In the year 2022, cryptocurrency has grown explosively in headlines throughout the business world.
However, despite it’s popularity, many seem to lack an understanding of what exactly Cryptocurrency is, or how to navigate its use.
Today I’ll be going over the basics of Cryptocurrency and how to make informed decisions regarding it’s effect on you and your business.
What is Blockchain/Cryptocurrency?
Blockchain technology was devised in reaction to the 2008 financial world crisis, and shortly after in 2011, the first cryptocurrency Bitcoin was created.
The purpose behind it’s creation was to allow for complete transparency of financial transactions through its technology.
This is an oversimplification; however, it can be seen as a complex encryption technology with many applications beyond digital assets/currency such as encryption of health and governmental records, patents and other use cases.
‘Blockchain’ is a technology that uses numerous computers to verify transactions, and once enough are confirmed in the transaction query, the transaction is allowed to occur. Those individuals/companies who offer their computers to encrypt and verify these transactions are given a small portion of the transaction. They are commonly referred to as ‘miners.’
While there are other methods of transaction verification, such as Proof of Stake or Proof of Authority, the method used by Bitcoin (the largest cryptocurrency) is Proof of Work and follows the process explained above.
Perception is Key
Since then, Bitcoin and other digital currencies (Dogecoin, Ethereum, etc.) have gradually gained acceptance across the world in numerous communities. One notable occurrence is El Salvador accepting Bitcoin as legal tender on June 5, 2021. The US government, along with multiple others, is also exploring the idea of minting its own digital currency.
The idea is that the value of these digital assets/currencies is based on how we perceive them, leading to high volatility that fluctuates rapidly even within a normal trading day.
Something as simple as a tweet from a well-known influencer can significantly impact the day-to-day value of a currency.
The Mythos Around Crypto:
Don’t criminal organizations use this?
Yes, modern criminal organizations do often use cryptocurrencies as a way to hide their transactions from the eyes of the law. However, this does not mean that cryptocurrencies are a black-market exclusive currency that should be avoided!
The recent adoption of cryptocurrencies by more of the world’s population actually permits consumers a massive variety of products from legitimate vendors to choose from, including large names such as Microsoft, Overstock, and even Tesla (until recently).
There is also a wide range of services available for users looking to convert cryptocurrency into gift cards or store credit at their favourite retailers.
Trading Crypto for family and friends?
Trading crypto on behalf of friends and family can quickly become problematic, as individuals who deal in cryptocurrencies on behalf of friends and family often use their own name. In most cases, authorities will attribute the transactions to that individual’s income if the cryptocurrency was bought under their account.
We highly recommend that individuals do not trade for their family members or friends on their behalf!
Unfortunately, power consumption is a serious topic of debate when it comes to cryptocurrencies, especially Bitcoin and Ethereum, the 2 most ‘mined’ currencies at the moment. It has been theorized that the power consumption of this technology so far has outgrown the usage of some small countries!
This has led to the creation and use of other digital currencies that only consume a mere fraction of the power that Bitcoin requires.
Can I use Crypto to avoid taxes?
In short: No, you cannot.
Why? CRA has been researching and exploring since 2015 how to better trace cryptocurrency transactions in order to find those who have not been reporting their gains on their tax returns. Once the rules, regulations, and laws have caught up, they will be able to go back and audit past years if they suspect there have been indications of tax evasion. In some cases, for 2020, individuals have had to pay up to $300,000 in penalties for not reporting their transactions.
It is not recommended under any circumstances to attempt to avoid paying taxes on your cryptocurrency holdings.
Do I need an accountant?
If the individual’s activities are fairly simple and done as a side hobby, it may not be cost-effective to use an accountant as the costs can outweigh the benefits. The individual can report their holdings on the relevant schedules in the individual’s personal tax return. However, when there is high-activity trading, such as margin trading or decentralized finance (DEFi), it may be appropriate to talk to a professional.
How is this relevant to my corporate taxes?
In regards to your business, the complexity behind cryptocurrency is whether it would be deemed as capital assets or inventory, which would then dictate if they are classified as capital gains or business income. The main idea is that capital property is assumed to be bought and held onto for many years, such as a house, securities, stock, bonds, or mutual fund trusts.
For those that trade on a consistent basis day to day or week to week, this would be likely considered inventory and subsequently classified as business income.
There is a common misconception that individuals can simply gift their cryptocurrencies to their children without tax consequences. CRA views this as a ‘taxable disposition’ since the advent of the ‘Kiddie Tax’ attribution rules, meaning that any income earned by the children could be taxed back to the parent.
Superficial loss rule
Due to the volatile nature of cryptocurrency, individuals often find themselves trading multiple times monthly, weekly, or even daily. The important thing to note is that if an individual sells for a loss and repurchases the asset within 31 days, they will not be able to claim that loss based on the superficial loss rules in the income tax act. Keep in mind corporations are not subject to the superficial loss rule.
Do I need to set up a company?
The answer to this depends on the individual’s situation and what their future plans are with their cryptocurrency ventures.
- How often will they be trading?
- Will they replace their day job with it?
It is important to talk to accounting and legal professionals as there are significant costs associated with forming a corporation and reporting on said assets.
That being said, if they are incorporated, any exchange accounts used in cryptocurrency transactions should be made in the name of the company, as if they are in the individual’s name, they will be taxable to the individual personally.
Whether incorporated or sole proprietor, business income allows for the flexibility to claim expenses against said income, such as electricity, computer equipment, business use of home office, insurance, accounting and legal fees, software costs, advertising, etc.
Business owners may also receive personal income derived from cryptocurrency that would lead to available RRSP room.
Provide ALL your information!
In order to meet regulatory and income tax requirements, it’s crucial that the individual provides all information available in order for the accountants and legal professionals to get the details right.
Yes, this means that every single trade or transaction MUST be recorded!
If an individual forgets a piece of information or even one exchange, it can create improper reporting and could lead to future tax audits with interest and penalties.
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This information cannot be deemed as direct financial advice or binding as each individual’s situation will vary. Individuals should engage with an accountant if they are not certain of how to treat their specific situation. The role of a chartered professional accountant is to provide their clients with sound financial advice and interpretation of the rules between the taxpayer and CRA.