Pandemic brought an extra spice to financial markets!
The financial markets climbed to a record high and still climbing, due to too much money in the economy. Like many other stocks, cryptocurrencies saw an uptick in investments, mostly by novel investors. Extremely low interest rates and increased stimulus from the government contributed to the influx of many new Canadian traders! Cryptocurrencies keep on attracting the interest of these young investors, many of them betting their savings or even government benefits payments on cryptocurrencies such as Bitcoin.
There are a lot of misconceptions and misinformation surrounding cryptocurrencies when it comes to income tax implications!
Such as, You don’t have to pay taxes if you deal in cryptocurrencies?
The above statement is absolutely incorrect. Though there is secrecy around the buyers and sellers of cryptocurrencies, it does not mean that you do not owe any taxes because of that.
Let’s be clear, the taxman is coming after this sooner than expected.
Disclaimer: This post explores different income tax implications attached to cryptocurrencies in Canada. Every taxpayer has its own unique tax situation so readers must exercise extreme caution while using any information provided in this article. It’s always best to consult your professional income tax preparer specializing in cryptocurrencies. Further, this post cannot be considered as any sort of investment, financial, business, or tax advice.
If you are new to cryptocurrencies and reading this post, we recommend you to read our easy-to-understand guide to Cryptocurrencies to understand much of the terminology used below.
Though cryptocurrencies, such as Bitcoin, are not legal tender, they are increasingly becoming the mainstream medium of exchange. There are many ways where you can expose yourself to the income tax implication of cryptocurrencies.
We are going to look into different transactions involved with cryptocurrencies:
- Buying cryptocurrencies
- Selling cryptocurrencies
- Exchanging cryptocurrencies
- Earning cryptocurrencies through mining
- Buying or selling goods using Cryptocurrencies
Based on the type of transaction cryptocurrencies are involved in, tax treatments vary.
Income tax rules applicable to cryptocurrencies in Canada
The Canada Revenue Agency treats cryptocurrencies as a commodity.
Any income from the transactions is treated as a Capital gain or a business income.
Three broad sets of income tax rules are applicable on transactions related to cryptocurrencies:
- Rules related to Business Income
- Rules related to Capital Gains
- Rules related to Barter transactions
Cryptocurrencies as Business Income
Business income is an earned income and allows netting off against business losses from other earned income. Sometimes taxpayers tend to declare their dealings in cryptocurrencies as business income simply to offset the loss from crypto business against either employment income or other business profits.
Whether a taxpayer’s transactions in cryptocurrencies can be classified as a business income or Capital gain depends on many factors. Whether a taxpayer is carrying out a business or not comes down to five key facts. There is no test provided by the income tax act to determine if the income is business income or capital gain. However, the courts have determined over the period of time what can be classified as business income.
Read: Business income vs capital gains
As far as cryptocurrency transactions are concerned, earning cryptocurrencies through mining is always considered a business income. Then there is an issue related to the hobby vs business income. For example, a computer-savvy taxpayer cannot mine bitcoins and offset the losses (by charging all expenses) against the employment income!
If you do mining yourself or hire (or contract) someone else, this is still business income. In case if someone else is doing it for you, you can deduct it as sub-contract expenses.
If you studied cryptocurrencies, bought the equipment, and now dealing in it on a frequent basis with an expectation of profit, you are most likely running a business. Sometimes, even one-time activity is an adventure or concern in the nature of trade.
Like any business, the taxpayers can claim certain allowable deductions against the gross business income to arrive at net business income. Some of these interesting deductions include home-office expenses and capital cost allowance. If there is a loss it can be offset against any other form of earned income and if not then it can be carried forward for 20 years or carried back for 3 years.
When there is an income from this business, bear in mind, you need to pay 2X of CPP (up to a certain threshold) and include full net business income to your taxable income.
For more details on Bitcoin miners and income taxes in Canada, please follow the link.
Cryptocurrencies as Capital gains
Only half of the capital gains are included in the taxpayer’s taxable income from the year. Any capital losses can offset capital gain from other sources. A taxpayer can generally carry back capital loss for three years and carry forward indefinitely.
CRA’s Interpretation Bulletin IT-479R provides information on treating securities transactions as Capital gain or business income. If you hold cryptocurrencies as capital property, the resulting gain or loss is Capital gain or loss.
Oftentimes, taxpayers are motivated to include all crypto transactions income as Capital gain so that only half of it is included in taxable income. This is important to determine if your crypto assets are capital property or you risk running a business!
Capital gains vs business income are some of the highly litigated areas in tax court so it’s best to seek professional tax advice.
Cryptocurrency exchange transactions
If you exchange one cryptocurrency with another one, a taxable event occurs!
If you purchase a good or service with your cryptocurrency, a taxable event occurs!
In such cases, rules related to barter transactions apply for the correct transaction treatment for income tax purposes. When one cryptocurrency is exchanged for another one, the sold currency is valued at its Fair market value and is considered disposed of. If the barter transaction happens while you are running a business of cryptocurrencies, the resulting gain or loss is business income or loss, otherwise Capital gain or loss.
If you pay for goods and services using bitcoin or any other cryptocurrency, a taxable event has occurred. The value of disposed off units of cryptocurrencies is higher of either the FMV of goods or services received or the FMV of cryptocurrency at the time of transaction.
This is important to understand how the valuation of inventory and capital properties work in order to determine the correct tax treatment of your income.
Bitcoin Crash: Sale and Buy Back
In case if there is a bitcoin crash and the taxpayer has sold all the units and then acquired back, you may want to look into rules related to superficial loss. If you held the cryptocurrencies as capital assets and incur superficial losses, you cannot deduct these losses in the year that occurred, instead, you will adjust the cost basis of these assets.
Read: Superficial losses at Canada Revenue Agency’s website
Voluntary disclosure program to correct past non-compliance or underreporting
The common myth that you can avoid the taxman by holding crypto assets is not valid anymore!
The compliance and intelligence on cryptocurrency transactions are getting stricter. Taxpayers are required to report their income or losses from crypto dealings on their tax returns. Internal Revenue Service and Canada Revenue Agency have pooled their resources to identify the taxpayers skipping the reporting on their income tax returns. The cooperation and exchange of information may cause more and more reviews and audits in the coming period.
If you skipped reporting income in the past years you still can utilize CRA’s Voluntary Disclosure Program (VDP) to correct your tax situation. If you recently filed a tax return that does not meet the past one-year-due condition of VDP, you can file an amended tax return.
Cryptocurrencies are continuously evolving. There is a high likelihood that we can see some sort of regulations, more CRA reviews, and audits in the coming days. Stay compliant, and if needed correct the past compliance.
If you have recently received a questionnaire consisting of multiple pages from the CRA asking for your dealing inc cryptocurrencies, get in touch with a professional income tax accountant.
Maroof HS CPA Professional Corporation is a Toronto-based Professional Accounting firm providing full-scale income tax services to individuals and corporations in Canada. Get in touch with us today!