with subsection 9(1) of the Income Tax Act. Their non-fungible tokens constitute inventory, and their profits from NFT sales are fully taxable. Those who receive royalties from copyright NFTs must also report their royalties as fully taxable business income.

Moreover, expenses incurred to earn business income are deductible under subsection 9(1) of the Canadian Income Tax Act. To create the non-fungible token, for example, an NFT artist must typically pay a “gas fee,” which is a processing fee for the computing energy that goes into creating and validating the unique NFT on the blockchain. For self-employed NFT artists and content creators who create non-fungible tokens to earn business income, the gas fee qualifies as a deductible expense.

Non-Fungible Tokens as Inventory: Calculating & Claiming Inventory Costs

Subsection 9(1) of Canada’s Income Tax Act codifies the deductibility of inventory costs by defining a taxpayer’s business income as the taxpayer’s “profit from that business.” The Income Tax Act doesn’t rigorously define how a taxpayer should compute inventory costs. Canada’s income-tax law mainly defers to commercial practice and generally accepted accounting principles (GAAP).

For instance, commercial practice prescribes the use of accrual accounting for most businesses—especially those with high inventory turnover. Thus, an NFT art dealer who maintains a rather large inventory of NFT artwork may recognize inventory costs on an accrual basis, which means that the NFT art dealer doesn’t deduct the cost of a non-fungible token as an expense for the fiscal period in which the NFT was purchased. Instead, the NFT art dealer recognizes the inventory cost as an expense for the fiscal period in which the non-fungible token was sold (i.e., cost of goods sold). For any NFT inventory remaining on hand at the end of the fiscal period, the inventory cost is recorded as an asset on the balance sheet for that period.

For more details about calculating and deducting the cost of blockchain-based inventory, read our “Tax Guide for Crypto & Bitcoin Businesses: Computing Inventory Costs.”

Canadian Income-Tax Returns for Incorporated NFT Artists, NFT Art Dealers & NFT Content Creators

If the NFT artist, NFT content creator, or NFT art dealer operates the business through a corporation, the corporation must file a T2 Corporation Income-Tax Return within six months from the end of its taxation year. (A corporation may have an off-calendar tax year coinciding with its fiscal period.)

The corporation’s tax owing must be paid within two months after the end of its taxation year. But if the corporation qualifies for the small business deduction, it may delay payment by a month—i.e., the tax owing is due within three months after the end of the corporation’s taxation year.

Canadian Income-Tax Returns for Unincorporated NFT Artists, NFT Art Dealers & NFT Content Creators (Sole-Proprietorship)

If the NFT artist, NFT content creator, or NFT art dealer operates the business as a sole proprietor (unincorporated), the individual must file the year’s Canadian T1 General Income-Tax Return by June 15^th of the following year. But the tax must be paid by April 30^th. (Otherwise, interest starts to accrue.) In other words, the tax is payable about a month and a half before the tax return is due.

GST/HST Obligations of Self-Employed NFT Artists & NFT Content Creators: Non-Fungible Token Sales as a Taxable Supply

Creating and selling NFT artwork may also give rise to GST/HST obligations. Section 165 of the Excise Tax Act imposes GST/HST on “every recipient of a taxable supply made in Canada.” A “taxable supply” basically refers to the commercial sale of goods or services, and it captures the sale of artwork by an artist and the sale of music by a musician.

Although a cryptocurrency-trading business constitutes a supply of financial services, which is exempt from GST/HST, commercial NFT sales remain a taxable supply. Under Canada’s Excise Tax Act, financial services don’t bring about GST/HST obligations, and a “financial service” includes the purchase or sale of a “virtual payment instrument,” which refers to a “property that is a digital representation of value, that functions as a medium of exchange, and that only exists at a digital address of a publicly distributed ledger.” So, fungible cryptocurrency, like Bitcoin, Ethereum, or Chainlink, falls squarely within the definition of a “virtual payment instrument.” But NFT artwork doesn’t. As a representation of a piece of art or music, a non-fungible token doesn’t serve as a “digital representation of value” and doesn’t “function as a medium of exchange.”

