Canadian Cryptocurrency Tax Planning: Transferring Cryptocurrency To A Bare Trustee Or Holding Cryptocurrency As A Bare Trustee – Canadian Tax Guidance From A Canadian Tax Lawyer

Introduction: Bare Trusts & Canadian Cryptocurrency Users

The developments in blockchain technology bring about an ever-increasing range of opportunities, arrangements, and assets—smart contracts, cryptocurrency liquidity mining and yield farming, and non-fungible tokens (NFT), to name a few. A bare-trust agreement may offer yet another layer of flexibility for Canadian cryptocurrency traders and blockchain investors.

This article is meant for cryptocurrency-savvy Canadians who may benefit from settling a bare trust concerning their blockchain-based assets and who seek to understand the notion of a bare trust. This article discusses three key topics concerning a bare-trust relationship—namely, its nature, its relevance for Canadian tax purposes, and the indicia proving its existence. This article concludes by offering pro tax tips from our top Canadian crypto tax lawyers to Canadian cryptocurrency users who have created or who seek to create a bare trust.

What is a Trust and What is a Bare Trust?

The trust concept finds its roots in equity, a body of law developed in the English Court of Chancery and adopted by Canadian courts. Equity distinguishes legal ownership from beneficial ownership. A person legally owns a property if his or her name is on title, yet the beneficial owner is "the real owner of property even though it is in someone else's name." (Csak v Aumon, [1990] 69 DLR (4th) 567 (Ont. HCJ), at p. 570.)

A trust, then, is a relationship between a trustee, a beneficiary, and a property. And it depends on the distinction between beneficial and legal ownership: the trustee legally owns the property; the beneficiary (unsurprisingly) beneficially owns the property.

The trust's creator (also known as the settlor) will often burden the trustee with duties to maintain or manage the trust property in the beneficiary's favour. For instance, the settlor might require that the trustee manage a large sum of money, cryptocurrency, or non-fungible tokens for a child or disabled beneficiary.

A bare trust, however, is a trust in which the trustee has no obligations other than to deal with the trust property in compliance with the beneficiary's directions. In other words, under a bare trust, the beneficiary retains complete control over the trustee's dealings with the trust property.

As such, a bare trust is primarily an agency relationship whereby the bare trustee holds title to property as the beneficiary's agent. An agency relationship exists where parties agree that one person (the agent) shall act in accordance with the directions of the other (the principal). Hence, a bare trust arises when parties agree that one person (the bare trustee) shall act in accordance with the directions of the other (the beneficiary) with respect to a property (the trust property). The trust property is, of course, the property over which the beneficiary enjoys true ownership but to which the bare trustee holds legal title.

How Is a Trust Taxed in Canada?

Although a trust is a relationship between entities and not itself an entity, Canada's Income Tax Act treats a trust as a separate taxpayer. Subsection 104(2) of Canada's Income Tax Act deems a trust to be an individual for income-tax purposes. This means that a trust must file a T3 trust income-tax return each taxation year. It also means that the settlement of a trust constitutes a disposition of the trust property to the trust, and the settlor may thereby trigger capital-gains tax.

Moreover, if the trust itself earns income, it pays Canadian income tax at the top marginal tax rate on the income remains in the trust. The trust may claim a deduction for the income that it pays to a beneficiary. The beneficiary accordingly pays tax on amounts received from the trust.

A trust that qualifies as a graduated-rate estate (GRE) doesn't incur top-rate tax on its income; a GRE's income is taxed at progressive rates. A "graduated-rate estate" basically refers to a deceased person's estate during the 36 months after that person's death.

A trust must also realize all accrued capital gains for income-tax purposes every 21 years. Subsection 104(4) of Canada's Income Tax Act deems a trust to have disposed of all capital property at fair market value every 21 years. (For spousal trusts, alter ego trusts, and joint spousal trusts, this deeming rule doesn't apply during the lifetime of the qualifying beneficiary. Instead, the deemed disposition occurs upon that beneficiary's death, and, if the trust continues, every 21 years thereafter.)

How Is a Bare Trust Taxed in Canada?

Canada's income-tax law ignores the bare trustee. Although subsection 104(2) of Canada's Income Tax Act deems a trust to be an individual for income-tax purposes, this deeming rule doesn't apply to "an arrangement under which the trust can reasonably be considered to act as agent for all the beneficiaries under the trust with respect to all dealings with all of the trust's property" (see: subsection 104(1)). As a result, if a person retains beneficial ownership of cryptocurrency, non-fungible tokens, or other blockchain assets while transferring legal title to a bare trustee—e.g., by transferring the assets to the bare trustee's wallet—the transaction does not constitute a disposition for income-tax purposes, and the settlor does not thereby trigger capital-gains tax.

