On November 2, 2023, the Canada Revenue Agency (CRA) answered a series of questions as part of the Association de planification fiscal et financière’s annual conference in Quebec City that may have significant tax implications for centralized cryptocurrency trading platforms (CTPs) and their Canadian clients.1
Responding to two questions about cryptocurrency, the CRA took two important positions:
- A client that holds cryptocurrency through the facilities of a CTP may not own the cryptocurrency for Canadian income tax purposes.
- The depositing of cryptocurrency with a cryptocurrency trading and lending platform could result in a disposition for Canadian tax purposes, which would be a taxable event for the client depositing the cryptocurrency.
These positions could result in substantial unforeseen tax consequences for Canadian taxpayers looking to deposit their cryptocurrency with CTPs and could also have a major impact on how these CTPs interact with their Canadian clients. Below, we discuss the two questions addressed by the CRA, the CRA’s responses and the key takeaways from those responses.
The First Question
The first question related to a Canadian taxpayer who purchased bitcoin through a CTP so that she could ultimately pay for items online. The bitcoin was subsequently lost due to a fraud against the platform. The question asked how the taxpayer’s loss of access to the bitcoin would be treated for tax purposes, including when the taxpayer could claim the loss.
The CRA stated that the tax treatment of the loss would depend on several factors. First, it would need to be determined whether the taxpayer held the bitcoin in the course of a business or as a capital investment. The CRA also remarked on the need to examine the contractual relationship between the taxpayer and the CTP to determine the ownership of the cryptocurrency and the CTP’s liability to the taxpayer due to the fraud.
As an example, the CRA suggested that the loss would be attributed to the taxpayer if the CTP acted as custodian of the cryptocurrency on behalf of the taxpayer. In contrast, the CRA stated that, if the CTP was the true owner of the cryptocurrency pursuant to its contractual arrangement with the taxpayer, then a review of that arrangement would be necessary to determine the nature of the taxpayer’s rights and potential loss to determine whether the loss is deductible.
The CRA also noted that the mere holding of cryptocurrency for future use will not cause it to be personal-use property and remarked on the general tax treatment of losses arising as a result of fraud.
The Second Question
The second question was whether a disposition would arise for Canadian tax purposes where a taxpayer transfers bitcoin to an account offered by a centralized cryptocurrency trading and lending platform that offers a variable return of approximately 4% per annum, payable in bitcoin, and the terms and conditions for the platform account provide that:
- the platform may hold the bitcoin in its own name and pledge, sell, lend or otherwise transfer or use the bitcoin deposited in the account in its discretion without informing the taxpayer;
- the profit derived from the use of the bitcoin by the platform is the property of the platform and not of the taxpayer;
- the taxpayer is entitled to withdraw up to an equivalent amount of the bitcoin account balance at any time; and
- the bitcoin to be paid to the taxpayer on withdrawal from the platform may be paid from a cryptocurrency wallet holding bitcoin received from the platform's various customers.
The CRA stated that determining whether an event, transaction or transfer involving cryptocurrency constitutes a disposition must generally be made in light of all the facts, the relevant clauses of the contract and the applicable private law. Noting their answer was based solely on the limited facts presented above, the CRA concluded the taxpayer likely transferred ownership of the bitcoin to the platform, resulting in a disposition for Canadian income tax purposes. In coming to this conclusion, the CRA noted that the terms and conditions for the platform account specifically provided that the platform acquired the right to use the assets, to make profits from them and to dispose of them at its discretion.
If the CRA is correct, these positions could have a substantial impact both on CTPs and their Canadian clients.
CTPs and Other Cryptocurrency Platforms
CTPs and other cryptocurrency platforms should consider the contractual arrangements they have entered into with their clients to determine whether their clients are transferring ownership of cryptocurrency to them. These platforms should consider whether they should modify their user agreements or terms and conditions to reduce the risk that their clients will experience unintended tax consequences by depositing cryptocurrency. For example, a CTP may wish to ensure its user agreement or terms and conditions expressly state that the platform will not acquire the right to use, profit from or dispose of assets deposited on their platforms (i.e., the factors the CRA highlighted in finding there was a transfer of ownership in response to the second question). Notably, CTPs registered under Canadian securities laws are generally precluded from taking such actions with client cryptocurrency holdings pursuant to their terms of registration, meaning these CRA positions should hopefully not affect registered platforms’ normal operations.
Further consideration must also be given to the consequences of staking services offered by CTPs. Pursuant to these services, CTPs will often allow clients to earn staking rewards should they opt-in to have their cryptocurrency staked in accordance with the consensus protocol of the relevant blockchain. Although staking services may not directly mirror the 4% variable return offered by the cryptocurrency trading and lending platform discussed in the second question above, they do have similar features that could come under CRA scrutiny.
Canadian Clients of CTPs
These CRA positions could result in significant unforeseen tax liabilities for Canadian taxpayers. For example, taxpayers with accrued gains on cryptocurrency held on capital account could realize capital gains on depositing their cryptocurrency with a CTP, even if they did not intend to immediately dispose of the cryptocurrency.
1 This legal update is based on a translation of the Income Tax Ruling Directorate’s provisional written answers to the questions posed at the conference. Revisions to this update may be necessary once final versions of these responses are released under the Income Tax Ruling Directorate's severed letter program.
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