Introduction – Cryptocurrency: Global Challenges, Regulations
and the Tax Implications Associated with the Seizure of Crypto
Assets
In May 2021, electric car manufacturer Tesla Inc. announced its
decision to stop accepting Bitcoin as payment. According to CBC,
Tesla’s announcement sparked a decline in cryptocurrency
prices. In June 2021, China announced its decision to ban all
financial institutions and payment companies from providing
services related to cryptocurrency transactions. According to CBC,
China’s announcement to “crack down on
cryptocurrencies” exacerbated the decline in cryptocurrency
prices. In addition, according to CBC, the Bank of Canada’s
Federal Reserve hinted that it may launch a challenge
“declaring that crypto works against the public good”.
Further, according to CBC, while many investors are worried about
potentially losing their digital investments, others have already
“lost more than half their investments” due to the
ongoing decline in the crypto market.
According to CBC, Tesla’s Inc.’s announcement sparked a
“nearly $1 billion US wipe off of the market capitalization in
the crypto sector”. CBC explains, Tesla Inc. announcement
played a significant role in cryptocurrency’s drop by 54%
“from a record high of $64,895 hit on April 14”, which is
the first monthly decline since November 2018. In addition,
according to CBC, China’s announcement exacerbated the decline
in Bitcoin which was initially sparked by Tesla’s decision to
stop accepting Bitcoin as payment. CBC explains, by mid-May,
Bitcoin experienced more than a 50% drop and “it hit a
three-and-a-half month low of $30,066” which was at its lowest
since January 2021. According to CNBC, by the end of June, Bitcoin
hit a monthly low of $28,908. Further, CBC explains, Bitcoin’s
decline negatively impacted other crypto assets including ether (a
coin that is limited to Ethereum blockchain network) which recently
dropped to its weakest level since late January 2021.
According to CBC, Bitcoin, which was already under pressure by
Tesla and China’s announcements, experienced a peak loss of
over 50%. Other cryptocurrency, such as Dogecoin, suffered even a
bigger loss “in percentage terms”, however, CBC explains,
the loss was greater for investors who “bought at
margin”. According to CBC, buying at margin is a “process
where investors borrow from their broker to invest but are required
by lenders to pay back part of what they owe if the value of their
stake falls below a certain level”. According to CBC, some
investors who bought at margin “are forced to sell into a
falling market”, unless they have excess funds to cover their
loan amount upon demand for repayment. CBC referred to the CNBC
business news service which reported that margin calls have also
heightened “volatility in the unregulated global crypto
market” where some investors borrow from their broker “at
ratios of 100 to 1”. That is, investors borrow $100 for every
$1 of their own money to purchase their investments. While this
kind of leverage investment can potentially be lucrative when
markets are rising, yet margin traders risk losing all of their
investments in a declining market. According to CBC, although
Canadian brokerages do not offer these types of margins, “in a
global market everyone suffers the consequences”.
In June 2021, according to CBC, El Salvador, which uses the US
dollar as its currency, became the first country to declare
cryptocurrency as a “legal tender”. CBC elaborates, El
Salvador’s President, Nayib Bukele, announced that the
“government will guarantee the convertibility to the exact
value in dollars at the moment of the transaction”. In this
context, CBC explains, some Salvadorians who recently negotiated
their salaries in Bitcoin may regret their decision due to the
recent decline in Bitcoin.
In addition, in June 2021, the Bank for International
Settlements (BIS) released its “Central Bank Digital
Currencies: An Opportunity for Monetary System” report (the
“BIS Report”) shedding light to the ongoing challenges of
the cryptocurrency market. According to CBC, the BIS Report
presents that central banks “will begin to issue their own
digital coins” and they may even take action to discourage the
use of cryptocurrencies. CBC pointed to the BIS Report’s
conclusion which states that “innovations such as
cryptocurrencies, stablecoins and the walled garden ecosystems of
big techs all tend to work against the public good elements that
underpins the payment system”.
According to The Jerusalem Post, the Knesset, which is the
legislature of Israel, joined the global trend of “creating
NFT – a non-fungible token” for Israel’s new President
Isaac Herzog, in honor of his inauguration. Simply put by Forbes
Media, NFTs are digital assets that represent objects (i.e., music,
art and videos) that can be bought and sold online and are often
encoded using the same software as cryptocurrency. The Jerusalem
Post explains, certain NFTs are becoming popular worldwide with an
“NFT of the original World Wide Web code recently sold for
$5.4 million”. According to The Jerusalem Post, the Knesset,
is the “first parliament in the world to create an NFT”
yet NFTs ongoing global success could attract others to join the
trend of “creating NFT”. For example, according to The
Jerusalem Post “artist Mike Winkelmann recently sold an NFT
for a record price of $69.3 million”. The Knesset reflects how
government officials are becoming increasing involved into NFTs and
cryptocurrency.
