Cryptocurrency and the Canadian Tax Landscape: A Legal Perspective
While there is no federal or provincial legislation explicitly addressing blockchains or cryptocurrencies, the question is not if Canadian laws apply, but rather which laws apply.
At MLG Blockchain, we want to push this conversation forward by providing research on the emerging legal issues in the Canadian blockchain space. We will be hosting the Blockchain Law and Open Source Software event on June 12th, 2018, in Vancouver, B.C., to bring together leading technology lawyers, financial professionals, FinTech journalists and anyone curious about the legal framework in our industry.
Until then, here is a shallow dive into Canadian tax law and how it relates to digital assets, produced by our regulatory consultant and researcher, Thierry Bahuch.
In the context of tax law, the Income Tax Act — which does not expressly address cryptocurrencies — applies to income earned from a sale of blockchain tokens, as it pertains to “any income unless expressly exempt” (s. 81 ITA). But which category characterization of income do proceeds from sales of cryptocurrencies fall under? Business income, employment income, or capital gains? Once we know this, then we can apply the relevant provision of the act. To be clear, blockchain technologies are not exempt from the law unless the legislation expressly states an exemption exists, or unless it is obvious that the law is irrelevant. Otherwise, any potentially relevant legislative instrument can and will apply to blockchain technologies.
Exploring Canadian Tax Law and Cryptocurrency
The Canada Revenue Agency (CRA) has declared that cryptocurrencies are taxable as commodities and not as currencies. This is to say that transactions involving cryptocurrencies will be treated as if they are barter transactions. A barter transaction is a transaction for a good or service in exchange for some good or service other than money. The governing regulation for barter transactions is Canada Revenue Agency’s “Interpretation Bulletin IT-490, Barter Transactions.”
In 2014, the CRA wrote that the bulletin “provides that in the case of goods bartered by a taxpayer for other goods and services, the value of those goods must be brought into the taxpayer’s income if they are business-related. As such, an exchange of one type of virtual currency for the other in such circumstances would trigger a disposition for income tax purposes.”
This means that even if no fiat money was received, a taxpayer must report a barter transaction to the CRA for the monetary value of the good or service received.
On their website, the CRA maintains that “goods purchased using digital currency must be included in the seller’s income for tax purposes. GST/HST also applied on the fair market value of any goods or services you buy using digital currency.” It is also crucial to note that the CRA has affirmed that barter transactions can allow for acquisition of capital property for the purposes of Part C of the Income Tax Act. This is significant, and will be explained below.
The Income Tax Act [ITA] is a federal act, and it applies to every province and every person who was either a resident in Canada, or was employed in, operated a business in, or disposed of taxable property in Canada during the tax year.
One of the main issues facing Canadians will be the characterization of the income earned from the sales of cryptocurrencies, as three types of income characterization exist and each are taxed differently.
The three characterizations of income are: 1) income earned from capital gains pursuant to part C of the ITA, or 2) income earned from a business or self-employment pursuant to part B of the ITA, or 3) income earned from employment pursuant to part A of the ITA. How we characterize a taxable cryptocurrency depends on how it was acquired. Sources for acquisitions are varied, and examples include: crypto-mining, ICO buy-ins, secondary market exchanges, employment compensation, self-distribution tokens, or distribution as a gift.
Profits on the sales of cryptocurrencies would presumably be preferably characterized as capital gains, because only half of the profit of capital gains is taxable (s.38(a) ITA), and that taxable half will only be taxed at the applicable tax rate. However, the CRA stated in What You Should Know About Digital Currency that “where an employee receives digital currency as a payment for salary or wages, the amount (computed in Canadian Dollars) will be included in the employee’s incomes pursuant to subsection 5(1) of the Income Tax Act.”
This likely means that such income will not be treated as capital gains even if it increased in value. This is because s.5(1) of the ITA falls under employment income. At the very least, this statement likely means that the value of the payment, or cryptocurrency paycheque, will not be considered capital gains. Nevertheless, any additional profit earned from an increase in the value of the initial payment may still be considered capital gains.
Let’s make this clear with an example: Assume your employer pays your salary or hourly wage in the form of bitcoin, which at the time of payment is equal to $5,000 USD. Once exchanged to fiat currency, that amount of bitcoin will likely be taxed as employment income. However, if that $5,000 becomes $15,000 because you retained the payment as bitcoin, then the additional $10,000 worth of bitcoin has a strong possibility of being characterized as a capital gain. Nevertheless, whether the additional value is characterized as bitcoin depends on the facts, intentions and ultimately the opinion of the relevant decision maker at hand.
According the CRA, whether profits from the sales of blockchain tokens is categorized as capital gains is based on a discussion of factors that are listed in IT-479R. Specifically, the CRA stated that “Digital Currency can also be bought or sold like a commodity. Any resulting gains or losses should be taxable income or capital for the taxpayer. Paragraphs 9 to 32 of Interpretation Bulletin IT-479R Transactions in Securities provide information that can help in determining whether transactions are income or capital in nature.”
In paragraph 10 of that bulletin, the CRA states that “where the whole course of conduct indicates that (a) in security transactions the taxpayer is disposing of securities in a way capable of producing gains and with that object in view, and (b) the transactions are of the same kind and carried on the same way as those of a trader or dealer in securities, then proceeds of sale will normally be considered to be income from a business and, therefore, an income account.”
This means that if the first two conditions, (a) and (b), are met, the income will likely not be considered capital gains and hence not subject to the tax benefits in s.38 of the ITA. The remainder of the bulletin describes factors informing that test and points to Interpretation Bulletin IT-114 Discounts, Premiums and Bonuses on Debt Obligations, which provides further factors for determining the characterization.
It is also important to note that “personal” and “commercial” cryptocurrency activities have different tax consequences, relating to both income tax and GST-HST issues. A number of court cases have considered how activities undertaken for profit are distinguishable from personal endeavours. A personal endeavour, in this context, is an activity primarily undertaken for pleasure, entertainment, or enjoyment, rather than for profit, business or commercial purposes.
In Stewart v. The Queen, 2002 SCC 46, the Supreme Court of Canada stated that “in order for an activity to be classified as commercial in nature, the taxpayer must have the subjective intention to profit and there must be evidence of businesslike behaviour which supports that intention.” This is important, because the court in this case held that if profits are earned from a personal endeavour, and are not commercial in nature, then they will not be taxed as income. This presents a serious advantage to those who can prove their profits are not commercial. However, this is a difficult characterization, since it is intuitively difficult to prove that earning profits is not part of the intention of the recipient of those profits.
If you’re interested in the developing legal environment surrounding blockchains and cryptocurrencies, join us as we host legal professionals in Vancouver, B.C, for the Blockchain Law and Open Source Software Panel on July 12th.
About the Author:
Thierry Bahuch is completing his final year of law school in British Columbia, Canada. He works for MLG Blockchain Consulting as a regulatory consultant, researcher and event coordinator. Thierry has been studying the legal aspects of blockchain use-cases and distributed ledger technologies since late 2016 and has been a cryptocurrencies enthusiast since 2014.
The above information is general information only and is not legal advice and should not be construed as legal advice. Given the quickly changing nature of laws, rules and regulations, there may be delays, omissions or inaccuracies in information contained in this information. While we have done our best to ensure the accuracy of this information, we do not guarantee that the information will be free from errors or omissions. Accordingly, it should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisers. Before making any decision or taking any action based on the following information, please consult a professional with the specific facts that are of interest to you in order to ensure you get proper consultation and legal advice. You should never delay in pursuing or disregarding legal advice because of the information contained in this document