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If a client has crypto gains from just a handful of trades that are determined to be capital gains, then any losses that might have incurred in their traditional investment portfolio can be used to offset the taxes on those gains.EDGAR SU/Reuters

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As more Canadians invest in cryptocurrencies, financial advisors can be the best resource to help them understand how evolving digital asset tax rules can impact their entire portfolios.

Recent guidance from the Canada Revenue Agency (CRA) shows a certain degree of subjective professional judgment is required for the rules to be applied correctly, says Rob Jeffrey a partner at Deloitte Canada’s tax practice in Halifax.

Advisors first need to understand “that the breadth of cryptocurrency holdings in Canada is higher than most people realize,” he says. “It is not just a small group of people.”

More than one-tenth of Canadians (13 per cent) surveyed said they have bought digital assets such as bitcoin or ethereum directly, according to a national KPMG LLP poll conducted in February. A slightly less amount of survey participants (11 per cent) said they bought bitcoin exchange-traded funds and/or other cryptocurrency funds. The poll results have yet to be released publicly but were obtained by Globe Advisor.

Advisors could potentially be unaware of their clients’ cryptocurrency holdings, but tax experts argue that they need this information if they want to help their clients make the most tax-efficient choices.

“Where advisors struggle is that the rules are not one-size-fits-all,” says Joseph Micallef, partner and national tax leader for financial services at KPMG in Toronto. “That’s the fundamental aspect advisors need to be careful about because [cryptocurrency holdings] are not just default capital [gains] or [business] income.”

Tax rules open to interpretation

The basic rules for cryptocurrency taxes are the same as for investments, says Mr. Jeffrey, but it’s not as clear-cut on which more specific set of rules apply.

For example, whether cryptocurrency gains or losses are considered capital gains or business income depends on the frequency of trading, with the odds of the CRA counting cryptocurrency gains as business income increasing with the number of transactions, he says. However, the CRA doesn’t specify the exact number of transactions, leaving the question open to interpretation.

The key thing for advisors to keep in mind when helping clients make that determination is that any cryptocurrency gains deemed to be business income will be taxes that can’t be offset by traditional capital losses.

On the other hand, if a client has cryptocurrency gains from just a handful of trades that are determined to be capital gains, Mr. Jeffrey says any losses that might have incurred in their traditional investment portfolio can be used to offset the taxes on those gains.

“From an advisor’s perspective, asking a few more questions about how frequent the trading is can really help add some insight,” Mr. Jeffrey says.

Storage location matters

Another issue that Mr. Micallef says he’s seeing more during the past two years is whether investors should be reporting their cryptocurrency-related income on the CRA’s T1135 form, which is meant for individuals holding $100,000 or more outside of Canada.

There has been a lot of debate on this question, he says, because there are two very different ways cryptocurrency investors can store the assets. In so-called “cold” storage, the assets are stored in a physical medium – such as a USB key – that the owner usually keeps nearby. In that case, clients could potentially argue their cryptocurrency holdings are actually in Canada.

“It’s a whole other aspect when you’re dealing with so-called ‘hot’ wallets, which are stored in the cloud,” he says, meaning the CRA could consider these holdings to be foreign-specified property. In such cases, clients must include them on their T1135.

“That’s a very important thing advisors also need to make clear to their clients,” Mr. Micallef says.

Perhaps the most important message Mr. Jeffrey says advisors need to get across to their clients is that the idea of cryptocurrency being “untraceable and therefore nontaxable,” is not true.

“What we’re seeing more often is the CRA actually requesting a client list from one of the cryptocurrency exchanges and being granted that list,” he says. “The assumption that the CRA doesn’t have access to that information is not a long-term reasonable assumption to make.”

According to the Ontario Bar Association, the CRA is following in the footsteps of the Internal Revenue Service in the U.S. in obtaining client lists via court orders.

Mr. Micallef says the orders are mostly focused on the largest and most widely recognized cryptocurrency exchanges, which means if transactions are not done on recognized exchanges, there isn’t an “ironclad mechanism” that enables the CRA to be informed of the moves.

That makes it all the more important for advisors to engage with their clients proactively about their experiences with cryptocurrency, Mr. Jeffrey says.

“The law has not kept up with the advance of technology here, which inherently leads to more uncertainty for taxpayers,” he adds.

Helping clients address issues of uncertainty, Mr. Jeffery notes, is perhaps the best way for advisors to demonstrate their value.

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