By Fabio Campanella CPA, CA, CFP, CIM
June 17, 2021
The last decade has seen a massive advancement in the acceptance and interest in the cryptocurrency sector. Bitcoin, the original and most popular cryptocurrency currently has an estimated circulation of 18.68 million coins with a current market value of approximately $47,000 CAD per coin. From this, one can infer a total market value of circulating Bitcoin of somewhere between $800-900 Billion CAD. This is a massive number. To put that into context, the current market capitalization of the Royal Bank of Canada is approximately $181 Billion CAD, so Bitcoin is no joke.
Naturally, when a new investment becomes so popular, especially when that investment represents a new asset class and technology, the application of tax laws to transactions related to that investment can become confusing. Bitcoin and cryptocurrency are no exception. There is very little precedent upon which to base your tax reporting and planning decision. Further, there are very few written laws that directly address the assets and their related transactions.
The purpose of this article is to address this confusion, and establish the current application of Canadian tax laws and CRA interpretation to the most common cryptocurrency transactions including:
- Mining of new cryptocurrency
- Using cryptocurrency in purchase and sale transactions
- Buying and selling cryptocurrency from a speculative standpoint
Throughout this article I will primarily address the processes and applications as they relate to Bitcoin as this is currently the most popular and widely used cryptocurrency.
Background: Business Income or Capital Gain:
Before we get into the details let’s take a look at the possible ways any investment transaction in Bitcoin can be taxed in Canada: either as business income or capital gain. When determining how your Bitcoin transactions are to be taxed you must first establish the nature of transaction and classify the transaction as either business income (loss) or capital gain (loss).
Current tax legislation dictates that business gains and losses are fully taxable at the taxpayer’s marginal rate whereas capitals gains and losses are taxable at ½ that rate. Clearly, most taxpayers wish to pay tax at ½ their marginal rate so the capital gains treatment is much more popular among investors.
As per the CRA’s current guidance (CLICK HERE)…
The following are common signs that you may be carrying on a business:
• you carry on activity for commercial reasons and in a commercially viable way
• you undertake activities in a businesslike manner, which might include preparing a business plan and acquiring capital assets or inventory
• you promote a product or service
• you show that you intend to make a profit, even if you are unlikely to do so in the short term
Business activities generally require some sort of activity that is regular, repetitive, or consistent over time. This is in contrast to something more passive whereby the investor simply buys an asset and holds it over time without frequent involvement.
For example, if you were to purchase 100 shares of TD Bank in a taxable brokerage account, collect and reinvest the dividend, hold the stock for 10 years, then finally sell the stock for a gain, it would be reasonable to report that gain as a capital gain.
However, if you were to buy 100 shares of TD Bank, actively monitor the price of the stock, sell when you believe the stock is high, repurchase when it is low, and actively trade the stock on a daily basis consistently over time, it may be reasonable to report the gains as business income which would be subject to full taxation at your marginal tax rate due to the frequent nature of your trades and the amount of effort put into the transactions.
Mining New Cryptocurrency:
In this discussion we are assuming that anyone mining Bitcoin is doing so for financial gain as opposed to a “hobby”.
When cryptocurrencies such as Bitcoin are created, we refer to that process as a “mining” transaction. Bitcoin mining is a process by which new Bitcoins are created and entered into circulation. It is performed by using complex mathematical problems and having a chain of computers solve these problems. Bitcoin uses blockchain technology to verify the legitimacy of Bitcoin transactions.
Individuals and organizations around the world setup sophisticated computers, which are all connected to each other. These computers are tasked with verifying existing Bitcoin transactions by solving complex mathematical computations. When computations are verified, the owners of those computers are rewarded with new Bitcoins and are also paid a fee in Bitcoin. The number of new Bitcoins that can be mined at any give time are strictly limited.
The actual process is much more complicated than this and is well beyond the scope of this article. From our standpoint what we need to concentrate on is the taxation of Bitcoin or cryptocurrency at the reward level. When a Canadian taxpayer takes part in Bitcoin mining and they receive new Bitcoin as a reward they have essentially been paid for providing a service with an asset that has a financial value.
Because the nature of Bitcoin mining is active and resembles a business activity the CRA generally classifies these sorts of transactions as business income rather than capital gain. Therefore, you must claim the Bitcoin you received as business income at the CAD equivalent when received.
Using cryptocurrency in purchase and sale transactions:
Although not common, it is entirely possible to accept Bitcoin as payment for goods and services. Such transactions are considered to be barter transactions by the CRA. A barter transaction occurs when two parties exchange goods or services without using FIAT or legal currency. When barter transactions occur between two individuals or organizations that deal at arm’s length it is a fundamental principle that these persons consider that the value of what is being received is equal to whatever is given up.
For example: Individual A sells a widget to individual B and accepts 1 Bitcoin in exchange for the widget.
In the simple transaction above, if the parties are transacting at arm’s length, it can be assumed that individual B accepts that the purchased widget is worth the value of 1 Bitcoin (presently valued at approximately $48,000 CAD) and individual A is fine with receiving that 1 Bitcoin as compensation for the widget.