While the obligation to pay GST/HST falls on the consumer, the obligation to actually collect the tax falls on the supplier—that is, the person who sells the good or service. A supplier need not collect GST/HST if earning less than $30,000 in gross revenue annually. But a Canadian business earning $30,000 or more in worldwide gross revenues must register for a GST/HST number and begin charging GST/HST on services provided or goods sold. Failure to do so will lead to penalties, interest, and possible prosecution for tax evasion.

Hence, if earning $30,000 or more in gross revenue, a self-employed Canadian NFT artist or content creator must register for a GST/HST number with the CRA, charge GST/HST on NFTs sold in Canada, collect that GST/HST, and pay it to the Canada Revenue Agency. This also means that a bookkeeping system must be put in place because the NFT artist is subject to a GST/HST audit by CRA.

If the Canadian NFT artist or content creator paid GST/HST to business vendors, the artist or content creator may claim those amounts as an input tax credit (ITC), thereby reducing the net GST/HST payable to the Canada Revenue Agency.  Examples of amounts claimable as ITCs include the GST/HST payable on commercial rent, the GST/HST payable on professional fees such as Canadian crypto tax lawyers or accountants, the GST/HST payable on internet-service fees, and the GST/HST payable on cell-phone fees (to the extent that the internet use and cell-phone use were business related).

GST/HST Filing Requirements for Self-Employed NFT Artists & NFT Content Creators

If obligated to register for GST/HST, the NFT artist or content creator must file GST/HST returns for each reporting period—even if the artist earned no revenue during that period or had no net GST/HST payable for that period.

The length of a taxpayer’s GST/HST reporting period determines when the taxpayer must file GST/HST returns and pay the net GST/HST.  A GST/HST reporting period can be annual, quarterly, or monthly.

• If the reporting period is monthly, then that reporting period’s GST/HST return and net GST/HST payable are both due by the end of the following month.
• If the reporting period is quarterly, then that reporting period’s GST/HST return and net GST/HST payable are both due within one month from the end of the quarter.
• If the reporting period is annual and the business is incorporated, then that reporting period’s GST/HST return and net GST/HST payable are both due within three months of the fiscal year-end.
• If the reporting period is annual and the business operates as a sole proprietorship, then that year’s GST/HST return is due by June 15^th of the following year. But that year’s net GST/HST payable is due by April 30^th of the following year. (In other words, the filing and payment deadlines match those for income tax.)

Moreover, the length of a reporting period depends on the business’s annual revenue during the last fiscal year. A business that earned $1.5 million or less may opt for an annual, quarterly, or monthly GST/HST reporting period. A business may opt for a quarterly or monthly GST/HST reporting period if it earned over $1.5 million but not more than $6 million. And a business must use a monthly GST/HST reporting period if it earned over $6 million during the last fiscal year.

Pro Tax Tips: Legal Opinion on Proper Tax Reporting of Non-Fungible Tokens, Non-Fungible Token Tax Planning & VDP for Unreported Income Tax and GST/HST

Canadian NFT artists and other Canadian taxpayers engaging in NFT transactions and blockchain-based arrangements will generally benefit from a tax memorandum examining whether their royalties on copyright non-fungible tokens should be reported as investment income, as business income, or as a blend of both. And if they’ve traded any non-fungible tokens, they’ll face a similar issue as to whether their profits should be reported as business income, as capital gains, or as a blend of the two. In addition, by holding cryptocurrency and non-fungible tokens with an aggregate tax cost exceeding $100,000, you will likely need to file a T1135 form with your income-tax return.

Our knowledgeable Certified Specialist in Taxation Canadian NFT-and-crypto-tax lawyer has helped numerous clients with issues concerning the proper characterization and reporting of cryptocurrency transactions, non-fungible-token transactions, and other blockchain-based transactions. If you’ve executed cryptocurrency transactions or transactions involving non-fungible tokens, contact one of our expert Canadian crypto-tax and NFT-tax lawyers for tax guidance.  A written tax memorandum containing a thorough tax-law analysis of your cryptocurrency transactions, non-fungible-token transactions, or other blockchain-based transactions guards against gross-negligence penalties should the Canada Revenue Agency disagree with your tax-filing position.

