Written By: Candy M. Davis, CPA, CGA
This article is an amendment to one released in 2018, as more information, rulings, and interpretations have subsequently been released by Canada Revenue Agency.
I personally became involved in the mining of Bitcoins and other altcoins around 2012. I have used these digital currencies both as a form of investment and to purchase goods/services. In addition, I have traded cryptocurrencies through online brokerages since 2013 when they began to rise in popularity.
At the beginning of 2018, I submitted a technical interpretation request to CRA looking for more specific guidance for the treatment of cryptocurrencies. In June, I received a short reply pointing to two documents previously released in 2013 and 2014. Following the written reply, I had a telephone meeting with the Canada Revenue Agency to discuss the matter further. It was in this meeting that I was able to confirm their opinions and requirements for tax reporting of certain cryptocurrency transactions. Some of these opinions from CRA have changed slightly over the years, such as the treatment of mined virtual currencies for tax purposes, but generally the original guidance has been consistent (and sparse!) since our discussions in 2018. As we have experienced a few years of general uncertainty as tax practitioners, I'm happy to share some guidance based on the information I have received from the Canada Revenue Agency and other related sources.
Note that this updated article is written December 15, 2021- given how quickly technology and the use of digital currencies has been evolving, there is a good chance that new rules or legislation will be introduced shortly. Therefore, this guidance may not necessarily be applicable at a future date.
The tax treatment of digital currencies differs depending both on how they are acquired and how they are used. The two main ways to acquire digital currencies are by purchasing them or by mining them using specialized computer software. We will not go into the specifics of how mining works in this article but if you would like more information there's a fantastic interview you can refer to with Michael Maier PhD, CPA, CGA and Joseph Devaney CPA, CA of Video Tax News. Once these coins are acquired they can be used in multiple ways- most commonly as a form of investment or to buy goods and services. In this article, I will focus on the tax treatment of these different uses as well provide references to certain documents which you may find helpful as you encounter these situations in the future.
Note that the discussion to follow makes the assumption that transactions occur between arm’s length parties and reflect fair market value. The use of the terms “virtual currency” and “digital currency” can be considered interchangeable for the purposes of this article.
Acquisition of Digital Currencies
According to the Canada Revenue Agency, they consider cryptocurrencies to be a commodity, not a currency, for the purpose of the Income Tax Act. As such, their acquisition and use will follow the guidance set for Barter Transactions which involves the trade of one good or service for another good or service.
A purchase of digital currencies for cash is the most straightforward type of transaction for tax purposes. Assuming the coins are purchased from an arm's length third party, it is likely that the amount paid for the virtual currency will reflect the fair market value of the coin at that time- thus the cost/adjusted cost base will be the amount of consideration paid.
Received as a form of payment for goods or services provided
Digital currencies are sometimes used to buy goods or services and these activities follow the rules for barter transactions. When a coin is exchanged for a good or service in an arm's length transaction, it is assumed that the fair market value of the coin exchanged will be equivalent to the fair market value of the good or service received. If the coin does not have a published or easily attained market value, then CRA has indicated that the department will normally accept the value to be equivalent to cost of the good or service that was provided in exchange.
Received as a Gift
The receipt of digital currencies as a gift, like other tangible gifts, will have an adjusted cost base of nil since no consideration is given up acquiring the currency. However, their fair market value should be reflective of the fair market value at the time of transfer. This is the value that will be used to determine the eligible amount of a gift for tax purposes as well if donations of coins, such as Bitcoins, are given to a qualified donee. See 2013-0514701I7 for further clarification by CRA on this topic.
Received through Mining
The CRA has recently released the most comprehensive guidance to date on the treatment of cryptocurrencies. It is especially appreciated to finally have some concrete information regarding the taxation of mined virtual currencies. You can access the guide here (updated to June 26, 2021 as of the date of this article).
Mining, the use of specialized mining software to discover coins such as Bitcoins, is done by individuals (privately or as part of a larger mining pool) as well as on larger commercial scales. As the difficulty in mining Bitcoins has increased over the years, it is more and more common to see them mined in a commercial manner. Individuals, more often than not, are now mining other easier-to-attain coins.
Unofficially, at one point, CRA had indicated that the cost of mined coins would be deemed to be nil for tax purposes arguing that there were no real direct costs that would be linked to the creation or receipt of mined coins and no consideration has been given up for them. We have finally received a slight update in position by CRA, and guidance on the tax treatment of these mined coins. This has been the only real change to the guidance provided since 2013/2014. Further clarification can be found in T.I 2018-077666 which states,
“Generally, when a miner successfully creates a valid block, they will receive two types of payments. One payment represents the creation of new cryptocurrency on the network and the other payment represents the fees from transactions included in the newly validated block. Those who perform the mining processes are paid in the cryptocurrency that they are validating.
In our view, Bitcoin received by a miner to validate transactions is consideration for services rendered by the miner. Where a taxpayer is in the business of Bitcoin mining, the Bitcoin received must be included in the taxpayer’s income at the time it is earned under section 3 and section 9 of the Income Tax Act.”