In May, Bloomberg reported that the “Bank of Israel is
testing Ethereum tech” in a recently launched internal digital
trial. Israel’s central bank issued a statement explaining that
its digital payment system could potentially create a positive
impact on the country’s economy by way of “simplifying
payment processes while providing security to both parties in a
transaction”, Bloomberg reported. According to Coindesk, some
believe that central bank digital currencies will create
“efficient and inexpensive infrastructure for cross-border
payments”. In addition, Coindesk reports, Sweden’s
Riksbank and the European Central bank are among some of the banks
that are “actively researching and developing their own
digital currencies in preparation for expected launches”
within the next five years. In contrast, Coindesk explains, the US
Federal Reserve is adopting a “more cautious approach”
with regards to launching its own digital currencies.
Despite the ongoing challenges of the cryptocurrency market, CBC
sheds light on some of the benefits associated with digital money
issued by central banks. CBC explains, unlike cryptocurrencies,
which could potentially “rise and fall unpredictably”,
the value of digital money issued by central banks “are
known”. In addition, CBC explains, unlike stablecoins, digital
money issued by central banks “can be spent anywhere as a
legal tender”. CNBC defines Stablecoins as
“cryptocurrencies pegged to an underlying asset”.
Further, both CBC and the BIS Report seem to suggest that digital
coins issued by central banks could potentially have many of the
advantages of cryptocurrency “without the disadvantages”.
For example, according to CBC, while digital money issued by
central banks “eliminate the role of an intermediary”
when investors transfer money, they also “protect privacy
while maintaining the integrity of the payment system and law
enforcement”. However, CBC explains, long-time crypto holders
will likely disagree with the above-mentioned benefits associated
with central banks issuing digital money. According to CBC, unlike
cryptocurrency, transactions and payments made by digital money
issued by central banks could potentially be traceable by
governmental authorities for various reasons including, but not
limited to, law enforcement and taxation.
Related to that, according to Block Crypto Inc., on July 7,
2021, Israel’s Minister of Defense, signed a seizure order for
crypto wallets which are presumed to be associated with Hamas
operatives. According to Block Crypto Inc., the crypto wallets
include a list of “84 addresses for Bitcoin, Tether, Ether and
Dogecoin, among others”. Block Crypto Inc. explains that the
National Bureau for Counter Terror Financing “attributes most
of these wallets to seven Palestinian nationals it associates with
Hamas” However, some of the crypt wallets “remain
anonymous”. Block Crypto Inc. explains, Hamas is a terrorist
Islamic group that controls the Gaza Strip. According to Block
Crypto Inc., the “European Union, United States, and Israel
have all designated Hamas or its affiliates as terrorist
organizations”. According to Block Crypto Inc., Israel’s
Minister of Defense issued a statement indicating that “any
individual who claims ownership of any or all of The Property
[namely, the 84 crypto addresses], may make their claims and submit
them in writing to the Head of the National Bureau for Counter
Terror Financing”. Further, Block Crypto Inc. explains that
“this is not the first time that Hamas has been identified as
using crypto to gather donations”. For example, Block Crypto
Inc. reports, in 2019 an Israeli not-for-profit organization
attempted to cease Hamas’ use of Coinbase and in 2020 the US
Department of Defense and Department of Justice exposed a
“massive seizure operation that hit cryptocurrency wallets
owned by Hamas, Al-Qaeda and ISIS”.
In early June 2021, US government officials recovered the
“majority of a multimillion-dollar ransom payment” in
Colonial Pipeline hack, CBC reported. According to CBC, this ransom
recovery was the first seizure undertaken by a “specialized
ransomware task force created by the Biden administration’s
Justice Department”. This reflects the increasingly aggressive
approaches government authorities are implementing to deal with
“the growing and increasingly destructive ransomware
attacks” that are targeting many industries worldwide,
including, but not limited to, the crypto market, CNN reports.
