The Canada Revenue Agency (the “CRA”) appears to be targeting users of bitcoin and other cryptocurrencies for audit, according to a Forbes online article (the “Article”). Moreover, the CRA is sending a questionnaire (the “Questionnaire”) along with audits, requiring taxpayers to describe their bitcoin-related activities.
As the Article points out, the scrutiny comes with little surprise. Jared Adams, the CRA Project Oversight Director, tweeted a would-be harbinger earlier this year. In response to a bitcoin-related company tweet explaining how to purchase bitcoin without the use of a bank account, Jared posted one “washingmachine.gif” to strongly insinuate attempted money-laundering.
South of the border, the Internal Revenue Service (the “IRS”) targeted bitcoin users in the past. A federal Judge in San Francisco ruled that Coinbase, a popular cryptocurrency marketplace, must supply the IRS with information identifying users who had more that US$20,000 in annual transactions on its platform between 2013 and 2015. While the IRS initially requested nine data points, including “complete profiles, know-your-customer due diligence, documents regarding third-party access, transaction logs, records of payments processed, correspondence between Coinbase and Coinbase users, account or invoice statements and records of payments”, the decision narrowed the scope of the documents the IRS can request to taxpayer ID number, name, date of birth, address, transaction logs and account statements, deeming the rest “not necessary”.
Back in Canada, It is unclear how the CRA selected the referenced group for audit. We were unable to find Federal Court documents compelling a Canadian cryptocurrency marketplace, like the recently defunct Quadriga CX, to provide user data to the CRA under Section 289(3) of the Excise Tax Act and Section 231.2 of the Income Tax Act. We found no evidence that a cryptocurrency marketplace—whose value-add proposition is privacy—has provided the CRA with user information. That said, it is conceivable such a marketplace shared user information without resisting a CRA request.
Accordingly, it is difficult to speculate as to how the CRA selected the initial bitcoin user group for audit. In a comment published in the Article, the CRA stated:
“In order to protect the integrity of our risk assessment systems, we cannot comment on the specific information or criteria we use to select files for audit. However, we use a combination of advanced analytics and business intelligence activities to ensure that we pick the highest risk files to audit while promoting a fair tax system for all Canadians.”
As discussed in our previous post, “Uber’s Tax Woes Signal Gig Economy is the Next Frontier in CRA’s Tax Collection Efforts”, the CRA has a history of developing strategies for emerging technologies after a protracted “wait and see” approach. The same holds true for cryptocurrencies. While the first open source bitcoin client was released on January 9, 2009, according to the CRA’s comments in the Article, “the CRA established a dedicated cryptocurrency unit in 2017”. Despite the delayed attention, the CRA has launched “over 60 active audits related to cryptocurrency”.
Meanwhile, the CRA Questionnaire appears aimed, in part, at elucidating user efforts to hide their tracks/increase their privacy. For instance, one of the 54 questions on the 13-page long questionnaire asks about the use of mixing services and tumblers which are used to obfuscate the origins of cryptocurrency funds and improve their privacy. Another question asks about the taxpayer’s use of ShapeShift or Changelly, platforms that have allowed users to exchange crypto assets without using their real-world identity. Yet another question asks whether a user has purchased cryptocurrencies from private individuals or bitcoin ATMs.
Several other questions appear to be aimed at the taxpayer’s acquisition, history and use of cryptocurrencies. These questions may be designed to derive the income tax implications on the sale of the individual’s cryptocurrencies.
To answer some of the pending questions, the CRA recently released a “Guide for cryptocurrency users and tax professionals” (the “Guide”).
The Guide corresponds with our explanation described in “Income Tax Implications on Sale of Cryptocurrency”. The question of reporting the gain or loss on the sale of cryptocurrencies for income tax purposes turns on whether the asset in question can be described as income or capital. This follows the case law describing the sale of property, which assesses the facts and circumstances surrounding the purchase and sale of an asset to distinguish between whether an asset can be considered income or capital.
The Guide describes the following as common signs you may be carrying on a business:
- you carry on activity for commercial reasons and in a commercially viable way;
- you undertake activities in a businesslike manner, which might include preparing a business plan and acquiring capital assets or inventory; and
- you promote a product or service.
you show that you intend to make a profit, even if you are unlikely to do so in the short term.
Accordingly, in certain circumstances a single transaction can be considered a business—”where it is an adventure or concern in the nature of trade”.
Nevertheless, the crypto market has cooled considerably since the formation of the 2017 task force. On December 16, 2017 at 7:00pm the price of bitcoin reached $25,006, as of March 12, 2019 it sits at approximately $5,186.72. Given the new status quo, several, less discussed, tax implications rise to the forefront. To the extent that the increased stability of crypto assets has reduced the appeal of speculation, it has increased the appeal of use as a fungible asset. According to the Guide, for income tax purposes, the use of cryptocurrencies to pay for goods and services is to be treated as a barter transaction. The value received for a sale of goods or services in exchange for a crypto asset should be the fair market value of the crypto asset.
Similarly, for GST/HST purposes, if a taxable product or service is sold for cryptocurrency as payment, the value of the cryptocurrency on which the GST/HST is to be assessed is the fair market value of the cryptocurrency at the time of the transaction.
The taxation of mining cryptocurrencies depends on whether the miner can be said to be carrying on a business activity or a personal activity (a hobby). This is a question of fact. A hobby is generally undertaken for pleasure, entertainment or enjoyment. If a hobby is pursued in a sufficiently businesslike way, it can be considered a business activity and taxed accordingly.
Whatever the application or transaction, the Guide suggests keeping meticulous books and records concerning your crypto assets.
Suffice it to say CRA crypto audits will likely, excuse the pun, ripple throughout the Canadian economy.
Whether you are seeking to proactively reduce your cryptocurrency tax exposure or have found yourself facing a CRA audit, the specialists at TaxChambers LLP can help.