Tax issues in cryptocurrency: an expert’s view

It is important for taxpayers to keep records of all cryptocurrency transactions as per CRA guidelines (Getty Images/hobo_018)

Since crypto investing and trading have become mainstream, the tax implications of cryptocurrency have become an increasingly important issue. At this stage, there are a number of areas where there is still some confusion around compliance with tax rules. We spoke to CPA John Oakey, national director of tax services at Baker Tilly Canada, about what we know—and don’t know—about the current tax implications of cryptocurrency.

CPA CANADA: What is the main challenge around cryptocurrency tax reporting right now?
JOHN OAKEY (JO): Due to the decentralized nature of cryptocurrencies, it is difficult for tax administrators to gather the necessary information to ensure compliance with tax rules—although both the IRS and CRA have been successful with court applications compelling cryptocurrency exchanges such as Coinsquare and Coinbase to provide details of customers' cryptocurrency transactions.

All countries are on board to try and find ways to deal with the situation, as cryptocurrency has shifted from being mainly an underground economy issue to a taxation issue. The Organisation for Economic Co-operation and Development has been working on cryptocurrency transparency reporting, setting forth a global tax transparency compliance framework with model rules for the automatic reporting and exchange of taxpayer information between countries relating to financial accounts and crypto-assets.

With more businesses and individuals buying and selling cryptocurrency either as an investment or for frequent trading, and with the global interest in cryptocurrency transparency reporting, the CRA and other tax administrators are looking into annual reporting requirements for cryptocurrency exchanges to enhance third-party tax reporting. The big challenge will be convincing taxpayers to self-report their cryptocurrency transactions, because anonymity won’t last forever.

John Oakey, CPA, national director of tax services at Baker Tilly Canada (Image provided)

CPA CANADA: What is the CRA’s current position on cryptocurrency?
JO: In its Guide for cryptocurrency users and tax professionals, the CRA states that cryptocurrency is a digital representation of value that is not legal tender, but can operate as a medium of exchange, which generally operates independently of a central bank, central authority or government. The CRA generally treats cryptocurrency like a commodity for purposes of the Income Tax Act, with taxable transactions resulting in business income or capital gains treatment, depending on the circumstances.

When cryptocurrency is used to pay for goods or services (including exchange for other cryptocurrency), the CRA treats it as a barter transaction for income tax purposes. In the guide, CRA states that “a barter transaction occurs when two parties exchange goods or services and carry out that exchange without using legal currency.”

CPA CANADA: How do taxpayers determine a taxable cryptocurrency transaction?
JO: Owning and holding cryptocurrency is not a taxable event, nor is watching the rise and fall of the price of cryptocurrency. When you gift, use, sell, or exchange cryptocurrency, it is considered a disposition for tax purposes requiring the reporting of either business income/loss or capital gain/loss, depending on the circumstances. Ultimately, the tax results are very similar if you are holding or trading company shares. It is taxed as a capital gain if the person was holding the cryptocurrency as an investment and taxed as business income if the person was holding cryptocurrency as inventory. A colleague and I provided some cryptocurrency tax related information to help address common questions.

CPA CANADA: Does cryptocurrency need to be reported as a foreign asset?
JO: In Canada, we don’t have any tax reporting mechanisms specifically designed for cryptocurrency reporting. We do however, have a self-reporting system for specified foreign property (T1135 ), and CRA does consider cryptocurrency to be specified foreign property if the cryptocurrency is situated, deposited or held outside of Canada and not used exclusively in the course of carrying on an active business. The problem taxpayers are facing with categorizing cryptocurrency as specified foreign property is where exactly is cryptocurrency located? With no guidance from the CRA on the actual location of cryptocurrency, taxpayers are left making their own decision—report or not report.

There are two trains of thought on this. One is disclosing it as foreign property on the T1135, even though cryptocurrency does not seem to fit neatly within the legislative definition. The other is not disclosing it as foreign property and treating it as being held in Canada based on the fact the CRA does not have a definitive position. This position comes with the risk of penalties if the CRA does not agree, so being able to support your position that cryptocurrency is held in Canada is very important. Given that the CRA has declined to state a view publicly, the fair result would be to not consider penalties until a clear statement is made on the issue.

CPA CANADA: How will Finance deal with cryptocurrency reporting in the future?
JO: There are three possible scenarios. First: Finance creates a new specific legislation that deals with cryptocurrency reporting. Second: It amends specified foreign properly legislation to squeeze cryptocurrency in properly. Third: Finance lets the CRA try and administratively fit cryptocurrency’s square peg into the existing specified foreign property round hole.

CPA CANADA: Does mining for cryptocurrency change the tax implications?
JO: Mining is more complicated and the rules dealing with cryptocurrency mining are different. For an overview of the taxation of cryptocurrency mining, you can refer to an article that summarizes a paper I wrote with Michael Brown and Myles Bilodeau for the Canadian Tax Foundation.

However, GST/HST is a bit of an issue for cryptocurrency miners, and the Department of Finance Canada has responded with two legislative amendments. One has been enacted into law (“virtual payment instrument”), and the other, which is specifically for cryptocurrency miners , has been proposed but not enacted.

CPA CANADA: What should taxpayers and CPAs be doing to avoid problems?
JO: It is important to keep records of all cryptocurrency transactions as per CRA guidelines. These include dates, cryptocurrency addresses, transaction IDs, receipts, dollar value, transaction descriptions, exchange and/or wallet records, etc. Miners should also keep receipts for hardware and expenses associated with the operation, contracts and records, and disposal of cryptocurrency earned.

CPAs should also ask clients if they have cryptocurrency holdings and/or transactions to report. There are a lot of people dabbling in cryptocurrency and they may not feel they need to disclose it. They may be unaware of their obligations in this respect; or they may be attempting to hide assets from the government. There are a lot of unreported transactions out there, so be proactive with your questions. If you feel the answers are not consistent with the facts, then you need to question the integrity of that client.

STAY CRYPTO CURRENT

Check out CPA Canada’s blockchain and crypto-asset resources as well as its taxation blog and other tax resources. And learn how and when to use the CRA’s voluntary disclosures program.