Published: November 1, 2021
Last Updated: November 1, 2021
Introduction – Bitcoin ETFs
On October 19, 2021, the first U.S based Bitcoin exchange-traded fund (ETF), ProShares ETF was launched. Within a week, another U.S. based Bitcoin ETF, Valkyrie Bitcoin Strategy EFT, launched on October 22, 2021. These two Bitcoin ETFs invest in Bitcoins through agreements to purchase the cryptocurrency in the future at an agreed-upon price.
However, these two U.S.-based Bitcoin ETFs are not the first Bitcoin ETFs in the world. In fact, there are already several different Bitcoin ETFs available in the Canadian securities market. These are the Purpose Bitcoin ETF (TSX:BTCC.B), the CI Galaxy Bitcoin ETF (TSX:BTCX.B), and the HIVE Blockchain Technologies (TSXV:HIVE). Unlike their U.S. counterparts, Purpose Bitcoin ETF and CI Galaxy Bitcoin ETF simply holds Bitcoin on its investor’s behalf instead of investing in future contracts. HIVE Blockchain Technologies on the other hand, mines Bitcoin and Ethereum for a profit using the funds it raised from investors.
We will discuss one of the major tax implications for investors of Bitcoin ETFs, which is the possibility of investing in the Bitcoin market through EFTs while enjoying the tax advantages of a Tax-Free Savings Account (TFSA) or a Registered Retirement Savings Plan (RRSP).
General Taxation of Bitcoin ETFs
Bitcoin ETFs are treated as mutual funds under the Income Tax Act. This means Canadian Bitcoin ETF holders will be taxed on any income and capital gains generated through holding the ETFs as well as capital gains or capital losses when they dispose of their ETFs. Canadian taxpayers can also carry forward or backward their capital losses from disposition of their ETFs to lower their tax liabilities in other years. Under the Income Tax Act, taxpayers are allowed to carry forward their capital losses indefinitely and carry back their capital losses for three years.
Qualified Investments for RRSP and TFSA
Under the Income Tax Act, only qualified investments can be vested in registered retirement savings plans (RRSPs), registered education savings plans (RESPs), registered retirement income funds (RRIFs), registered disability savings plans (RDSPs), and tax-free savings accounts (TFSAs). Only the following investments are considered qualified investments.
- Money and deposits
- Listed securities Public corporations
- Investment funds
- Debt obligations
- Warrants and options
- Foreign exchange trading
- Annuity contracts
- Gold and silver
- Small business investments
- Instalment receipts
- Escrow agreement
In order for Canadian taxpayers to invest in cryptocurrency investments through TFSA or RRSP, their cryptocurrency investments must fall under the list of qualified investments listed above.
Tax Characterization of Cryptocurrency.
Canada has yet to enact any tax legislation dealing expressly with Bitcoin or other cryptocurrency tokens. Likewise, Canadian courts have yet to decide upon a tax issue relating to cryptocurrency transactions.
On the other hand, CRA has expressed its view on cryptocurrency. The CRA views cryptocurrency as a commodity, which can be bartered for goods or services, or purchased and sold like securities. It is important to remember that CRA’s administrative guidelines are not the law. There have been articles from tax academics and tax practitioners arguing that cryptocurrencies should be considered a currency for taxation purposes. Nevertheless, since this issue has yet to be decided by legislation or the courts, Canadian taxpayers who choose to put their bitcoin investments into a TFSA or RRSP account run the risk of an expense tax audit and tax litigation process against the CRA.
Exchange Traded-Funds, TFSAs, and RRSPs
Exchange Traded-Funds are securities traded on a stock exchange the same way stocks are. ETFs are commonly held by Canadian TFSA or RRSP accountholders as they are considered qualified investments. Bitcoin ETFs should therefore be considered as qualified investments for TFSA and RRSP accounts.
Canadian taxpayers investing through a TFSA or a RRSP must ensure they stay compliant with the relevant rules to enjoy tax saving advantages and avoid costly penalties. The main tax traps for Canadian taxpayers are generating active income inside their TFSA or RRSP accounts, over contribute to their TFSA or RRSP accounts, contributing to their TFSA account as a non-resident, and withdrawing their RRSP account as a non-resident.
Carrying out a Business inside a TFSA or RRSP
Investments in a TFSA or a RRSP account must be passive rather than an active business. Canadian taxpayers who carry out a trading business inside a TFSA or RRSP will have their income taxed at the normal rate for business incomes. Whether a taxpayer has been carrying out active business inside a TFSA or a RRSP is determined by looking at whether the income generated inside that TSFA or RRSP is capital gains or income. The determination of income vs capital gains is a very complex issue and is discussed in depth here: [https://taxpage.com/articles-and-tips/a-canadian-tax-lawyers-introduction-to-business-income-vs-capital-gains/]
Contribution Limits of TFSA and RRSP
Both the TFSA and RRSP have contribution room which are the maximum amount a taxpayer can contribute to a TFSA or RRSP account without incurring penalties. Over-contributing above the limit can result in a penalty of 1% of the over-contributed amount per month.
Non-Resident Contributions to TFSA and Non-Resident Withdrawals of RRSP
A non-resident who contributes to his or her TFSA account while outside of Canada will incur a penalty of 1% of the amount contributed as a non-resident until that amount is withdrawn. A non-resident who withdraws from his or her RRSP account while outside Canada will incur a 25% withholding tax.
It is important to keep in mind residence for tax purposes is separate from one’s immigration or citizenship residence status. There is a body of case law on tax residence that takes a holistic approach, which can lead to considerable vagueness for individual taxpayers. Consult our experience Toronto tax lawyers if you have questions about your tax residence.
Pro Tax Tips- Be Aware of TFSA and RRSP rules
TFSA and RRSP can be powerful tax planning tools when used in combination with Bitcoins. It is important for Canadian cryptocurrency investors to keep in mind the passive investment rules, contribution limit rules, and rules concerning non-residents when it comes to investing Bitcoin ETFs in a TFSA or a RRSP account.
If you have questions about tax planning surrounding your cryptocurrency investments, or if you are being audited by the CRA, please contact our tax law office for tax guidance from one of our top Canadian tax lawyers.
"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."
Frequently Asked Questions
Yes, each transaction involving cryptocurrency will be considered a taxable event even if no cash has been realized through the transaction. This includes coin-to-coin transactions as well as receiving cryptocurrency tokens for services you rendered.
Frequency is only one of the factors when determining active income vs passive capital gains. Here is a partial list of the factors:
- Trading volume and holding period: a high volume of transactions combined with relatively short holding periods is an indication of business income;
- Special knowledge of securities: a TFSA holder with specialized knowledge of trading securities on the market or special knowledge of the shares being traded is an indication of business income;
- Financing or margin trading: buying shares on margin or trading on highly leveraged accounts are an indication of business income;
- Investment of time: a significant amount of time spent on researching and trading securities is an indication of business income;
- Nature of the shares being traded: in some cases, the more speculative a share is (eg. penny stocks or options vs. blue chip securities), the more it indicates business income;
- Intention at the time of purchase: although less relevant in a TFSA, the courts will still consider what the intentions were of the TFSA holder when purchasing shares.
It’s best to consult an experienced Canadian tax lawyer if you have questions related to active income vs passive capital gains.