Cryptocurrencies and Taxes in Canada: What You Need to Know

Are cryptocurrencies taxed in Canada?  What if you buy them on a Canadian crypto exchange? What if you keep them in a wallet? Does the Canada Revenue Agency (CRA) consider cryptocurrencies as legal tender? Why are Canadians asking so many questions about cryptocurrencies and taxes?

It’s because crypto traders have to pay taxes on their earnings. This will be a windfall profit for the government. Why? Because more and more Canadians are investing in cryptocurrencies.

Moreover, in November 2021, the cryptocurrency industry set a new record in its history: the capitalization of its market has indeed reached 3 trillion USD, meaning that in just 12 years, the value of all cryptocurrencies is 3 trillion USD, more than the value of the Toronto Stock Exchange. With more than 200 million members, the world of cryptocurrencies includes more than 13,800 virtual currencies and 429 cryptocurrency exchange platforms. 

Introduced in 2009, cryptocurrencies are now taking their place alongside the major banking institutions and enjoying growing recognition in the eyes of investors. But what about its value in the eyes of the government? The answer is that it is a great source of tax revenue.

This article answers the important question that has so far been left unanswered as cryptocurrency continues to grow in popularity. That question is: are the profits generated by cryptocurrency taxable in Canada? The answer is yes. 

What is cryptocurrency?

That’s a good question and one worth a lot of consideration. Bitcoin is the leader and first mover in what was called the decentralized digital currency back in 2009. Things have only gotten better for this new currency and we are seeing more and more cryptocurrencies making headlines in the news. 

In the next few paragraphs, we’ll take a fairly comprehensive look at the terminology that is essential to understanding cryptocurrency. We’ll also look at the history of the virtual currency. We end the article with a more in-depth explanation of investment concepts and the slightly less pleasant part that comes with them: taxes.

The flaws of the traditional banking system

“What about a ‘virtual’ currency, that is essentially traded through computers or smartphones?” This question, posed by Daniel Ichbiah and Jean-Martial Lefranc in Bitcoin and Cryptocurrencies for Dummies, is actually very polarising. It brings up the idea of an alternative mode of currency, a controversial concept not only in the finance community but also in the general public. Indeed, how much confidence can we have in virtual money? What about its volatility?

Ever since the introduction of paper money, banks have had to overcome the ever-present challenge of fraud and counterfeiting. Banking institutions’ efforts aim at making banknotes tamper-proof. Despite these efforts, there are still many counterfeit Canadian bank bills in circulation. 

Yes, bank technology has evolved. However, we must acknowledge that counterfeiters have also adjusted their techniques.  While fraud has relatively stabilized in Canada, it is still present. 

A safer alternative to the physical exchange of bills is increasingly common, if not universal, in recent history. Today, most people have chequing accounts and perform digital transactions on a daily basis. Cryptocurrency naysayers may not realize that its principles are based on the same foundations as current digital banking. But let’s go further.

In the beginning, there was Bitcoin

Modern history has shown us that banks, which handle virtual money, have not always behaved in exemplary ways. The 2008 stock market crash, caused by the failure of the American investment bank Lehman Brothers, the fourth largest bank in the United States, caused a number of problems. The fallout was the collapse of financial markets and the loss of millions of jobs. While tens of thousands of American families with mortgages lost their homes, the entire world entered a recession that was one of the greatest economic crises in history.

The lesson learned by many was that banks are not worthy of the trust placed in them. At least that’s what Satoshi Nakamoto, the creator of Bitcoin, told himself. Thinking that the bank model was unsustainable, Nakamoto’s realization was to create a new type of currency that relies on two important points of trust:

• Cryptography, or sophisticated mathematics;
• The owners or users of this cryptocurrency.

A decentralized currency

In developing his alternative digital currency project, Satoshi Nakamoto first thought of a system free of banks in order to get away from the concept of centralized banks. That’s when he developed his system based on person-to-person (p2p), which was already implemented in the 2000s by the Napster sharing software. This software allowed people to tap into each other’s hard drives and share MP3 music files. So we’re talking about the first major digital sharing system. 

Bitcoin is based on this fundamental idea: information is decentralized and distributed among users. Since there is no longer a bank to do the work of the third party, the system relies on data storage distributed among several users. Nakamoto even added the notion of anonymity, but we will come back to this. 

When we say global community, we also mean open source. We mean that the cryptocurrency does not belong to any publisher. The software that manages Bitcoin, for example, is available to all. 

The blockchain or the birth of trust in Bitcoin

To get people interested in his new system, Nakamoto relied on two new elements to promote trust. According to Ichbiah and Lefranc, these are:

• Prevent the same transaction from occurring two or more times in a row;
• Prevent that said transaction from being hijacked by a hacker who would transfer the amount in his own account. 

Those are the basics of the blockchain. In other words, every purchase using Bitcoins is listed in this chain. It is linked to the individual who made that purchase through the encrypted and unique encoding generated by the blockchain. 