Therefore, individual A should report the sale of their widget and take into income the CAD equivalent of 1 Bitcoin, or $48,000. If individual A is a GST/HST registrant and the sale of widgets is considered to be a taxable supply then GST/HST would be applicable to the transaction regardless of the form of payment. Subsequent to that transaction, individual A may convert the 1 Bitcoin received into CAD which would be considered a secondary transaction that may lead to a gain or loss on conversion. Such conversions are covered in the next section.
Buying and selling cryptocurrency from a speculative standpoint:
Personal tax liability is incurred when cryptocurrency is sold and realized as fiat currency or exchanged for another cryptocurrency. As discussed above, this tax liability is either on account of business income or capital gain. If the trading activity and volume of trades are very frequent, CRA will likely view the gains as business income as opposed to capital gains. In such a case, when Bitcoin or any other cryptocurrency is sold for fiat currency or another cryptocurrency, the profit over the cost base in which it was purchased will be reported as a business income for tax purposes. If assets are purchased for long term hold, the gains would be reported as capital gains.
The CRA has provided some guidance with respect to crypto-to-crypto exchanges and generally treats such exchanges as barter transactions (as described above). This means that exchanging one crypto for another is considered a taxable event and should be treated as a barter transaction that may result in income to the seller. But what type of income? Business or Capital Gain? The CRA provides some guidance and defers to their guidance around securities trading pursuant to IT-479R, Transactions in securities.
When transacting in securities, or in this case crypto currencies, the “intention at the time you acquired the securities” is of utmost importance. The CRA will follow the logic below to determine what your original intentions are:
a) Frequency of transactions:
• Displaying a history of extensive buying and selling of securities or of a quick turnover of properties would be more indicative of a business transaction than a capital transaction
• The CRA would look to the volume of crypto trades in a given taxation year to determine whether there were “quick flips” in positions and consistent short-term trades for profit
• The more frequent the trades the more the CRA will lean toward business income treatment
b) Period of ownership:
• How long are you holding onto your positions?
• Securities or cryptocurrency held for very short periods of time support a business income treatment more than positions held for the long-haul
c) Knowledge of the securities markets:
• The more knowledge and expertise you have in the securities or crypto sector the more the CRA will lean toward business income
d) Security transactions form a part of a taxpayer’s ordinary business:
• If securities transactions form a normal part of your primary business, or in this case crypto transactions, then the CRA is likely to lean more to business income rather than capital.
e) Time spent:
• If a substantial amount of time is spent studying the market and trading in the market then the CRA will lean more to business income.
• Is the investor trading with their own money or are they using a margin account or other forms of financing? Financing your crypto transactions leads more to business treatment.
• Is the taxpayer advertising or otherwise making it known that he or she is willing to purchase securities or cryptocurrencies? If that is the case the CRA leans more to business income.
h) In the case of shares, their nature:
• normally speculative in nature or of a non-dividend type.
None of the items above are a “silver bullet” that will 100% determine the nature of your crypto gains and losses, however, taken together on a case-by-case basis, they do provide taxpayers and auditors with guidance on how your crypto transactions should be reported.
Take the following examples:
Ms. X buys and sells Bitcoin on a daily basis. She studies the market and pays close attention to trade volume on a daily basis and is able to consistently generate positive returns on investment. She posts regularly on social media her thoughts on the Bitcoin market and also works as a licensed investment advisor who regularly trades Bitcoin and other securities and commodities on behalf of her clients. She trades using money borrowed on a home equity line of credit and rarely holds her positions for longer than 1 or two days. In such a case it would be reasonable to report her gains as business income.
Mr. Y bought 1 Bitcoin in 2019 at $12,000. He held onto the investment and did not pay much attention to the market, never making another trade. In 2021 he lost his job as a factory worker and ran into some financial difficulty. He noticed that Bitcoin was selling at $48,000 and decided to sell his 1 coin earning himself a $36,000 profit. Mr. Y had never invested in anything else in his life, used his own personal savings to make the original purchase, does not use social media, and spent no time at all researching his investment. In such a case it would be reasonable to report his gains as capital gains.
While the examples above are extreme, they do outline some simple case facts and how the CRA may approach a case when making their determination. It is important that individuals consult with their own tax advisors when making a reporting decision.
Cryptocurrency is a relatively new asset class and as such the taxation of cryptocurrency is somewhat confusing and not exact. Individuals who do decide to mine, transact in, or trade cryptocurrencies should familiarize themselves with the basic tax concepts that can have an effect on their individual reporting requirements. Consulting with qualified professionals is highly recommended.
Fabio Campanella CPA, CA, CFP, CIM, is a founding partner of Campanella McDonald LLP. He is a tax specialist, an investment advisor, and an estate and life insurance advisor licensed in the Province of Ontario. His practice focuses on building tax-efficient retirement and estate plans for entrepreneurs, retirees, and high-income earning professionals. You can access his website by clicking HERE.