Keep Calm and Keep Mining – What is Taxable in Crypto Mining?
In this article, we will discuss the taxation implications of Cryptocurrencies, from the standpoint of using it as a medium of trade, actively trading as a business as opposed to holding it as an investment, GST/HST implications, mining and donating it. Finally, Cryptocurrencies’ qualification as a specified foreign property is briefly mentioned.
Cryptocurrency Used In Barter Transactions (Unit of Payment)
There is nothing explicit in the Income Tax Act (“ITA”) that says that Cryptocurrencies are taxable. The CRA does not view Cryptocurrencies as legal currency, but rather, as a commodity. As a commodity, the use of it as a medium of exchanges falls under the category of a barter transaction, and CRA discusses the tax implications in Interpretation Bulletin, IT-490 (Barter Transactions).
A barter transaction happens when one good or service is exchanged for another good or service without any money switching hands. For example, a car mechanic provides his repair services to an accountant, who in return agrees to prepare the mechanic’s financial statements and tax returns for the year.
It is a fundamental tax principle that in an arm’s length transaction, the value of what is given up is at least equal to the value of what is received in return, with all amounts translated into Canadian dollars.
CRA considers that barter transactions can be included in income under sections 3 and 9 of the ITA or can result in a disposition or acquisition of capital property, eligible capital property, personal-use property or inventory.
Where a vendor accepts Cryptocurrencies as payment for providing goods or services which are usually provided by him in the course of carrying on a business or profession, the fair market value of those goods or services (i.e. the price) , in Canadian dollars, is to be included in the vendor’s income.
The cost of the Cryptocurrencies received by the vendor is considered by CRA to be the same amount as the total value of the goods or services that were given up by the vendor, plus or minus any cash involved. In a non-arm’s length transaction, the cost of the Cryptocurrency or crypto coin received is restricted by Section 69 to their fair market value.
From the standpoint of the purchaser, where the Cryptocurrencies given by the purchaser originated from a business or profession, the purchaser is considered to have received income or proceeds of disposition equal to the fair market value of the Cryptocurrency, expressed in Canadian dollars. Any gain or loss on disposition would need to be calculated at that time either on account of income (100% taxed) or capital (50% taxed). This is determined by the facts and circumstances of the taxpayer’s situation. Similarly, the cost of the services, goods or property received by the purchaser is the same amount as the Cryptocurrency given up, plus or minus any cash involved. In non-arm’s length transactions, the cost of the services, goods or property received would be restricted by section 69 to their fair market value.
When it is difficult to determine a value for the goods or services have given up, the CRA will allow the value of the goods or services received to be the price at which the transaction took place as long as the parties were dealing at arm’s length. For example, if the purchaser above was not able to determine the value of the Cryptocurrency given up, the value of the services, goods or property received could be used to value the transaction for tax purposes. With the current technology available, it is easier to value the Cryptocurrency in Canadian dollars. Going forward, we may see the Cryptocurrency value being used more often for valuing the transaction.
In a 2013 technical interpretation (2013-051470117), the CRA outlined its position when a taxable supply is made. Basically, when a business sells goods or services for Cryptocurrencies and the sale is subject to GST/HST, the business must collect GST/HST on the fair market value of the Cryptocurrencies at the time of the sale. Initial coin offerings (ICO) would likely fall under this rule, particularly when they are issued in exchange for other cryptocurrencies.
It is interesting that CRA’s position on the treatment of GST/HST is contrary to its position regarding the treatment of cryptocurrency as a “barter transaction” for income tax purposes.
Trading In Cryptocurrencies vs. Holding As Investment
Per CRA’s December 2013 technical interpretation (2013-051470117), where a person trades or sells Cryptocurrencies like a commodity, the resulting gain or loss may be on account of income or capital. This can only be determined by reviewing all the facts and circumstances. Interpretation Bulletin IT-479R (Transactions in Securities) provides general comments for determining if a transaction is an income or capital in nature. If the person is repeatedly buying and selling Cryptocurrencies for profit, this will be considered a business and the income will be fully taxable as business income. Per paragraph 7 of IT-490, the cost to the taxpayer of property received in exchange for Cryptocurrencies (e.g., another cryptocurrency) will be the same as the value of the Cryptocurrencies given up as consideration. If the Cryptocurrencies are held as an investment, without frequent trading involved, then this activity would be considered to be capital in nature.
A mining activity occurs when a person uses powerful computers to process complex online mathematical algorithms called “blocks” in the course of processing and settling all transactions within the blockchain and is rewarded for performing this service with a Cryptocurrencies. The Cryptocurrencies gained in this process is required to be reported as income. If he is doing this as a business, he would be allowed to deduct the costs of the computers and electricity as well as other related expenses in determining his income for the year Pursuant to a March 2014 technical interpretation (2014-0525191E5), the CRA has indicated that the taxpayer, in determining his income, will need to value his inventory at the end of the year pursuant to the rules in section 10 of the ITA and Part XVIII of the Regulations. Under these provisions, inventory would be valued at either the Lower-of-Cost-or-Fair Market Value Method or the Fair Market Value Method, unless the business is an adventure or concern in the nature of a trade, in which case the valuation method to use is the cost of acquisition (per subsection 10(1.01) of the ITA). . If the miner subsequently sells the Cryptocurrency for an amount that is more than what he initially received, the excess amount is also included in business income.
It is a question of fact as to whether the Cryptocurrencies are held as capital property or inventory.
If the miner is instead viewed as acquiring a capital property, then his adjusted cost base would be the market value of bitcoin at the time he was rewarded with the Cryptocurrency token for his services. The adjusted cost base would also include the cost of electricity used to run his computers. The miner would incur a capital gain or loss when he sells the Cryptocurrency, depending on its market value at that time.
The CRA does not provide any clear guidance on whether mining activities are subject to GST/HST. If mining is considered to be a taxable supply of services to the entire network, it would be difficult (if not impossible) to identify any particular recipient of the service provided by the miner in order for the miner to collect GST/HST. While in theory GST/HST should be charged, it is difficult to see how this will work in practice.
Donations of Cryptocurrencies
Gifts of Cryptocurrencies are subject to the charitable donation rules in the ITA. When Cryptocurrencies is gifted to a “qualified donee”, CRA considers that the fair market value of the Cryptocurrencies at the time of transfer is the “eligible amount” of the gift for tax purposes. If Cryptocurrencies are used to purchase a property that is donated, the fair market value of the property would be used as the “eligible amount” for tax purposes.
Specified Foreign Property
Taxpayers should be aware that the CRA considers Cryptocurrencies as “specified foreign property” under section 233.3 of the ITA and is therefore required to be reported on Form 1135 (Foreign Income Verification Statement) to the extent that it is situated, deposited, or held outside of Canada and not used exclusively in an active business.
As the legal and regulatory status of Cryptocurrencies is unknown at this time, there is still a great deal of uncertainty about the taxation of Cryptocurrencies as well. As with any rapidly evolving area, the taxpayer is advised to monitor new developments in CRA policy, case law and tax literature. Bear in mind that the previously discussed CRA interpretations regarding the tax treatment of Cryptocurrency are administrative positions only, and may be subject to legal challenge in the future.