Published: February 21, 2023
Last Updated: February 21, 2023
The increasing scrutiny of cryptocurrency tax returns by the Canada Revenue Agency (CRA)
Many tax agencies and regulatory bodies around the world have increasingly focused on cryptocurrency traders for the past several years, including in particular the IRS and the CRA. One challenge a tax agency often faces is the anonymous nature of the cryptocurrency transactions, which makes it difficult to identify the taxpayers for a Canadian crypto tax audit.
IRS filed a generic request known as the “John Doe” summons on all of Coinbase’s US users who transferred bitcoins between 2013 to 2015. Unsurprisingly, in March 2021, the Federal Court of Canada issued an order allowing the CRA to require Coinsquare Ltd., which is Canada’s largest cryptocurrency exchange, to provide certain information related to cryptocurrency traders.
Despite Coinsquare’s initial effort to fight the order, Canadian crypto tax lawyer acting for Coinsquare eventually reached an agreement with the CRA to turn over certain user information dating back to 2014. With such information and the shared taxpayers’ information from the IRS, the CRA will certainly uncover some taxpayers who failed to disclose their cryptocurrency transactions, which will lead to more CRA tax audits.
Over the past few years, cryptocurrency traders have been under increased scrutiny from numerous tax agencies and regulatory bodies around the world, in particular the IRS and the CRA. The anonymous nature of cryptocurrency transactions presents one difficulty a tax agency frequently encounters, making it difficult to identify the taxpayers for a tax audit. IRS issued a general summons known as the “John Doe” request in 2016 to each US user of Coinbase who exchanged bitcoins between 2013 and 2015. Unsurprisingly, the Federal Court of Canada granted permission to the CRA in March 2021 to demand Coinsquare Ltd., the largest cryptocurrency exchange in Canada, to give specific information about cryptocurrency traders. Despite initially attempting to resist the request, Coinsquare eventually came to an agreement with the CRA to turn over specific user information dating back to 2014. With this data and the shared taxpayer information from the IRS, the CRA will undoubtedly find some taxpayers who failed to disclose their cryptocurrency transactions, which will result in more tax audits.
The CRA cryptocurrency tax audit commonly asked questions
Taxpayers have been receiving 13-page questionnaires with 54 questions from the CRA regarding their crypto tax audits. Typically, these inquiries relate to investments, mining history, assets, wallets, and other relevant subjects. Here are a few examples of questions from the CRA’s audit questionnaire:
- How did you start engaging in the cryptocurrency industry, and when did you start?
- Do you mine cryptocurrencies or engage in investments in cryptocurrencies? Are you participating in the space in any other capacity, such as an advisor, educator, provider of cryptocurrency ATM services, vendor of hash power, operator of an exchange, participant in a mining pool, or in any other venture pertaining to the space, in addition to these?
- Do you utilize any cryptocurrency mixers or tumblers? Which services do you use, if so? Would you kindly submit us the tracing history and all of the cryptocurrency addresses you “mixed” with? Why do you use these services?
- Do you utilize changelly or shapeshift exchange? If so, please provide us with the cryptocurrency addresses you used to trade with as well as the dates you completed these “swap” exchanges.
- Can you tell us about every cryptocurrency you own? Please provide us with a chronology of when you converted from fiat to cryptocurrency.
The taxation of cryptocurrency gains
The way in which gains from cryptocurrency-related activities like mining or trading are taxed depends on the specifics of the case and the circumstances of the individual.
Gains from cryptocurrency trading for individuals may be taxed as either business income or capital gains. The character is mostly determined by the intention at the time, which is mirrored by additional elements listed in Happy Valley Farms:
- the transactions’ frequency;
- the holdings’ time frame;
- the intent to acquire the securities with the intention of making a profit;
- the securities’ kind and amount; and
- how long the activity took.
When it comes to cryptocurrency mining, there are two basic ways to categorize the activity: as a business or as a personal hobby. According to case law, an activity must be conducted in line with objective criteria of businesslike behaviour and the taxpayer’s primary goal must be to generate a profit in order for it to qualify as a business. The activity is a hobby, not a business, if the personal aspects of the activity outweigh the degree to which the taxpayer carried out the activity in a commercial manner.