Subsection 104(1) also deems a bare trust to not be a trust for income-tax purposes. For that reason, a bare trust needn't file a T3 trust income-tax return. In addition, a bare trust isn't subject to the 21-year deeming rule under subsection 104(4) of Canada's Income Tax Act. So, the bare trust isn't forced to realize all accrued capital gains for income-tax purposes every 21 years.

And if, in accordance with the beneficiary's directions, the bare trustee sells some or all of those blockchain assets to a third party, the transaction is taxed as though the beneficiary had dealt directly with the third party. That is, the beneficiary must report the resulting gain or loss as income. (The resulting gain or loss will be reported either on capital account or on income account, depending on the facts surrounding the transaction.)

The same is true for the foreign-reporting rule requiring a Canadian-resident person to file a T1135 form if that person owns "specified foreign property" with a total cost exceeding $100,000. Cryptocurrency, NFTs, and other blockchain-based assets are "intangible property," and, because they exist on decentralized digital platforms, they're "situated, deposited or held outside Canada." As such, they typically meet the definition of "specified foreign property." Although the bare trustee holds legal title to the digital assets by means of the bare trustee's wallet, those digital assets truly belong to the bare trust's beneficiary. If the beneficiary's total cost for those cryptocurrency, non-fungible tokens, and other blockchain assets exceeds $100,000, the beneficiary must file a T1135 form disclosing those assets.

For the most part, a bare trust's GST/HST treatment reflects its income-tax treatment. That is, courts will generally ignore a bare trust when applying the provisions of Canada's Excise Tax Act. This is relevant to Canadians who create, sell, and trade non-fungible tokens. Commercial sales of non-fungible tokens might bring about GST/HST obligations because commercial NFT sales qualify as a taxable supply under the Excise Tax Act. Thus, if you engage in commercial NFT sales through a bare trust in which you're the beneficiary, you may need to register for GST/HST and to charge, collect, and remit GST/HST on your NFT sales in Canada.

There are exceptions to the Canadian tax treatment of a bare-trust relationship. For example, a bare trustee isn't ignored for the purposes of the GST/HST New Housing Rebate (see: The Queen v Cheema, 2018 FCA 45). Thus, while Canadian tax law typically ignores bare trusts, this treatment isn't universal. The lesson is that, before entering a bare-trust relationship, you must first confirm that the bare trust will indeed bring about the desired tax consequences in your particular circumstances. For tax guidance concerning bare trusts, speak to one of our expert Canadian tax lawyers in Toronto today.

How Do You Determine Whether a Bare Trust has been Created?

As with a conventional express trust, a bare trust must exhibit the so-called three certainties: (1) certainty of intention, (2) certainty of subject, and (3) certainty of object. The certainty-of-intention requirement deals with the settlor's intention to create a trust, and this requirement demands that the settlor demonstrate an intention to create a trust by obligating the trustee to hold a property for the beneficiary's benefit. The certainty-of-subject requirement deals with the property that the settlor intends to put in trust, and it demands three things. First, the settlor must own the property—at least beneficially—that the settlor intends to put in trust. Second, the trust property must be ascertainable when the trust comes into existence. Third, each beneficiary's entitlement to the trust property must be sufficiently defined. Finally, the certainty-of-object requirement deals with the trust's beneficiary or beneficiaries. Under this requirement, it must be possible to ascertain each beneficiary (if the trust is a fixed trust) or to determine the beneficiary status of a given individual (if the trust is a discretionary trust).

But the principles of agency law also prove relevant in a bare-trust relationship. This is because a bare trust is essentially a principal-agent relationship in which the agent holds legal title to property that the principal beneficially owns. Hence, the principles that discern whether parties have entered an agency relationship also bear upon whether parties have created a bare trust.

An agency relationship may emerge in one of two ways: First, it may arise by agreement between the principal and agent. Their agreement may be express, or it may be implied by the conduct or situation of the parties. Second, an agency relationship may retrospectively emerge by the principal's subsequent ratification of acts done on his behalf.

The essential ingredients of an agency relationship are that (i) the principal and agent must both consent, (ii) the principal has given the agent the authority to affect the principal's legal position, and (iii) the principal retains control over the agent's actions. The parties need not have reduced their agency agreement to writing. If no written agency agreement exists, the parties' conduct determines whether they intended to create an agency relationship.

The key feature is the level of control that the alleged principal exerts over the alleged agent. Notably, in an agency relationship, the principal retains beneficial ownership of any property subject to that relationship. Hence, when an agency relationship calls for the agent to acquire the principal's property, a bare trust potentially arises: If the agent acquires the principal's property with the sole responsibility of carrying out the principal's instructions, the agent holds that property as a bare trustee while the principal enjoys the rights associated with beneficial ownership—that is, the rights to use, possess, dispose of, earn income from, and destroy the property. If, on the other hand, the alleged agent need not accept the principal's instructions on dealing in the property, or if the alleged agent has significant independent power, discretion, responsibility over the property, he is neither an agent nor a bare trustee.

