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Published: April 6, 2020

Last Updated: October 21, 2022

Background – Death of QuadrigaCX Chief Executive and Lost Cryptocurrency Keys

QuadrigaCX, Canada’s largest cryptocurrency exchange, lost its founder and chief executive Gerald Cotton on December 9, 2018. Gerald was travelling in India where he was working to open an orphanage when he suddenly passed due to complications with his Crohn’s disease. The problem for some Canadian cryptocurrency owners is that Gerald was apparently the sole holder of the passwords and codes needed to access the “cold wallets” that held much of the company’s cryptocurrency. The result is that about USD$190 million worth of cryptocurrency is no longer accessible, leaving QuadrigaCX’s investors in the lurch. Additionally, QuadrigaCX filed an application for creditor protection on January 31, 2019 which was granted on February 5, 2019. Judge Michael Wood has given QuadrigaCX a 30 day stay of proceedings which will prevent any lawsuits against QuadrigaCX from proceeding for that duration, giving the company some time to access the exchange’s crypto currency accounts or to come up with the necessary funds to satisfy the company’s creditors. That said, it is very possible that the cryptocurrency will be irretrievable and the company may be forced into bankruptcy.

Tax Implications for QuadrigaCX Investors

Beyond the obvious problem of losing their invested cryptocurrency, investors should also be cognizant of the tax implications of this event for them. If QuadrigaCX becomes insolvent and unable to pay back its investors, which at this point seems very possible, those investors will end up with a tax loss that can be used to offset some of their taxable income for 2018 or 2019. However, there is some difficulty in determining both 1) the timing of the loss, and 2) the type of loss that can be claimed.

Timing of the Tax Loss

With regards to the timing and the type of loss, it is necessary to first determine how this specific cryptocurrency exchange works, since it is apparently different than some other exchanges. In general, when an individual purchases cryptocurrencies, for example Bitcoin, on an exchange, they are not buying a specific Bitcoin, but rather buying an entitlement to withdraw a Bitcoin from the exchange’s corporate cryptocurrency wallet. Similarly, when one trades that Bitcoin held in the exchange for another cryptocurrency, typically no cryptocurrencies are actually moved from one wallet to another; rather, the exchange simply adjusts its internal accounts accordingly to track what it owes to each accountholder or investor. In a sense, this would mean that any cryptocurrency an exchange is unable to pay back could be considered a bad debt. In that case, the loss can be claimed in the year that it is determined to be a bad debt. This determination is made by the creditor (the cryptocurrency holder in this case) with the application of the proper factors and acting in a reasonable and business-like manner. Specifically, the Federal Court of Appeal has listed 7 factors:

  1. The history and age of the debt;
  2. The financial position of the debtor;
  3. Changes in total sales of the debtor as compared with prior years;
  4. The debtor’s cash, accounts receivable and other current assets;
  5. The debtor’s accounts payable and other current liabilities
  6. The general business conditions of the country, the community of the debtor, and the debtor’s line of business; and
  7. The past experience of the taxpayer in writing off bad debts

Looking at the factors, considering the Chief Executive has passed away, the high likelihood that QuadrigaCX’s corporate cryptocurrency wallet is irretrievable, the extremely high amount of debt, and the firm’s lack of continuing business, it would be reasonable for an investor to write off his QuadrigaCX investment as a bad debt in 2019 or possibly 2018. Talk to one of our experienced Canadian tax lawyers and make sure you are claiming a loss or bad debt correctly.

Characterization of the Tax Loss

In terms of the type of loss, if it is characterized as a bad debt, then investors can elect for s.50(1) of the Income Tax Act (the “Tax Act”)to apply which would deem that the debt was disposed of for proceeds equal to nil and then reacquire it immediately after the end of year at a cost of nil. What that means is that the investor would be considered to have sold and then rebought the debt at $0 value and this would result in a capital loss equal to the adjusted cost basis, also known as book value, of the debt. It should be noted that s.20(1)(p) of the Tax Act allows for the full deduction of a bad debt rather than only providing a capital loss, but this applies only to bad debts that had already been included into a business’ income (i.e. a business performs work and issues an invoice that is unpaid and becomes a bad debt – under the accrual method of accounting, the amount of the invoice is included in the business’ income as soon as the invoice is issued, but when it becomes a bad debt, the full amount of the invoice can be deducted). However, for QuadrigaCX investers and users, the bad debt would not have been included into income, and thus s.50(1) would apply rather than s.20(1)(p). For example, if an investor purchased a Bitcoin at $100, but the value of the Bitcoin was at $5,000 at the time it became a bad debt, the investor would only be entitled to a capital loss of $100, not $5000. Furthermore, capital losses can only be used to offset capital gains (so they wouldn’t be able to offset normal business or employment income). Additionally, capital losses can be considered to be half as valuable as a non-capital loss because only 50% of a capital gain is taxed in Canada, so $100 of capital losses would only translate to a reduction of $50 in income (assuming there are capital gains in the current or prior years to offset the losses) and, at a top marginal tax rate of about 50%, a tax savings of $25.

On the other hand, if a taxpayer is running a cryptocurrency trading business, the loss may be characterized as a non-capital loss. Similar to commodities and securities, buying and selling cryptocurrency can be characterized as an investment activity where proceeds/profits are considered capital gains, or they can be characterized as trading or business activities where the proceeds/profits are considered business income. If a taxpayer is considered to be running a cryptocurrency trading business, then rather than being capital property, the cryptocurrency would be considered inventory, and the loss of the inventory would allow the taxpayer to claim a non-capital (or business) loss. The practical result of this is that the taxpayer would be able to use the non-capital loss to offset other business or employment income, and dollar of loss for dollar of loss, the non-capital loss would save the taxpayer twice as much tax as the capital loss as exemplified above, and is not restricted to offsetting capital gains.

Tax Tip – Get Professional Canadian Tax Lawyer Advice in Determining Whether your Profits or Losses are on Account of Capital or Business.

Of course, the difficulty is in determining whether one’s activities should properly be considered an investment or a business. Generally, when profits are involved, an investment/capital characterization is most beneficial because of the 50% tax rate, but where losses are involved, a business/non-capital characterization becomes more attractive. The consequence of getting it wrong is that interest and penalties will apply if the CRA find that the incorrect characterization resulted in insufficient tax being paid. Contact our top Canadian tax law firm and make sure you are reporting your taxes in the way that benefits you most, but also to make sure you are doing it right and avoid costly penalties and interest.


"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."

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