Kathryn Walker is a tax lawyer at Thorsteinssons LLP
Bitcoin's stratospheric jump in value was an investment spectacle reminiscent of the dot-com boom, including its recent decline in value. Other cryptocurrencies have also increased in value, market capitalization and, to some degree, legitimacy.
This flurry of investment activity has led to substantial gains for some and while cryptocurrency has been touted for its anonymity – with buying and selling executed by proxy through a virtual wallet – those trading or investing in cryptocurrency should be aware that this will not shield them from tax obligations. Indeed, south of the border, the Internal Revenue Service recently won a legal battle with the cryptocurrency exchange Coinbase that required Coinbase to produce thousands of customer records, identifying the real people attached to virtual wallets.
And so it is for good reason that in the past few months lawyers and accountants have been inundated with queries regarding the tax implications of trading and investing in cryptocurrency. While there is no substitute for individual professional advice in such a new, complicated and rapidly evolving area, here are some basic signposts for navigating the tax implications of your cryptocurrencies.
Why would I report my cryptocurrency gain? Isn't it all anonymous?
When people buy cryptocurrencies, they do so through a coin exchange – such as coinsquare, QuadrigaCX and Cancoin. The exchanges offer various degrees of anonymity, some requiring customers to provide a passport, others only asking for cash payment.
Once consumers purchase cryptocurrency, it is held in their virtual wallet, which is essentially just software. To date in Canada, it is possible that people's relationship to their wallet need never be unmasked. Its like going on a dating app, creating a profile and flirting unabashedly. No one needs to know it's you.
Well, that works well enough until you want something real. As soon as you want a real date, or real money, the mask comes off. While you can keep your cryptocurrency in the virtual world and never identify yourself as its true owner; the moment your cryptocurrency hits the ground, when you buy something or cash out, the jig is up.
I sold some cryptocurrency last year. What do I need to do?
Report your gains and maybe your losses. The Canada Revenue Agency, in policy statements from 2013, said that cryptocurrency is not a form of money, but a type of property. Generally speaking, what this means is that cryptocurrency will be taxed like an investment in stocks, and depending on your circumstances will need to be reported as either income or a capital gain. The key thing to know is that if you sold cryptocurrency for more than you paid, the difference between what you paid and what you received on disposition is your gain and you need to report it in your tax return.
I bought some computer software using cryptocurrency. Do I have to pay tax?
Buying something with cryptocurrency is one of those events when your virtual money becomes realized – like meeting the person from the dating app for coffee. Things get real and your gains are crystallized.
The upshot is, if you acquired your cryptocurrency for $1 and then some time later used it to buy software worth $1,000, you've got a gain of $999. And like it or not, you have to report that gain and pay income tax on it.
But that's not the end of the story: The plot thickens because, depending on how much you are buying and selling, you may also be required to collect or pay GST/HST. The CRA has said that cryptocurrency transactions are like barter transactions. This means as far as the CRA is concerned, if you bought software with cryptocurrency, it's like trading a chicken for grain and both the chicken and the grain are subject to GST/HST. That's right, you may need to be collecting GST/HST when you buy things with cryptocurrency. Again, this is only what the CRA has said. It's an administrative position and there are reasonable legal arguments for challenging the CRA's characterization of cryptocurrency.
I traded bitcoin for ethereum. Do I need to report anything?
From a tax perspective, this scenario is identical to buying software with cryptocurrency. CRA policy says that transaction is a barter transaction. Each side of the transaction is characterized as a disposition of property, and each disposition is taxable as income or a capital gain based on the fair market value of the cryptocurrency at the time of the transaction.
I "mined" cryptocurrency. What are the tax consequences?
Cryptocurrencies are made up of coins or tokens that can be produced through processes referred to a "mining." Mining involves two key activities: solving problems and verifications.
Miners solve complex computer problems and when they do so they are rewarded with a coin or a token. Solving problems requires using heaps of computing power, which essentially means shouldering a big electricity bill. Miners also verify the transactions that take place with the cryptocurrency, and when they do so they can get coins as payment.
Cryptocurrency miners should report as income the cryptocurrency they earn, and should be able to deduct associated losses, such as those hefty electricity costs.
I was paid in cryptocurrency. What should I do?
If your employer has paid you with cryptocurrency, it's like being paid with money. You will be required to pay income tax on your earnings.
If you are an independent contractor and you have been paid with cryptocurrency, again, from a tax perspective, it's like being paid with money. You need to pay income tax and collect GST/HST, but you can also deduct associated expenses and claim input tax credits.
These are early days in the taxation of cryptocurrency. Things may change. Parliament may legislate. The courts may weigh in. For now, the most important thing to know is that your cryptocurrency gains – and losses – are a taxable event.