Canada: Tax Assistance

Cryptocurrency a Target of the International Tax Coalition: An Overview

During the summer of 2018, a collaborative effort was initiated by an international coalition of tax authorities, which included the Canada Revenue Agency (CRA) and the US Internal Revenue Service (IRS). Their goal was to work together, pooling their resources, to unveil cryptocurrency users who had circumvented their tax obligations.

Subsequently, the CRA, IRS, and other tax authorities have continued to refine their strategies for identifying cryptocurrency users, aiming for potential tax audits and investigations into tax evasion. Since 2019, for example, numerous Canadian cryptocurrency users were taken aback when they received an extensive 13-page questionnaire from the CRA, delving into their cryptocurrency transactions. In the United States, the IRS successfully compelled at least one digital currency exchange to disclose user account information. Tax authorities have also escalated efforts to criminally prosecute individuals who exploit cryptocurrencies such as Ripple (XRP), Litecoin (LTC), Chainlink (LINK), Dash, Zcash (ZEC), Ethereum (ETH), Bitcoin Cash (BCH), and Bitcoin (BTC) for tax evasion.

In addition to the examination of the mechanisms that grant the Canada Revenue Agency the capacity to efficiently identify, investigate, and potentially take legal action against cryptocurrency users, this article delivers Canada cryptocurrency tax related advice designed to be of assistance to Canadian cryptocurrency users.

The Joint Chiefs of Global Tax Enforcement (J5): Building Internation Cooperation Empowering the Canada Revenue Agency to Identify Canadian Cryptocurrency Traders and Investors

On July 3, 2018, the CRA became a Joint Chiefs of Global Tax Enforcement (J5) member, a collaborative international initiative established to combat tax evasion and money laundering associated with cryptocurrencies.

The J5 consists not only of the Canada Revenue Agency but also of tax authorities from Australia, the United Kingdom, the Netherlands, and the United States of America. The J5's mission revolves around facilitating information exchange and collaborating on investigations to confront the unique challenges posed by cryptocurrencies to tax authorities in these member nations. Specifically, the initiative is dedicated to uncovering unreported income and assets related to various cryptocurrencies like EOS, Binance Coin (BNB), Monero (XMR), Tether (USDT), Bitcoin SV (BSV), and Bittensor (TAO).

The establishment of this cooperation marked a synchronized endeavour by tax agencies to gain a deeper understanding of cryptocurrency transactions involving taxpayers across Canada, Australia, the United Kingdom, the Netherlands, and the United States of America.

IRS Advancements: Leveraging Resources and Finding Inspiration

The US Internal Revenue Service (IRS) has seemingly assumed a leading role in the quest for information regarding cryptocurrency transactions. Back in 2017, the IRS, for instance, secured a court order compelling Coinbase, a virtual currency exchange, to disclose data about any user whose account involved "at least the equivalent of $20,000 in any one transaction type (buy, sell, send, or receive) in any one year during the 2013 to 2015 period." For each account meeting these criteria, the IRS acquired details including the account user's name, taxpayer ID number, birthdate, address, and comprehensive transaction records, encompassing detailed transaction logs and the names of the counterparties in each transaction (refer to: United States v. Coinbase, Inc., Case No.17-cv-01431-JSC). This court order impacted over 14,000 Coinbase users.

In today's landscape, tracking transactions with popular cryptocurrencies such as Bitcoin poses no significant challenge for the IRS, the Canada Revenue Agency, and similar tax authorities. Bitcoin's transparent blockchain system enables tax agencies to readily pinpoint users. However, the IRS is currently on a quest to equip itself for investigating transactions involving the following cryptocurrencies:

• privacy coins like Zcash (ZEC), Dash (DASH), Komodo (KMD), Grin (GRIN), Monero (XMR), Horizon (ZEN), Verge (XVG);
• Layer 2 off-chain protocol networks such as Lightning Network (LN), Celer Network, Raiden Network; and
• side-chains including OmiseGo and Plasma.

The IRS has announced a reward of up to $1 million for developers who devise tracking technology for privacy-centric cryptocurrencies and innovative blockchain technologies.

The IRS has introduced mandatory cryptocurrency reporting for US taxpayers. Since the 2020 tax year, the US individual income-tax return (Form 1040) mandates that taxpayers disclose their cryptocurrency activities. Taxpayers will encounter the following question, located just below the address line on Form 1040: "At any time during 202*, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?" This new requirement significantly raises the stakes for cryptocurrency users who might have previously relied on a less transparent approach to tax filing. (In 2019, the IRS included a cryptocurrency question on Schedule 1, an additional-income form that many Americans didn't submit.)