Therefore, when parties haven't recorded their agreement in a written legal instrument, a number of factors speak to whether the parties have created a bare trust with respect to a property. Relevant questions will include the following (amongst others):

• Does the purported bare trustee deal in the alleged trust property without the purported beneficiary's direction or permission?
• Does the purported bare trustee derive any personal benefit from the alleged trust property?

This determination calls for a detailed analysis of the parties' arrangement in light of the principles governing agency and bare-trust relationships. So, if you want to create a bare trust concerning your cryptocurrency, non-fungible tokens, or other blockchain assets, or if you seek to confirm whether you hold these assets as a bare trustee, please consult one of our experienced Canadian tax lawyers.

Pro Tax Tips: Tax-Planning Opportunities Involving Crypto-Based Bare Trusts & The Importance of a Written Bare-Trust Agreement

A bare trust affords the flexibility of holding cryptocurrency, non-fungible tokens, or other digital assets in a wallet or exchange account under another person's or entity's name while preserving the tax treatment that correctly reflects your true ownership of those digital assets.

This often proves useful to Canadian taxpayers who want to incorporate a cryptocurrency-trading business. By operating a cryptocurrency-trading business through a Canadian-controlled private corporation (CCPC), a Canadian cryptocurrency trader not only gains access to the small-business deduction (SBD) tax rate but also reaps the benefits of tax-deferral opportunities. Section 85 of the Income Tax Act allows a tax-deferred rollover of cryptocurrency, non-fungible tokens, or other blockchain assets to the corporation at cost, thereby deferring personal tax on any accrued, unrealized gains. But as a matter of convenience, after incorporating the cryptocurrency-trading business, the business owner might prefer to avoid transferring title to the cryptocurrency wallets or exchange accounts under the owner's name. This can be accomplished by means of a bare-trust agreement whereby the owner continues to hold legal title to these assets solely for the benefit of the crypto-trading corporation. For tax purposes, the corporation will be treated as if it dealt directly with the crypto assets in the wallet or exchange account. (For more information on incorporating a cryptocurrency-trading business, see our article about the Canadian tax benefits of operating your cryptocurrency-trading business or NFT-sales business as a CCPC.)

Another common scenario arises when a Canadian taxpayer wants to invest in cryptocurrency, non-fungible tokens, or other digital assets, and the taxpayer asks a more crypto-experienced friend or relative to make the purchase on the taxpayer's behalf. The friend or relative will then purchase the digital assets using the taxpayer's money and hold the asset as a bare trustee for the taxpayer's benefit. In accordance with the bare-trust relationship, although the bare trustee holds legal title to the digital assets, the resulting tax responsibilities fall solely on the taxpayer who beneficially owns the digital assets underlying the bare trust.

As mentioned above, the creation of a bare trust does not require a written agreement. The parties' conduct is what determines whether they intended to create a bare trust. Still, if parties intend to create a bare trust, they should execute a written bare-trust agreement. Likewise, parties who have already entered an oral bare-trust agreement should memorialize their pre-existing bare-trust relationship by executing a written bare-trust agreement. Although the bare-trust agreement is itself distinct from the document recording that agreement, the Canada Revenue Agency will likely dispute the existence of a bare trust without documentary evidence.

If you plan on entering a bare-trust agreement concerning digital assets or if you want to confirm whether a crypto-related arrangement qualifies as a bare trust, consult with one of our knowledgeable Canadian NFT-tax and crypto-tax lawyers today. Not only can our expert Canadian tax lawyers provide tax guidance about crypto-planning opportunities involving bare trusts, but they can also draft a bare-trust agreement containing the clauses that you require for your blockchain-related arrangement.

Frequently Asked Questions

Question: What is a bare trust? And what's its significance for tax purposes?

Answer: A bare trust is a trust in which the trustee has no obligations other than to deal with the trust property in compliance with the beneficiary's directions. In other words, under a bare trust, the beneficiary retains complete control over the trustee's dealings with the trust property. As such, a bare trust is primarily an agency relationship whereby the bare trustee holds title to property as the beneficiary's agent. Canada's tax laws typically ignore a bare trust. For example, if a person retains beneficial ownership of cryptocurrency, non-fungible tokens, or other blockchain assets while transferring legal title to a bare trustee—e.g., by transferring the assets to the bare trustee's wallet—the transaction does not constitute a disposition for income-tax purposes, and the settlor does not thereby trigger capital-gains tax. Likewise, the bare trust's income is taxed as though the beneficiary had earned that income directly. Also, a bare trust needn't file a T3 trust income-tax return.