In summary, the fair market value of the digital/virtual currency received from mining would be reported in income in the tax year it is received. This value would also become the cost or adjusted cost base for the calculation of future income or gains, to be discussed shortly.
Use of Digital Currencies and Related Tax Treatments
Buying Goods and Services
CRA has indicated in IT-490 that "the value of these goods or services must be brought into the taxpayer's income where they are the kind generally provided by him in the course of earning income from, or related to, a business or profession carried on by him."
Note that when cryptocurrencies are received as a form of payment, GST registrants will be required to calculate and remit the GST on the fair market value of the service or good sold. On the other end, ITC’s may also be claimed by registrants for the GST deemed paid by cryptocurrencies. See the discussion in 2013-0514701I7 for more information.
Trading one Digital Currency for Another
One of the more common issues now encountered by tax practitioners, is the common use of brokerages that enable online trading of several digital currencies. Often these coins can be bought and sold for other coins without being ever exchanged for cash. Unbeknownst to many avid traders, each time a coin is traded for another, there is a deemed disposition of the original coin- triggering a taxable event. This is true even if the coins are never converted to cash in the year or never leave the brokerage account. Even if the coins are similar in nature, they will be considered different individual properties. CRA has provided DOC 9515925, which deals with the exchange and partition of land, as a reference. In this letter, CRA states that “the exchange of one parcel for another would be considered a barter transaction which would give rise to a disposition and a possible capital gain”. Similarly, the exchange of one coin for another will also give rise to a disposition and a gain or loss.
After speaking with several tax practitioners, I’ve noticed that there have been some differing ideas of how CRA may choose to assess the sale of investments in cryptocurrencies (capital gain or regular income) in light of their previous statements that these are to be treated as commodities not currencies. Given the opposing definitions and tax treatments of commodities vs. capital properties in the Income Tax Act, this has caused some unease for accountants in tax planning and advising clients. In my 2018 telephone meeting with CRA, they confirmed that their assessments of whether or not investment and trading of digital currencies will be considered taxable of account of capital or on account of income will be based largely on paragraphs 9 through 13 of IT479R “Transactions in Securities”. which they have since confirmed in subsequent publishings. As such, the same consideration will be given for the trading of cryptocurrencies as for the assessment of other common securities- ie. Is an individual investing on a personal level (capital) or in a commercial manner (income).
Short-term personal investments/Day Trading: If the buying and selling of the digital coins meets the criteria for business transactions set out in IT479R, it will be fully taxable on account of income. Some of the criteria that are often considered for this classification include the frequency of trades, the knowledge and expertise of the individual regarding those activities and underlying securities, period of ownership.
Long-term investments: Assuming these long-term investments are considered personal in nature then the subsequent sale will be on account of capital.
In summary, digital currencies will be considered commodities for the purposes of buying and selling goods (barter transactions), however they may be treated like securities for the purpose of buying and selling them as investments. Further direction can be found in document 2013 -0514701I7.
Sale of Mined Digital Currencies
For tax purposes, the treatment will be different depending on whether the individual is considered to be mining the coins personally as a "hobby" or in a commercial manner. In the T.I. 2014-052519, CRA provided some guidance in determining whether or not these mining activities would be considered a personal or business endeavor- pointing to Stuart versus the Queen, 2002 SCC 46, in which, " 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 business like behavior which supports that intention”. Personal activities, conversely, are those that are undertaken not for profit, but for pleasure and entertainment. As is often the case, there will be many circumstance-specific facts to consider when assessing if activities are undertaken as a business or not. It is the opinion of this author that mining would rarely be considered a “hobby” are and likely, in most situations, taxable undertakings.
When a coin that has been mined is later sold on account of capital (capital gain), the ability to deduct mining costs is lost. However, costs incurred to sell the coins, such as brokerage fees, would likely be deductible.
Conversely, if the mining process is considered done commercially, any profit will be fully taxable on account of income. In this case there will be several costs that can be expensed against the income earned from sale of the digital currencies (otherwise unavailable in the case of non-business-related mining). These will include cost such as warehouse rental space, amortization for computer hardware and software and related equipment, utilities, and other business expenses. Note that the digital currencies will be held as inventory and must be valued in accordance with the standards set out in interpretation bulletin IT-473R "Inventory Valuation". This bulletin specifies that this inventory may be valued at the lower of cost or fair market value at the end of the year, or at its fair market value at the end of the year. These regulations are set out in section 10 of the ITA and part XVIII of the Income Tax Regulations.
Cryptocurrencies are fast gaining popularity and acceptance around the world and are more than likely going to change our financial landscape. And while Canada’s tax laws have been slow to issue concrete guidance on the subject, there is enough precedence and relatable tax laws in effect to begin to help steer our clients in the right direction. While some of our firms may deal with more complex cryptocurrency scenarios, this is a great start for tax accountants, lawyers, and their clients to gain a general understanding of the rules as they currently sit. With any luck, we will have better direction from Finance and CRA in the near future.
Foreign Income Reporting?
Consider where you or your clients are earning their income and holding their cryptocurrencies. Are they purchased and held in brokerages in other countries? You may need to file the T1135 Foreign Income Verification Statement