The IRS has achieved notable success in its efforts to combat tax evasion by cryptocurrency users. The intersection of cryptocurrency and tax evasion gained widespread attention on October 6, 2020, when John McAfee, the renowned anti-virus software developer, was apprehended in Spain on tax-evasion charges filed in the United States. The US Justice Department contends that McAfee evaded US taxes by diverting his income into cryptocurrency-exchange accounts held under the names of proxies. The indictment reveals that, between 2014 and 2018, McAfee did not file any tax returns despite amassing millions through various endeavours, including cryptocurrency trading.

Without a doubt, the IRS's technological advancements are poised to serve as a source of inspiration and benefit for the Canada Revenue Agency (CRA) in its endeavours to identify, conduct tax audits, and prosecute Canadian cryptocurrency users. It's entirely possible that the CRA will follow in the footsteps of the IRS by considering mandatory disclosure of cryptocurrency activities for Canadian taxpayers. Additionally, the CRA enjoys direct access to the wealth of data collected by the IRS through cryptocurrency tracing technology and information extracted from various cryptocurrency exchanges. This collaboration stems from their participation in both the J5 alliance and the Canada-US Tax Treaty. As outlined in Article XXVII of the Treaty, both nations are obligated to exchange information that is relevant to the enforcement of their respective tax laws. This information-sharing mechanism has significantly contributed to the Canada Revenue Agency's ability to identify Canadian taxpayers for potential cryptocurrency audits.

CRA's Tax Audit Questionnaire for Cryptocurrency

The usual starting point for a CRA tax audit involves the issuance of a notification letter to the taxpayer. This letter serves to inform the taxpayer about the upcoming audit, specifying the tax years or reporting periods under scrutiny, as well as providing a broad outline of the audit's focus. It's common for these letters to incorporate an initial questionnaire.

When chosen for a CRA cryptocurrency tax audit, Canadian taxpayers are furnished with a comprehensive 13-page cryptocurrency audit questionnaire. This extensive questionnaire comprises more than 50 questions covering various areas, including:

• The timeframe of acquiring or using cryptocurrency;
• The origin of the purchased cryptocurrencies;
• Utilization of third-party exchange wallets;
• The source of funds used for cryptocurrency purchases;
• Record-keeping practices for cryptocurrency transactions;
• Involvement in initial coin offerings (ICOs);
• Whether the taxpayer's cryptocurrency holdings yield passive income (e.g., Node, Masternodes, Supernodes, etc.);
• Participation in cryptocurrency mining, including details about the mining hardware and associated energy expenses;
• Acceptance of cryptocurrency as payment for goods or services;
• The frequency of cryptocurrency transactions; and
• Time dedicated to monitoring cryptocurrency markets.

The taxpayer is also required to provide bank account statements and any other documents that enable the CRA tax auditor to corroborate the taxpayer's responses.

Tax Pro Tips: Maintaining Records, Legal Insights on Appropriate Cryptocurrency Tax Reporting, the Voluntary Disclosures Program for Unreported Cryptocurrency Earnings, and the Protection of Solicitor-Client Privilege

During a CRA cryptocurrency tax audit, a taxpayer without adequate records will face challenges. It's crucial for cryptocurrency traders, investors, and businesses that receive cryptocurrency as payment to maintain comprehensive transaction records.

For users of cryptocurrency exchanges, it's advisable to regularly export transaction data to prevent potential loss. To avoid situations like the Quadriga bankruptcy, ensure you maintain essential records concerning your cryptocurrency transactions. These records should include:

• Transaction dates;
• Receipts for cryptocurrency purchases or transfers;
• Cryptocurrency values in Canadian dollars at the transaction time;
• Digital wallet details and cryptocurrency addresses;
• Transaction descriptions and information about the other party, including their cryptocurrency address;
• Records from exchanges;
• Any accounting and legal expenses; and
• Software expenses for managing your tax matters.

If you're involved in cryptocurrency mining, make sure to maintain these records along with your cryptocurrency transaction data:

• Proof of purchase for cryptocurrency mining hardware;
• Documentation of expenses linked to your mining operation, such as electricity bills, mining pool fees, and maintenance costs;
• Detailed information about your mining setup, including hardware specifications and the duration of hardware operation; and
• Records pertaining to the mining pool you're part of, including relevant details and your participation history.