Question: I transferred various cryptocurrency and non-fungible tokens to my friend. How do I determine whether I have created a bare trust? What happens if this transfer doesn't qualify as a bare trust?

Answer: If you in fact didn't create a bare trust when transferring the cryptocurrency and NFTs to your friend, then you have disposed of those digital assets at fair market value, which means that you may incur capital-gains tax.

As with a conventional express trust, a bare trust must exhibit the so-called three certainties:

• certainty of intention: You must have intended to create a bare trust.
• certainty of subject: You must have owned the cryptocurrency and non-fungible tokens that you settled into the bare trust, the bare trust property must be ascertainable when the trust came into existence, and your beneficial entitlement to the trust property must be sufficiently defined.
• certainty of object: It must be possible to ascertain that you were the beneficiary.

But the principles of agency law also prove relevant in a bare-trust relationship. This is because a bare trust is essentially a principal-agent relationship in which the agent holds legal title to property that the principal beneficially owns. Hence, the principles that discern whether parties have entered an agency relationship also bear upon whether parties have created a bare trust. The essential ingredients of an agency relationship are that (i) the principal and agent must both consent, (ii) the principal has given the agent the authority to affect the principal's legal position, and (iii) the principal retains control over the agent's actions. If no written agency agreement exists, the parties' conduct determines whether they intended to create an agency relationship.

In short, the bare-trust determination calls for a detailed analysis of your arrangement in light of the principles governing agency and bare-trust relationships. So, to confirm whether you created a bare trust, please consult one of our experienced Canadian tax lawyers.

Question: Is it necessary to have a written bare-trust agreement?

Answer: The creation of a bare trust does not require a written agreement. The parties' conduct is what determines whether they intended to create a bare trust. Still, if parties intend to create a bare trust, they should execute a written bare-trust agreement. Likewise, parties who have already entered an oral bare-trust agreement should memorialize their pre-existing bare-trust relationship by executing a written bare-trust agreement. Although the bare-trust agreement is itself distinct from the document recording that agreement, the Canada Revenue Agency will likely dispute the existence of a bare trust without documentary evidence. Our expert Canadian tax lawyers can draft a bare-trust agreement containing the clauses that you require for your specific circumstances.

Question: I am the beneficiary of a bare trust containing cryptocurrency and non-fungible tokens. Do I need to file a T1135 Form?

Answer: For income-tax purposes, the bare trustee is ignored, and the beneficiary of a bare trust is treated the same as a person who holds the property without an intermediary. Generally, you must file a T1135 form for each tax year in which the following three conditions applied: (1) you were a Canadian tax resident; (2) you held "specified foreign property" during the year; and (3) your aggregate tax cost for the "specified foreign property" exceeded $100,000 (in Canadian currency) at any point during the year. Cryptocurrency, NFTs, and other blockchain-based assets are "intangible property," and, because they exist on decentralized digital platforms, they're "situated, deposited or held outside Canada." As such, they typically meet the definition of "specified foreign property." Therefore, although the bare trustee holds legal title to your cryptocurrency and non-fungible tokens by means of the bare trustee's wallet, you may need to file a T1135 form reporting those blockchain assets if their total cost exceeds $100,000. That said, "specified foreign property" excludes "property that is used or held exclusively in the course of carrying on an active business." This includes inventory. So, if you operated a cryptocurrency/NFT-trading business, the cryptocurrency and NFTs that you held as inventory don't qualify as "specified foreign property." This might apply to the cryptocurrency and NFTs in your bare trust. So, to confirm whether you must file a T1135 form with your income-tax return, speak to a knowledgeable Canadian tax lawyer.

Question: I hold cryptocurrency and non-fungible tokens as a bare trustee for a family member. Do I need to file a T1135 Form?

Answer: The definition of "specified foreign property" arguably includes the bare trustee's legal title. Under paragraph (h) of the definition, "specified foreign property" includes "an interest in [...] any property [...] that is specified foreign property." This might capture the legal title that the bare trustee holds in the digital assets comprising the bare trust. Still, the bare trustee holds merely vacuous legal title to the digital assets, so the bare trustee's cost for that interest should be nominal. As a result, even if bare legal title to digital assets meets the definition of "specified foreign property," the bare trustee will likely fail to meet the $100,000-cost requirement. Canadian tax statutes are exceedingly complex. If you hold any asset, including cryptocurrency or non-fungible tokens, as a bare trustee, consult with our Certified Specialist in Taxation crypto-tax lawyer for advice on your Canadian tax-reporting obligations.