Moreover, according to IFC, Kazakhstan has signed a new taxation
law to tax cryptocurrency mining effective January 1, 2022. IFC
explains, while the new law is “expected to generate billions
in the national currency”, businesses are speaking out against
the taxation of cryptocurrency mining. According to IFC, many
businesses are opposed to the new taxation law and are concerned
about its impact on the future of the mining industry in Kazakhtan.
Cryptocurrency mining activities are subject
to taxation under regular Canadian tax law rules. However,
determining whether your cryptocurrency mining activities
constitute a business or a hobby for Canadian income tax purposes,
and the method of reporting profits, is complex tax law matter. Our
top Canadian tax lawyers can help identify your Canadian
obligations, and tax planning opportunities, with respect to
cryptocurrency mining. Visit our firm’s website to read more on
Crypto Currency Taxation – Income Tax Implications
of Mining.
The IFC reports sheds light on the fact that governmental
authorities across the world are focusing their attention on
“the regulation of the cryptocurrency market” as in the
example above whereby China is banning the cryptocurrency market
and has ordered its banks to cease facilitating cryptocurrency
transactions. In addition, IFC reports, while South Korea precisely
designed a comprehensive set of rules for exchanges within the
crypto market, Canada issued notices to “several exchanges
[Poloniex and KuCoin] for failing to comply with regulations within
time”. However, with Canada “implementing stricter
regulations out of concern for bitcoin’s energy impact, miners
are getting ready to leave the country for other sources of
power”, Coindesk reports. In addition, Bitmex and Binance are
among the cryptocurrency exchanges leaving Canada because of its
new securities regulations. It is important to realize that
potential tax implications could arise if the departure of
cryptocurrency exchanges requires conversion of any coin into any
other coin or into fiat in order to transfer to another exchange.
For example, the disposition of cryptocurrency will trigger a
taxable event that must be reported, pursuant to Canada’s
Income Tax Act, which could potentially give rise to a capital gain
or business income. Yet while it is uncertain whether stricter
restrictions and the regulation of the cryptocurrency market and
the cryptocurrency mining industry will be effective, IFC explains,
governmental authorities are becoming increasingly eager to
maintain control over their currencies.
Concerns Associated with Cryptocurrency: Global Challenges,
Regulations and the Tax Implications Associated with the Seizure of
Crypto Assets
There are significant concerns and challenges associated with
the cryptocurrency market, including specific cryptocurrency tax concerns. Specifically,
mentioned previously, Tesla reversed its decision to accept Bitcoin
payments, China announced its decision to ban all financial
institutions and payment companies from providing services related
to cryptocurrency transactions, and central banks, such as The Bank
of Israel, are issuing their own digital coins while discouraging
the use of cryptocurrencies. While many investors and traders are
worried about potentially losing their digital investments, others
have already lost a substantial portion of their digital
investments. Some cryptocurrency traders are forced to sell their
investments in a declining crypto market because of margin calls.
Furthermore, as previously mentioned, the Bank of Canada’s
Federal Reserve and central banks are hinting that they may
“take action to discourage crypto’s use”. Yet, even
if central banks and Canada’s Federal Reserve take action to
discourage the use of cryptocurrencies, it is unclear how efficient
or effective their actions will be in discouraging the use of
cryptocurrency. In addition, despite the volatile nature of the
cryptocurrency market, it is uncertain whether the value of digital
money issued by central banks would potentially exacerbate
volatility in other markets or even its own market. It is important
to realize that any changes in crypto holdings, including coin to
coin changes, have tax implications even if carried out in reaction
to market changes.
Some governments around the world seem to be focusing their
attention to the regulation of various aspects of cryptocurrency.
For example, Kazakhstan is set to tax cryptocurrency mining, Israel
ordered the seizure of a list of crypto wallets, and China is
banning all practices related to cryptocurrencies. Yet, it is
unclear whether stricter restrictions and regulations of the
cryptocurrency market and the taxation of cryptocurrency mining
will give governmental authorities control over their
currencies.
Further, as previously mentioned, Israel’s Minister of
Defense, signed a seizure order for crypto wallets which are
presumed to be associated with Hamas operatives. Similarly, USA
Today recently reported that US government officials recovered the
“majority of $4.4 million cryptocurrency ransom payment in
Colonial Pipeline hack”. These examples shed light on the
domestic powers available to governmental authorities in context of
cryptocurrency transactions and the cryptocurrency market. While
some governmental authorities are becoming increasing eager to
maintain control over their currencies, others have the ability and
desire to seize cryptocurrency where they deem it to be
appropriate.
