What Cryptocurrency Investors Need to Know at Tax Time
Although investing in cryptocurrencies has been very volatile since their inception, the trend until very recently has been up. And for those who have been involved for over a year: way up. One question we hear a lot is: “I made a lot of money but it’s all in crypto… what do I do?!”
As a result, a number of investors have substantial gains which remain in crypto form, unconverted into Fiat. One of the reasons for this is the fear of triggering an income tax consequence which is a very real and substantial concern. So what is the best way to structure your crypto investments? You must perform a complex analysis to determine the best structure under the circumstances, but here is a basic guideline of the issues to consider.
Step One: Capital gain or income
The first step in creating the best tax structure for cryptocurrency holdings is to determine whether the gains derived from investment would be considered capital or current income. Capital income is preferable because only 50% of capital gains come into income when calculating your tax liability. Current income is treated the same way as employment income: 100% of it is included in income, and your graduated tax rate is applied to that amount to calculate your taxable income minus deductions and net of credits.
There is no bright-line test to determine whether the gain derived from the investment in cryptocurrency is a capital or current gain. Canadian tax law cases provide some guidance on the factors that are most likely to be considered by the Canadian Revenue Agency (“CRA”) in determining whether gains earned from disposing cryptocurrencies are capital gains from investment or current income from a trading business or adventure or concern in the nature of trade. In Vancouver Art Metal Works Ltd. v. Canada,  2 FC 179, the court cited the factors to be considered in determining whether the taxpayer’s course of conduct indicates the carrying on of a business:
- the frequency of the transactions
- the duration of the holdings
- the intention to acquire the securities for resale at a profit
- the nature and quantity of the securities, and
- the time spent on the activity
This list of factors is not exhaustive, and the CRA and the courts may consider other relevant factors such as knowledge of the market, financing and advertising. The analysis is heavily fact-dependent where a significant single factor may decide a case.
The case law demonstrates that being involved in a large number of transactions within a short period of time of ownership, coupled with the intention to resale at a profit, may suggest that the gains should be characterized as business income rather than capital gains. For example, in Wong v. The Queen, 2013 TCC 130, the court found that the taxpayer was engaged in more than 600 securities transactions over a five-year period, with each security held for a brief period of time, and that even though the taxpayer had the intention of earning capital gains, the court held that he was engaged in an adventure in the nature of trade. The number of transactions alone, however, is not a determinative factor. The court in MNR v Taylor,  CTC 189 made it clear that a single transaction can result in current income, not capital, when a taxpayer acts as a professional trader with the intention to make a profit. This case may suggest that a purchase of Bitcoin in September 2017 and a subsequent sale in December 2017 when the price reached its historical high may look like an adventure or concern in the nature of trade if the taxpayer’s course of conduct and intention clearly indicated it to be such.
Step Two: Determine your Taxable Events
Trading between tokens and coins throughout the tax year could also result in multiple taxable events. If you purchased ether or bitcoin at the beginning of 2017 you would have seen a substantial gain by the middle of that year. If you then used your crypto to buy altcoins, for example, pursuant to an Initial Token Offering, then you would be deemed to have received the amount of the gain at the time you made that trade. For example, if you bought one Ethereum coin at $10 in January, and then in June when they were worth $500 you traded them on an exchange for 500 tokens worth $1, the act of bartering those tokens would result in you realizing the $499 as income as if you sold them at fair market value when you executed the trade. It is therefore very important to keep track of all those transactions in order to accurately determine your tax liability at the end of the year.
Step Three: Create a Corporation?
Once you have determined whether your income would be capital or current, as well as the sum of your taxes owing from interim trades, we would explore whether using a Corporation would be beneficial. Corporations have the benefit of allowing you to separate your crypto assets from your other assets for liability reasons as well as potentially utilize tax benefits in a number of circumstances. One problem that arises is how to move those crypto assets into a corporation. There are few ways of doing this:
1) Rollover: by executing an asset exchange agreement or a “rollover” under Section 85 of the Canada Income Tax Act. A rollover allows you to move assets into a corporation and take back fixed value shares that are equal in value to the crypto assets that were rolled in. This defers a tax consequence that would otherwise be triggered when you move assets into a corporation you own and control.
2) Once the corporation is incorporated you can set up corporate bank accounts as well as accounts with trading platforms such as exchanges. You should also have wallets that are exclusively devoted to the corporation that would hold the cryptographic assets.
3) Depending on whether the corporation is an active business there could be substantial tax benefits to selling the shares of the corporation instead of the crypto.
Tax strategies involving cryptocurrency are still in their infancy but we have had extensive experience in structuring and dealing with individuals with high volumes and values of cryptocurrency. If you have questions about structuring your crypto holdings in the most tax-efficient manner please contact us and we would be happy to speak to you about structures that will optimize your holdings and advise on strategies for liquidating those assets when the funds are required.
PLEASE NOTE: THIS IS NOT INTENDED TO BE LEGAL ADVICE AND SHOULD NOT BE RELIED ON AS SUCH. IT IS IMPORTANT THAT YOU CONSULT WITH A LICENSED PROFESSIONAL.