It is common knowledge that taxation authorities around the world are playing catch up with the developments of new technology. One of the most interesting areas of such ongoing technological development has been the advent of Bitcoin. But at least in the case of Bitcoin it seems that the Income Tax Act’s broad general definitions mean the Department of Finance is ahead of the game for once.
Bitcoin is a type of virtual currency. It is not issued by any central bank nor subject to the monetary policy of any government. It can be purchased using regular currency from others that are prepared to sell some but the ‘printing’ of new currency is limited and based on mathematical algorithms which will cap the total number of bitcoins in circulation. Some vendors accept Bitcoin as payment based on the USD / Bitcoin conversion rate as determined by a number of exchanges and transactions for goods or services are effected by the electronic ‘transfer’ of Bitcoins.
Fortunately for the tax community, a detailed understanding of the technical aspects of Bitcoin are unnecessary to appreciate its tax treatment but, as always, the basics are germane.
Where do Bitcoins come from?
Currency is generated initially through an act of mining. Mining describes the creation of coins ex nihilo (i.e. creating coins from nothing) but is generally a reward or payment (depending on how you look at it) for helping to propagate the underlying blockchain technology. When Bitcoin was new, mining rewards were high, now, mining rewards are much lower and more difficult to achieve without powerful computer power.
Mining then can be either a commercial activity or hobby but in both cases, the individual is being paid for his or her work in propagating the underlying technology. The CRA’s view (published in the mining heyday of 2014) on this is somewhat interesting in that it considers the coins mined as inventory in a business rather than strictly payment – which one might be the expected result if Bitcoin were considered currency. The IRS position on this issue simply states that the entire amount received by the miner is included in income.
But, in other ways, the CRA position on virtual currencies is easier to understand. For example, if these currencies are held as capital then they are taxed as such. A taxpayer engaged in the trading of currencies may find that the CRA’s position in those circumstances is that the currencies are inventory in a business rather than being held on capital account. Tax professionals understand the implications of these are significant.
Canada Revenue Agency and Bitcoin
There is an additional interesting element regarding whether or not these intangible currencies are in fact specified foreign property. The CRA’s position is that they indeed are and, if they otherwise qualify for reporting, must be recorded each year on the relevant schedule. The twist is that these currencies are designed to be anonymous and hard to trace, some even impossible. So enforcement of these disclosure provisions will be interesting and one imagines the CRA will default to arbitrary assessments (aka net worth assessments) as an auditing position. Perhaps equally nerve-wracking is that the unregulated nature of the markets, and the ease with which untraceable currencies can be switched from one to another, may make it difficult for any but the most diligent investor to have records of any kind – even if they seek to properly report their gains.
The prevalence of various cryptocurrencies is only going to increase over time. Tax professionals will need to better understand their client’s holdings and advise them that their activities with respect to these types of currencies will have different tax consequences. That said, one of the reasons cryptocurrencies are interesting is that they can be virtually untraceable. One wonders what steps the taxation territories will take to ensure compliance with these various positions that they have spent time formulating.
By: Adam Aptowitzer
Originally published in the Canadian Tax Payer, June 16, 2017 – Volume xxxix No. 12, p. 95-96