A Canadian-controlled private corporation (CCPC) enjoys a reduced tax rate on its first $500,000 of active business income, and its individual shareholders can defer shareholder-level tax to the extent that retained earnings stay within the corporation. As a result, a self-employed Canadian NFT artist or self-employed Canadian NFT content creator may benefit from incorporating the business. For more information, see our article about the Canadian tax benefits of operating your cryptocurrency-trading business or NFT-sales business as a CCPC. Contact one of our skilled Canadian NFT-tax and crypto-tax lawyers today for advice on tax-planning in relation to operating your NFT-sales business through a corporation.

Cryptocurrency users no longer benefit from anonymity because of advances and cooperative efforts of tax authorities like the Canada Revenue Agency (CRA), Internal Revenue Service (IRS), and Her Majesty’s Revenue & Customs (HMRC).  Canadian taxpayers with unreported cryptocurrency profits should find this alarming. And while blockchain non-fungible tokens are relatively novel, taxpayers engaging transactions involving NFTs should be equally concerned. If you filed Canadian tax returns that omitted or underreported your cryptocurrency profits or your profits from non-fungible tokens, you risk facing not only civil monetary penalties, such as gross-negligence penalties, but also criminal liability for tax evasion.  And if you failed to file T1135 forms for your NFT holdings, the standard late-filing penalty can be upwards of $2,500.00 per unfiled form, and the gross-negligence penalty can be upwards of $12,000.00 per unfiled form. Moreover, while a cryptocurrency-trading business constitutes a supply of financial services, which is exempt from GST/HST, commercial NFT sales remain a taxable supply. Therefore, a self-employed NFT artist or self-employed NFT content creator who generates over $30,000 in annual revenue must register for a GST/HST number with the CRA, charge GST/HST on NFT sales within Canada, collect that GST/HST, and pay it to the Canada Revenue Agency. Failure to do so will lead to penalties, interest, and possible prosecution for tax evasion.

The CRA’s Voluntary Disclosures Program (VDP) may grant relief from penalties, interest, and prosecution relating to unreported taxable income, unfiled T1135 forms, and unreported GST/HST. If your VDP application qualifies, the Canada Revenue Agency will abandon criminal prosecution and waive gross-negligence penalties (and may cancel or waive interest). A VDP application is time sensitive, so you cannot afford to delay. The CRA’s Voluntary Disclosures Program will reject an application—therefore denying any relief—unless the application is “voluntary.” This essentially means that the Voluntary Disclosures Program must receive your VDP application before the Canada Revenue Agency contacts you about any of the non-compliance you seek to disclose. For more information about qualifying for relief under the VDP, see our article on the CRA Voluntary Disclosures Program.

You may qualify for relief under the CRA’s Voluntary Disclosures Program. If your VDP application qualifies, the CRA will renounce criminal prosecution and waive gross-negligence penalties (and may reduce interest). But your voluntary-disclosure application is time-sensitive. The CRA’s Voluntary Disclosures Program will reject an application—therefore denying any relief—unless the application is “voluntary.” This essentially means that the Voluntary Disclosures Program must receive your voluntary-disclosure application before the Canada Revenue Agency contacts you about the non-compliance you seek to disclose.

Our expert Certified Specialist in Taxation Canadian tax lawyer has assisted numerous Canadian taxpayers with unreported cryptocurrency and blockchain transactions. We can carefully plan and promptly prepare your voluntary-disclosure application. A properly prepared disclosure application not only increases the odds that the CRA will grant tax amnesty but also lays the groundwork for a judicial-review application to the Federal Court should the Canada Revenue Agency unfairly deny your voluntary-disclosure application. To determine whether you qualify for the Canada Revenue Agency’s Voluntary Disclosures Program, schedule a confidential and privileged consultation with one of our expert Canadian tax lawyers.

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