As for security: well, since the transaction is encrypted in the chain, it is distributed throughout the network. That means that it is recorded in all the computers that are connected to the blockchain. If a fraudster wants to forge a transaction, then he has to attack the whole blockchain and create a parasitic and alternative blockchain that can generate identical copies of the encrypted currency. 

Ethereum and smart contracts

Since the software that Bitcoin is based on is free, it quickly became possible to modify and improve it. This is indeed what happened with smart contracts, which were introduced by Ethereum creator Vitalik Buterin. The smart contract is based on the possibility of linking a cryptocurrency to the automatic execution of programs when certain conditions are met.

Limited supply

Part of what makes Bitcoin so popular is the way it works and its innovative structure, but it’s also its limited supply over the long term. In creating Bitcoin, Sakamoto chose to limit Bitcoin’s production to 21 million units. This is why the price of Bitcoin found on any crytocurrency exchange follows the principle of supply and demand. Each Bitcoin is created using a protocol that chains together a series of codes that allow a new unit to be inserted into the shared chain. 

Investing in cryptocurrencies

Security? Speed ? Anonymity? What makes one virtual currency different from another? There are many investment strategies related to cryptocurrency. No matter which one you decide on, you have to be prepared for the idea of taxes, since they undeniably accompany the concepts of profits. 

What is the tax stance regarding cryptocurrency profit?

As we have seen recently, the value of a unit of Bitcoin can surpass the US$90,000 mark. With increased value comes increased profits on paper. If you’re in a situation where you’ve been doing well with your cryptocurrency investments, or if you’re planning to make the move into this digital world, the following is important information to keep in mind.

The Canada Revenue Agency and profits from cryptocurrencies

It was said earlier, but let’s take the time to say it again: the system on which cryptocurrencies are based operates in a decentralized manner. In other words, the currency created by these institutions does not belong to any bank. Yet, be aware that profits made from any cryptocurrency are taxable in the year they are generated. Don’t be caught off guard like many investors have been and know now how the Canada Revenue Agency (CRA) views crypto gains. 

Cryptocurrency and taxes: a commodity, not a currency

In the eyes of the CRA, cryptocurrency is not considered legal tender. That’s why the CRA bases its recognition of cryptocurrencies on the unanimous definition that defines them as digital assets. They are sometimes also referred to as a crypto asset.

The CRA therefore considers cryptocurrency to be a commodity for the purposes of the Income Tax Act. According to the CRA,”Any income from transactions involving cryptocurrency is generally treated as business income or as a capital gain, depending on the circumstances.” So the income generated from its trading is taxable.

Cryptocurrency and taxes: transacting with of cryptos

To talk about transacting is to define how an individual uses his or her cryptocurrency investment. Generally speaking, the possession and holding of cryptocurrency is not taxable. In other words, one can have purchased Bitcoins in 2010 and still own them to this day.

However, the following actions must be reported and are taxable:

• The sale or donation of cryptocurrency;
• The exchange of cryptocurrency that also includes obtaining another cryptocurrency;
• The conversion of cryptocurrency into a currency, such as Canadian dollars;
• Using the cryptocurrency for purchases of goods or services.

Two types of taxation for crypto gains

First, you should know that the CRA is intensifying its measures and efforts to supervise the cryptocurrency sector. In fact, it has set up a specialized cryptocurrency unit. What is its purpose?  To carefully monitor those who try to illegally benefit from the gains following their cryptocurrency exchanges. 

Cryptocurrencies and taxes: how do you declare your earnings? 

First, it’s important to know that the CRA distinguishes between business income and individual capital gains when it comes to taxation. 

Taxing business income

The distinction is important: are you considered a business or an individual in the eyes of the CRA? In general, this seems to be more-or-less clear cut to the government. The CRA mentions on their site that certain exceptions may apply. If you trade cryptocurrency as a business or trade cryptocurrency every day for profit, you most likely classify yourself as business income in the CRA’s tax eyes. 

If so, be aware that the Canada Revenue Agency will tax 100% of your earnings. This is scary! As a business, all crypto earnings are taxable and the CRA calculates according to your marginal tax rate. 

Not sure? Here’s how the CRA defines its category of cryptocurrency mining by a business: 

• You are operating for business reasons and in a commercially viable manner.
• You are undertaking activities in a professional manner, which includes preparing a business balance sheet and acquiring capital assets or inventory.
• You promote a product or service.
• You demonstrate that you intend to make a profit in the short or long term.

While these criteria are very well defined on their site, the Canada Revenue Agency also emphasizes the notion that “Whether or not you are carrying on a business must be determined on a case-by-case basis.” A little hope for all those who are concerned. 

