How to minimize the cryptocurrency tax burden this tax season

Leading tax lawyer shares his strategy for protecting clients’ cryptocurrency gains from the CRA

How to minimize the cryptocurrency tax burden this tax season
David Rotfleisch is a tax lawyer, chartered professional accountant and founder of Rotfleisch & Samulovitch PC.

With tax season approaching, one leading Toronto tax lawyer says he isn’t seeing as many cryptocurrency dispositions as he has in past years. But when they do show up, he has a strategy in place, one he honed during the Bitcoin bubble of 2017.

David Rotfleisch, tax lawyer and principal at Rotfleisch & Samulovitch PC takes a detail-driven and hybridized approach to protect his clients’ tax liability.

Under current CRA guidelines, the disposition of a crypto asset needs to be reported as either business income or a capital gain.

“What is more advantageous from a tax point of view is to have capital treatments,” Rotfleisch explains. “But you have a risk of the CRA saying, ‘no, this is not capital, this is income, you've got twice the tax liability of what you reported, and we're going to hit you with gross negligence penalties.’”  

As business income is fully taxable while only 50 per cent of capital gains are, he dives into clients’ cryptocurrency earnings and clarifies what looks like the former and what is defensible as the latter. He builds in a series of memos defending the capital gains claims in case the CRA comes calling.

“Absent our analysis, the CRA would come in and take a look at the whole portfolio,” Rotfleisch said. “They would see some you bought some Bitcoin yesterday, you sold it today. One clear income account and they're going to [tax] everything as an income account. They're not going to go into detail.”

Cryptocurrencies (or cryptos) are digital assets, designed to function as a decentralized medium of exchange protected by cryptography rather than a state guarantee. More than 2,000 different cryptos exist, including Bitcoin, Ethereum, Ripple and Litecoin. In late 2017 Bitcoin, which Rotfleisch says is a consistent indicator of overall cryptocurrency value, peaked at around US$20,000. It has since fallen to around US$10,000 but remains volatile. 

The CRA’s guidelines for cryptocurrency taxation emanate from a key premise: cryptos are a commodity, not money. Rotfleisch accepts this is fair. Cryptos like Bitcoin often behave more like gold, with wildly fluctuating values, and still aren’t widely acceptable as a medium of exchange. Though that is changing slowly, for the moment he thinks it’s not worth challenging the CRA’s base premise, which leaves smart filing as the best means for a tax lawyer to protect their client.

Rotfleisch says there are risks associated with claiming crypto income on a capital account but insists that in certain cases it can be defended as a capital gain.

One of the key factors is time. The CRA treats gains from property sold shortly after it’s bought as business income. A cryptocurrency sold after held for a longer period, can be seen as a capital gain.

When Rotfleisch prepares filings claiming cryptocurrency income as a capital gain he’ll include sometimes 30 or 40 pages of memos to defend the filing. Those memos detail why this crypto income is filed as a capital gain. More clear cases of business income, where a client bought a crypto one day and sold it the next, are less defensible. Taking a detail-oriented approach is key to Rotfleisch’s strategy.  

If the cryptocurrency market picks up again, tax lawyers and their clients need to stay aware of how they can break up that income, says Rotfleisch.

“If you did any crypto transactions, you need an analysis as to whether they're on income or capital accounts,” Rotfleisch said. “That's the high and the low of it. You need to be very careful to get it right.” 

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