Significantly, there are Canadian tax implications to
governmental authorities confiscating cryptocurrencies about which
our experienced Canadian tax crypto lawyers can advise.
Governmental authorities may attempt to seize cryptocurrency
wallets and information relating to cryptocurrency transactions in
order to identify tax evading taxpayers, encourage compliance with
Canada’s tax system and collect taxes on unreported income. In
addition, government officials could potentially use confiscated
cryptocurrencies to trace and investigate other crypto wallets and
their holders. It is important to realize that there are also tax
implications associated with the seizure of cryptocurrency assets.
For example, seized crypto can give governmental authorities
guidance in context of enacting and implementing stricter
regulations surrounding the taxation of cryptocurrency. As well,
the seizure of cryptocurrency can potentially lead cryptocurrency
holders and traders to escape their tax obligations by avoiding
certain countries that are implementing restrict regulations. From
a Canadian tax point of view, a seizure of cryptocurrency assets is
considered a disposition and under Canada’s Income Tax Act such
taxable event must be reported on the crypto holder’s income
tax returns, which could potentially give rise to a capital or
income gain or more likely a loss.
The Taxation of Cryptocurrency in Canada
Under Canada’s Income Tax Act, any income from
cryptocurrency transactions is characterized as business income or
as a capital gain. As well, losses involving cryptocurrency
transactions are treated as business losses or capital losses.
Taxpayers must establish whether a cryptocurrency transaction
results in income or capital for income tax purposes. When
cryptocurrency is used to purchase goods and services, the Canada
Revenue Agency will treat the transaction as a “barter
transaction” for income tax purposes. A “barter
transaction” occurs when good are exchanged or services are
carried out without the use of legal currency. However, the use of
the cryptocurrency to acquire goods or services will be considered
to be a disposition for income tax purposes giving rise to a gain
or loss.
In addition, where a taxable property or service is exchanged
for cryptocurrency, GST/HST that applies to the property or
services is determined based on the fair market value of the
cryptocurrency at the time of the exchange.
Pro Tax Tips – The Tax Implications of Cryptocurrency
Canada has yet to enact legislation-tax or otherwise-dealing
expressly with cryptocurrency or cryptocurrency transactions.
Likewise, Canadian courts have yet to decide upon a tax issue
relating to cryptocurrency or cryptocurrency transactions.
If you have questions concerning the tax treatment of
cryptocurrency or cryptocurrency transactions or the potential tax
implications associated with governmental authorities confiscating
cryptocurrency contact one of our top Canadian tax lawyers for tax
guidance. Our Certified Specialist in Taxation Canadian tax lawyer
has extensive experience in dealing with cryptocurrency
taxation.
If you or your business have unreported income, or wrongly
reported as capital gains instead of business income, earned
through cryptocurrency transactions, you may qualify for relief
through CRA’s voluntary-disclosures program (VDP). Voluntary
disclosures, also known as tax amnesty, are a complex area of law
that requires detailed analysis and advice from an experienced
Canadian tax lawyer. Consider contacting our certified specialist
in taxation Canadian tax lawyer for appropriate tax guidance with
respect to a possible voluntary disclosure application.
The purpose of the Voluntary Disclosures Program is the
avoidance of “tax evasion and aggressive tax avoidance”
to ensure a tax system that is responsive and fair for all
Canadians. Canada’s Voluntary Disclosures Program promotes
compliance with the law and allows taxpayers, including
corporations, the opportunity to voluntarily (1) correct inaccurate
or incomplete information; and/or (2) disclose to the CRA
information which was not previously reported. Canadian taxpayers
who have unreported income may be eligible for penalty relief and
partial interest relief under Canada’s Voluntary Disclosures
Program. A valid Voluntary Disclosures Program application
must:
- Be “voluntary”;
- Be “complete”;
- Include payment of the estimated taxes owing. A taxpayer who is
not capable of making such payment at the time of the application
may request consideration for a “payment
arrangement”; - Include information pertaining to income tax that is at least
one year past due; - Include information pertaining to GST/HST for at least one
reporting period that is past due.
To qualify for the relief under the Voluntary Disclosures
Program, the taxpayer must submit a complete application to the
program and meet its above-mentioned requirements. If you have
unreported income or would like appropriate tax planning to reduce your tax burden please
contact our tax law office for tax guidance from one of our top
Canadian tax lawyers.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.