Our Certified Specialist Canadian tax lawyer can offer guidance on maintaining accurate records and correctly reporting your cryptocurrency earnings, reducing the risk of misrepresentation in your tax filings. For instance, you might find value in a tax memorandum assessing whether your cryptocurrency profits should be categorized as capital gains, business income, or a combination of both. It's crucial to note that intermediary transactions, like acquiring Bitcoin for the purpose of acquiring another cryptocurrency, can also trigger taxable events.

The advancements and collaborative actions of tax authorities have effectively ended the perceived anonymity enjoyed by cryptocurrency users. This development should be of significant concern to Canadian taxpayers who have undisclosed profits from cryptocurrency dealings. If you've submitted tax returns that excluded or understated your cryptocurrency profits, you run the risk of incurring not only civil financial penalties, like those for gross negligence but also the potential for criminal charges related to crypto tax evasion.

You might be eligible for relief through the CRA's Voluntary Disclosures Program (VDP). If your VDP application meets the criteria, the CRA will refrain from pursuing criminal charges and may waive gross-negligence penalties (and potentially reduce interest charges). However, it's crucial to note that the VDP application process is time-sensitive. For your application to be considered "voluntary," it must be submitted to the VDP before the CRA initiates contact with you regarding the non-compliance you intend to disclose. Our seasoned Canadian crypto tax lawyers have extensive experience assisting numerous Canadian taxpayers involved in cryptocurrency matters. They can expertly plan and promptly prepare your voluntary-disclosure application. A well-prepared application not only enhances the chances of the CRA accepting your disclosure but also sets the stage for a potential judicial-review application to the Federal Court in case the CRA unjustly denies your disclosure.

For an assessment of your eligibility for the Voluntary Disclosures Program, we recommend scheduling a confidential and privileged consultation with one of our highly knowledgeable Canadian tax lawyers. It's important to note that the Canada Revenue Agency is legally prohibited from compelling the disclosure of information protected by solicitor-client privilege. Essentially, solicitor-client privilege safeguards your confidential communications with your tax lawyer, preventing the CRA from accessing details of the legal advice you've received. Conversely, communications with an accountant are not afforded the same level of protection. Therefore, if you are seeking tax guidance while aiming to keep this information beyond the reach of the CRA, it is advisable to consult with a Canadian tax lawyer first. If the involvement of an accountant becomes necessary, your Canadian tax lawyer can engage the accountant on your behalf, thus extending the umbrella of privilege to this collaborative effort.

Frequently-Asked Questions (FAQs)

What can you anticipate during a CRA crypto tax audit?

During a cryptocurrency tax audit conducted by the CRA, it's essential to anticipate inquiries regarding your cryptocurrency tax obligations and the disclosure of various documents. These documents should encompass all wallet IDs and blockchain addresses under the taxpayer's ownership or control, in addition to encompassing details related to digital currency exchanges (DCE) and peer-to-peer (P2P) facilitators. These details should include associated user IDs, email addresses, IP addresses, and account numbers linked to those platforms.

Is reporting cryptocurrency mandatory?

Indeed, cryptocurrency profit reporting is obligatory, as is filing a form T 1135 specifying the existence of Cryptocurrencies assets if the total cost of foreign assets is in excess of dollars $100,000. According to the law, transactions involving virtual currency remain subject to taxation, making it necessary to incorporate these transactions in your tax returns.

Do I have to pay taxes if I made a profit from Bitcoin?

Absolutely, if you earned a profit from Bitcoin, you are still required to fulfill your tax obligations. In accordance with the law, cryptocurrency can also be considered taxable income, including if you received Bitcoin in exchange for virtual services or if you engaged in a coin-for-coin exchange with your Bitcoin or other cryptocurrency.

Is it possible to use Bitcoin for tax payments in Canada?

A few Canadian municipalities have embraced cryptocurrency payments for property taxes. Richmond Hill and Innisfil, located north of Toronto, have become the first in the country to do this. While other municipalities like Toronto have considered the option, they have not yet put it into practice.

Is income from cryptocurrency subject to taxation?

The CRA has not specifically covered Bitcoin taxation in its Information Circulars or Interpretation Bulletins but has now issued press releases indicating that Cryptocurrencies transactions are taxable. When a taxpayer sells Bitcoins, the income can be taxed either as business income or as capital gains resulting from the sale of property.

What is the regulatory framework for cryptocurrency in Canada?

Canada permits the use of digital currencies, encompassing cryptocurrencies, but they are not classified as legal tender in the country. It's important to note that Canada's tax regulations, including the Income Tax Act, are applicable to transactions involving cryptocurrencies.