Should You Incorporate Your Cryptocurrency Activity? 6 Crypto Taxation FAQs
Published:
May 20, 2022
Author(s):
On May 22, 2010 (affectionately known as “Bitcoin Pizza Day”), a Floridian bought two Papa John’s pizzas with Bitcoin. The day is famous both as the first transaction with the first cryptocurrency, and for the price paid: 10,000 Bitcoins – the equivalent of over CAD $380M as of May 22, 2022. Since the first Bitcoin Pizza Day, the worldwide use of cryptocurrency has steadily grown, increasing the number of cryptocurrencies, transactions and businesses. And like any business, there comes a time when it makes sense to consider incorporating. When’s the right time? It’s the classic lawyer answer: “It depends.” To help you decide if you should consider incorporating your crypto activities, here are the answers to six common questions about the taxation of cryptocurrencies in Canada.
1. Why should I incorporate my cryptocurrency activities?
There are many factors to consider when deciding whether to incorporate a business. A key consideration is the potential tax benefit. Many people consider incorporating their crypto activities because of the significant gap between:
- The capital gain tax rules (50% of the capital gain is added to your income and taxed at your marginal tax rate, usually over 26%).
- The sole proprietor business income tax rate (taxed at your marginal tax rate, usually over 26%).
- The corporate business income tax rate (approximately 15%).
2. When does a cryptocurrency activity trigger tax implications?
Cryptocurrency transactions trigger tax implications when there’s a “disposition” of cryptocurrency. A disposition is how you get rid of an asset. Generally, owning cryptocurrency isn’t a taxable event. But there can be tax consequences when you do any of the following:
- Sell or gift cryptocurrency.
- Convert cryptocurrency to fiat (government-issued) currency.
- Use cryptocurrency to buy goods or services. When you use cryptocurrency to purchase goods or services, the Canada Revenue Agency (CRA) treats this as a barter transaction for income tax purposes. A barter transaction occurs when two parties exchange goods or services and carry out that exchange without using legal currency – and in Canada, cryptocurrency is considered a commodity, not legal tender.
- Trade or exchange cryptocurrency. Generally, when you dispose of one cryptocurrency (e.g. Bitcoin) to acquire another cryptocurrency (e.g. Ethereum), the barter transaction rules apply. This transaction is considered a disposition. The CRA requires that you report this transaction, as if you had sold your Bitcoin for Canadian dollars and then separately bought Ethereum with Canadian dollars. This information is then reported as either business income (or loss) or a capital gain (or loss).
3. How’s cryptocurrency income taxed?
Cryptocurrencies are a relatively new concept, with characteristics that oddly straddle several asset classes. The CRA has classified cryptocurrency as a commodity for all purposes relating to the Income Tax Act. Depending on the circumstances, the CRA treats income (or losses) from transactions involving cryptocurrency, and earnings (or losses) from cryptocurrency activities, as either:
- Business income or losses.
- Capital gain or loss.
Incorporating is only useful from a tax perspective if the CRA recognizes your crypto transactions as business income, and not as a capital gain.
4. Is the resulting income “business income” or a capital gain?
So how does the CRA distinguish between business income, derived from carrying on a business, and a capital gain?
Common Signs. Common signs that you might be carrying on a business, and that the resulting income is “business income”, include:
- Carrying on activity for commercial reasons and in a commercially viable way.
- Undertaking activities in a businesslike manner, which might include preparing a business plan and acquiring capital assets or inventory.
- Promoting a product or service.
- Showing that you intend to make a profit, even if you’re unlikely to do so in the short term.
Frequency. Business activities normally involve some regularity or a repetitive process over time. But each situation is considered on a case-by-case basis. In some cases, a single transaction is considered a business, for example, when it’s an adventure or concern in the nature of trade.
Timing. Another factor to consider when determining if there’s a business activity is the date the business begins. If you’re still setting up or preparing to go into business, the CRA might not consider your activities to be business activities just yet. You usually have to undertake significant activity that’s part of your income-earning process before the CRA will acknowledge business activity has occurred. The CRA generally doesn’t consider any funds or property you receive before your business begins to be business income. Similarly, you can’t claim deductions for income tax purposes before the business begins. For more information, please review the CRA’s archived content on the start of business operations.
Examples. Typical examples of cryptocurrency businesses include:
- Mining.
- Trading.
- Exchanges (including ATMs).
You can find more information on business income versus capital gains in the CRA’s Interpretation Bulletin IT-479R (in particular, paragraphs 9 to 32) and its Guide T4037, Capital Gains.
5. Is cryptocurrency earned through mining taxable?
One way to acquire cryptocurrencies is to earn them through mining. But the cryptocurrency you earn through mining doesn’t trigger tax implications until you dispose of it. The income tax treatment for cryptocurrency miners is different depending on whether their mining activities are a personal activity (a hobby) or a business activity. The CRA makes this decision on a case-by-case basis. A hobby is generally undertaken for pleasure, entertainment or enjoyment, rather than for business reasons. If the CRA considers you to be acting as an individual engaged in a hobby, when you dispose of the mined crypto you’ll only pay capital gains tax. But if the CRA considers your mining to be more akin to a business activity, when you dispose the mined crypto you’ll pay income tax based on your marginal personal rate (if you’re a sole proprietor) or at the corporate rate (if you’re incorporated).
6. How do you value cryptocurrencies?
To report cryptocurrency income on your tax return, you’ll need to convert the value of the cryptocurrency into Canadian dollars to calculate the business income (or loss) or the capital gain (or loss). Where you can’t determine the value of a cryptocurrency transaction in Canadian dollars, you must use a “reasonable method” to determine the “fair market value”. Generally, the CRA’s position is that the fair market value is “the highest price, expressed in dollars that a willing buyer and a willing seller who are both knowledgeable, informed and prudent, and who are acting independently of each other, would agree to in an open and unrestricted market”. Whatever method you choose, use it consistently and keep a record.
Please contact your McInnes Cooper lawyer or any member of our Corporate & Business Law Team @ McInnes Cooper to discuss incorporating your cryptocurrency activities.
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