October 18, 2021, 2:19 PM EDT) — Cryptocurrencies, such as Bitcoin, are in use throughout various jurisdictions. On Sept. 7, 2021, El Salvador became the first country to accept Bitcoin as legal tender. Interestingly, foreign investors are exempt from tax on their Bitcoin profits in El Salvador, a move presumably to encourage foreign investment.
Meanwhile, different countries have disparate income tax treatment of cryptocurrency transactions. There is uncertainty surrounding the taxation of bitcoins in Canada, and the tax consequences may be different depending on how they were acquired.
The good, the bad and the ugly of Bitcoin
David Rotfleisch Bitcoins are a type of virtual currency known as “cryptocurrency” and were originally created by an anonymous computer programmer in 2009. They are based on blockchain technology which creates an indelible permanent record of all transactions related to the cryptocurrency.
Because cryptocurrencies are designed to allow for anonymous exchanges, they have become an international cause for concern for income tax and other authorities due to their use in money laundering, tax evasion and other illegal activities.
Since the creation of Bitcoin, its value and that of other cryptocurrencies have fluctuated dramatically.
Today, there are hundreds of cryptocurrencies with new initial coin offerings coming out all of the time. Many have unique features. However, we will discuss Bitcoin as a paradigm of cryptocurrency.
There are three ways in which a person can acquire bitcoins:
- Through the use of computers to create the Bitcoin in an online process called “mining.”Mining is a practice whereby a user sets up a personal computer to run processes and solve algorithms that “discover” new coins based on the architecture of the currency when it is created.
For most cryptocurrencies there is a fixed upper number of coins, so once all are discovered the coins have been “mined out” and no further units will be available to miners. However, the coins still exist and can be used for purchases and trade as usual.
- By purchasing them online through a Bitcoin exchange for traditional currency; or
- As consideration in exchange for services.
CRA’s tax treatment of cryptocurrency — so far
The Canada Revenue Agency (CRA) has not yet comprehensively addressed the issue of cryptocurrency tax in any of its publications. However, it has issued Income Tax Rulings and Technical Interpretations to address the tax treatment of specific transactions involving cryptocurrency.
In a March 2014 Technical Interpretation, the CRA provided some guidance and outlined its position regarding the income arising from cryptocurrency activities.
CRA’s position is that when a taxpayer pays for a product with bitcoins, the CRA will deem that transaction to be a barter transaction.
When a taxpayer disposes of bitcoins, the transaction will be subject to taxation as either an income from a business source or as capital gains from disposition of property.
Whether the gain is on income or capital account will depend on various factors including whether the taxpayer’s activities involving cryptocurrency have sufficient commercial nature, as set out by the Supreme Court of Canada in Stewart v. Canada 2002 SCC 46.
To get a better idea how a barter transaction would be taxed with cryptocurrency used as currency, one needs to have a basic understanding of how a more traditional barter transaction works.
In a barter scenario, when a taxpayer pays for goods or services using cryptocurrency, the taxpayer will need to include the fair market value of the goods received in income. This is to ensure that the full value of the goods or services received is accounted for in the taxpayer’s income.
Say a taxpayer who owns a retail store sells a product with a fair market value of $20. The customer pays for the product with one unit of cryptocurrency, presumably having a value of $20. However, because cryptocurrencies are not official currency, in order to ensure that the entire value sold to the consumer purchaser through the transaction is accounted for when determining the store taxpayer’s income for the year, the value of the product, $20, not the value of the cryptocurrency when the goods are sold, is used for tax purposes.
Taxpayers who speculate in cryptocurrency by buying and selling them using conventional (fiat) currency, or coin-to-coin transactions, will find that the income tax treatment is different than in a barter transaction scenario.
Should a taxpayer choose to purchase and sell cryptocurrency with an eye to making a profit, different rules apply.
In effect, cryptocurrency can be analogized to any other piece of property. When the cryptocurrency is disposed of for a price higher than what was paid, a capital gain will arise, and one half of the gain will be included in the taxpayer’s income.
This type of transaction, done many times during the taxation year, could lead to different tax treatment. For example, if a taxpayer repeatedly purchases and sells bitcoins for a profit, the CRA may choose to assess the taxpayer as being in the business of speculating on Bitcoin, and include all profits in the taxpayer’s income as business income arising from an adventure in the nature of trade instead of a capital gain. Business income is fully taxable as opposed to capital gains which are taxed at a 50 per cent rate.
In an April 2015 Technical Interpretation, the CRA noted that cryptocurrencies situated and held outside of Canada that are not used exclusively in the course of carrying on an active business would be “specified foreign property.” This means that the value of the cryptocurrency has to be reported in a T1135 Statement to CRA every year by a Canadian resident for tax purposes if the total cost of all “specified foreign property” (including cryptocurrencies) is more than $100,000.
So far, the tax treatment of cryptocurrencies in Canada is complex, fact dependent and subject to a great deal of uncertainty. More is sure to follow from CRA.
David J. Rotfleisch is the founding tax lawyer of Rotfleisch & Samulovitch P.C., a Toronto-based boutique tax law and corporate law firm. He appears regularly in print, radio and TV. With over 35 years of experience as both a tax lawyer and chartered professional accountant, he has helped startup businesses, resident and non-resident business owners and corporations and cryptocurrency traders with their tax planning, with will and estate planning, voluntary disclosures and tax dispute resolution including tax audit representation and tax litigation.
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"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."