Like other businesses, cryptocurrency transactions are equally taxed. We provide you tips and guides on cryptocurrency taxes
What is cryptocurrency
A cryptocurrency is a virtual currency created and secured digitally using cryptography, making it difficult to counterfeit. When we say that cryptocurrency is created digitally, we mean that it is an encrypted data string representing a unit of currency. Cryptocurrency, also known as crypto, is purely virtual, meaning that there are no physical components to it except the value it can buy in terms of goods or services it can pay for.
Like physical money (fiat) issued by governments or central banks, you can use cryptocurrencies to conduct transactions like buying, selling, and transferring funds. Unlike physical cash, however, cryptocurrency is not a legal tender. It does not belong to a particular government that can issue or regulate its use. For that reason, the creators of specific crypto organize and monitor transactions carried out using that crypto through a peer-to-peer technology called the blockchain. The blockchain also serves as a secure ledger that records every transaction using the crypto.
There are many kinds of cryptocurrencies. They all have fluctuating values and exchange rates with each other. Bitcoin, the first cryptocurrency, was created in 2009. It is the most popular and most valuable crypto.
Aside from online transactions, you can use cryptocurrencies to buy fiat currencies and vice versa. As a decentralized digital asset with no issuing or regulating authority, how to effectively treat cryptocurrency for taxation has always been a daunting task. In this article, we will look at the CRA guide for determining the applicable tax in different cryptocurrency transaction scenarios.
CRA treats cryptocurrency as a commodity
Since its emergence, many people have accepted cryptocurrency not only for the privacy or anonymity it provides but also for its convenience during transactions. With many organizations, businesses and individuals adopting crypto as a payment medium, many legal transactions involving huge amounts are carried out daily. Considering that cryptocurrency is not a legal tender, the Canada Revenue Agency (CRA) has to define it properly to tax it effectively.
The CRA wants to ensure that taxpayers account for the total value of goods and services received through crypto transactions in their income. However, since cryptocurrencies are not government-issued, the CRA treats them as a commodity to enable the taxation of transactions conducted with them. In other words, the CRA regards all crypto transactions involving the purchase of goods and services as a barter exchange. By defining purchase of goods and services with crypto as barter transactions, the CRA requires every taxpayer to add to their incomes the fair market value of the goods when they file their tax returns.
Perhaps a scenario will help you understand this better. Let’s assume you own a retail outlet, and sometimes you restock by paying with bitcoin. The CRA considers this BTC transaction a barter exchange. The CRA requires you to determine the fair market value of the goods you bought using BTC in Canadian dollars to file a proper tax return. It is this dollar amount that you will report in your tax return for taxation. In other words, your tax return has to account for the value of the BTC as at the time of the transaction in the government-issued legal tender – CAD.
Business income vs capital income
The complications and uncertainties regarding cryptocurrency taxation mainly come from the fact that, unlike fiat currency, it is not a legal tender. This complication makes determining what constitutes a taxable income a little complex. In Canada, the CRA classifies any income you earn from crypto transactions as business income or capital gains. The yardstick for deciding if an income is a business income or a capital gain is based on the circumstances of the transaction. The scenarios below will help you determine the tax treatment of bitcoin and other cryptocurrencies by the CRA.
When you use crypto to pay for something
Between the time you purchased something with crypto, you may realize a gain or a loss when you use or sell it. Using crypto this way makes it a capital that could create a capital gain or loss.
When you consider crypto a property or asset
It’s common to sell crypto at a higher price than it initially cost you to acquire them. This transaction can create a taxable capital gain or loss.
When you buy and sell cryptocurrencies regularly
Crypto speculation is similar to a day trading business, and the CRA would consider the income from these serial transactions as a business income.
When you mine cryptocurrencies
How the CRA would treat cryptocurrency tax, in this case, depends on whether you mine crypto as:
- A hobby: When you mine as a hobby, you only realize income when you sell it for a payment that could be treated as a capital gain or loss. You cannot claim mining costs in this case.
- As business: If your mining activity is part of a crypto trading business, the mined crypto would be treated as inventory. When you sell this crypto inventory, it will generate an income that would be treated as a business income.
Also, when you conduct mining as a service, the fees you earn for providing such service would be treated as business income.
Aside from scenarios involving transactions, other cases determine how crypto is valued for tax.
Cryptocurrency held outside Canada
Cryptocurrencies held outside Canada are considered foreign property. For this reason, you should report the value in a T1135 Statement if the total price is more than $100,000.
Cryptocurrency held as capital property
In this case, the CRA requires you to record it at the adjusted cost base, in other words it’s carried at cost.
Cryptocurrency held as inventory
In this case, you can determine the value of cryptocurrency using one of two methods:
- At the lesser of the cost when acquired, or it’s fair market value; or
- At fair market value.
Whichever you choose, it must be applied consistently year-to-year.
What if you are given crypto, or it is received as an ‘airdrop’?
The CRA treats cryptocurrency received in this manner as non-taxable. However, such receipts would be considered taxable if the cryptocurrency could be considered an income source. The Income Tax Act defined “income from a source” under section 3 as, which can be generally worded as:
- Regular in occurrence
- Requiring an organized effort or pursuit on your part to receive it
- Having an enforce a claim to receive it
- Involving a marketplace exchange
- Arises from your pursuit of profit
When you accept cryptocurrencies as payment for taxable goods and services, you must determine the FMV of the crypto at the time of such transaction in government-recognized CAD. This CAD value is what you have to include in your GST/HST return as revenue, with the applicable amount of GST/HST both collected and reported.
The CRA has laid the guidelines for cryptocurrency taxation. The obvious benefit is that taxpayers won’t evade tax by hiding their transactions and incomes in cryptocurrencies. However, the CRA guidelines still have some drawbacks despite the applaudable motive.
These drawbacks stem from the nature of cryptocurrencies in the first place. Aside from being a decentralized currency that the government cannot fully control, it is purely a digital or virtual currency encrypted to afford anonymity to those who use it. For this reason, taxing a crypto transaction has the following drawbacks:
- Unlike fiat currency transactions, when engaging in crypto activity, every business’s individual intent on how they mean to use the crypto currency needs to be looked at to determine how it should be treated and which tax rules should apply.
- The value calculation has many loopholes, resulting in punishable mistakes in reporting. Also, dubious taxpayers could capitalize on these loopholes to evade tax payments on business incomes or capital gains.
- The crypto market is highly volatile. The rate at which it changes value creates a wide discrepancy between the value at the time of transaction and reporting.