Tax Pro Tips – How to get ready for a tax audit on cryptocurrencies
A crypto investor or trader should keep records when you purchase, dispose, or mine cryptocurrency to ensure you have accurate information about your activities. A taxpayer who does not keep proper financial cryptocurrency records will be at the CRA’s mercy during a cryptocurrency tax audit. Therefore, a taxpayer should generally maintain the following cryptocurrency transaction records but not limited to:
To guarantee you have accurate information about your operations, a trader or investor in cryptocurrencies should keep records whenever they buy, sell, or mine cryptocurrency. During a CRA cryptocurrency tax audit, a taxpayer who does not maintain accurate financial cryptocurrency records will be at the CRA’s mercy. As a result, a taxpayer should normally keep the following cryptocurrency transaction records, but not only these:
- the transaction’s date
- the addresses of cryptocurrencies
- transaction’s ID
- receipts for cryptocurrency purchases or transfers
- after you completed the transaction, the cryptocurrency’s value in Canadian dollars
- the transaction’s details and the other party’s information (such as their cryptocurrency address)
- exchange documents
- wallet history
- legal and accounting costs
- the cost of the software you need to manage your taxes
The following records should also be kept if you mine cryptocurrencies:
- receipts for the hardware you bought to mine cryptocurrencies
- receipts to prove your out-of-pocket costs for the mining operation
- mining pool contracts, and records of any additional mining activities
- the mining pool agreements and documents
- any further documentation on mining activities
- the disposal of the cryptocurrency obtained through mining activities
A taxpayer is not compelled to respond to every query posed by a CRA crypto tax auditor, though. The Federal Court of Appeal affirmed in MNR v. Cameco Corporation, 2019 FCA 67 that the CRA lacked the authority to compel a taxpayer to provide information during the tax audit stage. However, a taxpayer should be aware that the CRA may reach an unfavourable conclusion and suggest additional fines if he or she decides not to provide information during a CRA cryptocurrency audit. It is never advisable for a taxpayer to deal with the CRA directly, and it is strongly advised that they hire a knowledgeable Canadian crypto tax lawyer to help them prepare their answers to the CRA’s cryptocurrency tax audit questionnaires and communicate with the agency. If a Canadian tax lawyer is needed, they can extend the solicitor-client privilege and hire an accountant on the taxpayer’s behalf if one is needed.
Does a taxpayer have to respond to every question raised by a crypto tax auditor?
Taxpayers cannot be forced to provide information during the crypto tax audit stage by the CRA. However, the CRA may make an unfavourable conclusion and suggest additional fines if a taxpayer refuses to respond to certain tax audit inquiries. Therefore, keeping accurate financial records and hiring a knowledgeable Canadian cryptocurrency tax lawyer to help you with the process are the best ways to get ready for a cryptocurrency tax audit.
What exactly is a voluntary disclosure program? What would it mean for a taxpayer?
A voluntary disclosure application is intended to allow taxpayers who failed to disclose their income or made mistakes on past tax returns to come clean and correct their errors. To be eligible for the voluntary disclosure program, a taxpayer must meet five prerequisites. If accepted, the taxpayer may be excused from penalties and obtain partial interest relief under specific conditions.
An audit of my crypto tax filings is currently underway. What outcomes are possible?
A crypto tax audit can result in an assessment or reassessment that includes higher tax amounts. If the CRA thinks someone submitted a false statement or omitted information from a return intentionally or under conditions that would constitute gross negligence, they will nearly always levy a gross negligence penalty with a 50% increase in tax. A criminal inquiry may be opened by the CRA if it believes a taxpayer has engaged in tax evasion by fabricating documents and claims or deliberately not reporting income. This investigation may result in a criminal tax prosecution with jail as a possible outcome in addition to the inevitable tax evasion penalties.
“This article just offers general information. It is only up to date as of the publication date. It hasn’t been updated, thus it might not be applicable anymore. It does not provide legal advice, hence it cannot or should not be relied upon. Every tax situation is different from the cases discussed in the articles since it is specific to its facts. If you have specific legal questions, you should get in touch with a lawyer.”
"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."