While the CRA confronts new challenges, tax lawyers say long-established principles still apply
When contemplating the tax implications of cryptocurrency, says Vern Krishna, a tax lawyer and law professor, the first thing to consider is that they are not, in fact, currencies “as we know them.” A central bank typically recognizes a currency as a medium of exchange “with relative stability and great acceptance.” In that sense, he says crypto is a property, not a currency.
“It’s a relatively new phenomenon that hasn’t been tested in any major or significant way,” says Krishna. “We do not have the benefit of high-level judicial interpretation.… To have senior-level judicial administration, you’re probably looking at eight to 10 years. That’s how long it takes for a tax case to be determined.”
But many of the tax-law questions that arise from crypto are – unlike crypto – not new, says Nicolas Cloutier, a tax litigator at McCarthy Tétrault.
“As a rule of thumb, most of the principles that we apply to crypto now are just the principles that we apply to everything else. It’s interesting, but it’s not all novel… Traditionally, whatever money you make, unless it’s a windfall – a gift from God or your parents – is either a capital gain or income.”
“This is simply a new form of transaction,” says Krishna. “The principles remain exactly the same.”
Between capital gain or income, taxpayers’ preferred classification of their crypto trading may depend on whether they enjoyed a profit or incurred a loss, he says. Business income is fully taxable, while capital gains are only taxed at half. But a business loss is fully deductible against other income, while a capital gain is “restricted” – only 50 percent of it is deductible against other capital gains.
“I suspect, without being cynical, given the nature of tax law, people will want to characterize the gain or loss to their advantage,” says Krishna. “We like our losses to be considered business losses so that we can deduct them fully. We like our gains to be capital gains so that we pay tax only at one-half.”
Whether crypto is taxed as capital gains or income is “simple to state, very hard to answer,” says Toronto tax lawyer David Rotfleisch. “Nothing in the Income Tax Act clarifies that issue. So you look at the case law, and judges have developed a number of tests.”
The foundational test examines the intention of the person who executed the transaction producing the gain, says Krishna. Regal Heights Ltd. v. Minister of National Revenue and Irrigation Industries Ltd. v. The Minister of National Revenue, from 1960 and 1962, are the seminal cases enunciating the intention test, “which is what we use, primarily,” he says.
“This may sound childish,” says Cloutier, “but business is busy-ness.” If crypto is transacted in a manner that is “organized,” “business-like,” “structured,” and takes up a lot of the taxpayer’s time, it is taxable as business income, he says.
The crypto-trading platform Coinsquare’s 2022 tax guide lists the following as a “taxable event”: selling or gifting crypto, converting crypto into cash, trading or exchanging crypto – including trading one type for another – and using crypto to buy goods or services. The guide said the CRA would examine several factors to determine whether the event will produce a capital gain or business income. These factors include trading volume, amount of time between trades, time spent researching markets and planning, whether crypto-trading is the taxpayer’s primary source of income, whether they have outside financing, and whether they advertise or promote their trading.
David Piccolo, a tax litigator and partner at TaxChambers in Toronto, says he has recently seen that Canada Revenue Agency has been beefing up its crypto-auditing capabilities. The trend, he says, originated with Coinsquare and the 2021 Federal Court ruling ordering the platform to disclose to the CRA a trove of information on its users. Coinsquare is among Canada’s largest crypto-trading platforms.
The company was required to disclose all accounts that had contained a minimum of $20,000 in value on the last day of the year, in any year from 2014 to 2020. Coinsquare also had to disclose the 16,500 largest accounts on its platform during that period.
In an article on his website, Rotfleisch writes that the Coinsquare disclosures are part of a “global trend” in which crypto-exchange platforms are being compelled to provide customer information. The Coinsquare case was preceded in 2017 by a US court order forcing the exchange Coinbase to make similar disclosures to the Internal Revenue Service.
In the Coinsquare case, the CRA also obtained external key addresses, says Geneviève Favreau, an associate in McCarthy’s tax group. “This is huge,” she says, because, with these keys, the CRA can track these users’ other crypto transactions on the blockchain. “We saw CRA showing their teeth … in this Coinbase decision.”
The CRA has also been sending around questionnaires, asking detailed questions about crypto holdings, and now have “actionable information” on crypto-holders, says Cloutier. “It’s really something that is top of mind for them.”
Coincidentally, while CRA is looking harder at crypto, they also recently “narrowed significantly” the voluntary disclosure program, he says. The program used to allow taxpayers to correspond anonymously with the CRA to disclose previously non-disclosed income, pay taxes owing, avoid prosecution and, in some situations, also get a break on the interest and tax owed. The program is no longer anonymous and has become more limited in the relief offered to taxpayers.
“That program becoming more stringent – more difficult – around the same time as crypto was becoming audited may have put some people invested in crypto, who have not complied with their tax obligations, in a difficult spot, especially compared to other asset classes.”
Because crypto transactions are transparently tallied on the blockchain, crypto is also easier to audit than other assets – art or gold, for example – which can be hidden, says Cloutier. “Cash is the ultimate refuge for tax evaders. And crypto is the ultimate problem. Forever, you’ll be found. If the CRA pulls out the information from the blockchain, what are you going to say?”
There is a tension between a self-reporting system such as Canada’s and the decentralized financial system in which crypto exists, says Piccolo. He says the CRA will have to determine appropriate reporting obligations and whether additional reporting requirements are necessary.
“The whole point of the blockchain is that you have the ledger and that you can trace everything back to the chain,” he says. “The question that has to be answered, I think, is how much of that information, in a self-reporting system, is CRA going to require the taxpayers to actually provide?”
From a policy perspective, the CRA will have to create an administratively easy system while providing relevant information to the agency, says Piccolo. “Ultimately, they’ll have to get there.”
“That’s where there’s going to be a lot of questions. A lot of the existing questions aren’t necessarily that new. I think they’re just being applied to this space.” What will be “completely different” is how taxpayers report chunks of the blockchain to the CRA, he says.
Hypergrowth: Numb5er of cryptocurrencies worldwide
Nov. 2019: 2,817
Feb. 2021: 4,501
Oc. 2021: 6,826
Jan. 2022: 9,929
Feb. 2022: 10,397
Crypto’s most valuable: Bitcoin
As of April 11, 2022
Total circulating: 19 million
Average Market Price: US$39,489
Market Capitalization: US$757.72 billion
Market Capitalization Nov. 9, 2021: US$1.279 trillion
Exchange Trade Volume: US$309 million
Exchange Trade Volume May 19, 2021: $3.192 billion