Examples of cryptocurrency businesses

• Business income is collected by the CRA based on the first year of business activity and therefore from the beginning of transaction. It is actually very important to keep a record of the value of the cryptocurrency acquired upon purchase for the business. These amounts will serve as the basis for calculation during the tax period. 
• The CRA considers these activities to be in the realm of business and anyone who engages in them will be considered as a business
• Cryptocurrency mining: if you are a miner, and make gains and profits on your transactions, that income is treated as that of a business. 
• Trading cryptocurrency: since cryptocurrencies are often purchased on online trading platforms, it should be understood that any activity that includes selling, exchanging and buying cryptocurrency constitutes trading. Exchanging for other cryptocurrencies or for traditional money is also part of trading. If your business deals in these activities, it will be subject to business income tax rates.
• Cryptocurrency trading, including automated teller machines (ATM): any profit made from cryptocurrency profits falls under the business category according to the CRA.

Reporting your business income

So, if your crypto activities meet the Canada Revenue Agency’s definition of business, you have a duty to report profits, but also losses on your business tax return. Here are some important points to remember when you find yourself in front of the taxman:

• You must keep track of when you acquired the cryptocurrency and have the value of your portfolio at the time of acquisition. Make sure you convert it to Canadian money so you don’t miscalculate. To do so, make sure to use the exchange rate that was in effect at the time of acquiring the said cryptocurrency.
• If you paid your employees in cryptocurrency, the same principle will apply for them. They will need to keep a good amount of information.
• Consider organizing a booking system that records all transaction dates, purchase receipts and cryptocurrency transfers in addition to any exchange log.
• Keep descriptions of transactions: this includes the buyer’s crypto address.
• Finally, be sure to include all accounting, legal, and software and hardware costs associated with managing your company’s tax affairs.

GST and PST on cryptocurrency

Any business in Quebec must charge the goods and services tax (GST) and the Quebec sales tax (QST). Elsewhere in Canada, there is the provincinal sales tax(PST). Sometimes this causes confusion, which is why Hardbacon has created a GST and PST calculator to help people across Canada figure out these taxes. If you are a business owner and you conduct crypto exchanges either through your services or through your products, be aware that federal and provincial sales taxes are calculated based on the fair market value of the cryptocurrency at the time of the exchange. The CRA specifies this clause on its website.

Cryptocurrencies and individual taxes 

There is an important distinction between business income and personal capital gains. Indeed, the CRA charges individual taxpayers a tax on 50% or half of the capital gain. It is worth repeating: owning cryptocurrency is not taxable in the eyes of the CRA. It’s the trading and transactions that are, since they involve taxable revenue in the eyes of the law.

Therefore, as soon as you perform one of the elements listed below, you trigger a tax procedure at the CRA:

• The purchase of goods or services with cryptocurrency.
• The sale of inventory.
• The donation of stock.
• The exchange of stock for another cryptocurrency or for traditional currency.

Want to buy an apartment with your cryptocurrency? The buying or selling goods or services with crypto is a crypto transaction so capital gains will still apply. That’s a lot of money, so it’s best to be cautious.

For example: you bought $5,000 worth of Bitcoins in 2018, and the value of your investment has reached the $30,000 mark in 2021. You decide to trade your inventory and convert it to Canadian currency. Your marginal rate applies and it is only on half of the profits. 

In other words, the profit margin on your investment is $25,000. The Canada Revenue Agency will apply a tax to 50% of the $25,000 capital gain, using your marginal tax rate. You may be paying taxes on $12,500. 

Cryptocurrencies and taxes: what about anonymity?

As mentioned above, the blockchain can provide anonymity to cryptocurrency users in some cases. But the CRA can force trading platforms to hand over information about its users, as the US government has done. This means that tax and fiscal institutions won’t recognize the anonymity guaranteed by cryptocurrency holders.

Q&A

Where did cryptocurrency come from?

Satoshi Nakamoto appears to be the inventor of Bitcoin. In reality, this pseudonym is quite enigmatic and nobody knows who is behind Nakamoto. Bitcoin launched in 2009 when its inventor put together several innovative principles under the concept of cryptocurrency. Since then, cryptocurrencies have been gaining popularity.

How does cryptocurrency work?

There are a few concepts that are important to understand about the way cryptocurrency works. 

• Cryptocurrencies are characterized by the absence of a central bank. In other words, it is a decentralized monetary system.
• Their operating principle is based on two systems: one of digital signatures and the second of cryptography.
• A shared distributed ledger called the blockchain encrypts and registers the transaction.
• This shared network records all transactions and thus keeps track of all owners of a cryptocurrency.

This type of network is a person-to-person (p2p) network. Data storage and permissions do not exist in a centralized machine. In fact, each computer in this type of network has the same rights and access as the others.

Every cryptocurrency transaction must be part of a mining operation. The task of the miner is to verify the validity of the transactions and then generate a proof of his or her work by encrypting it. You must store your cryptocurrency in a secure wallet.

How does the government view cryptocurrency? 

It is important to note that the Canada Revenue Agency (CRA) considers cryptocurrency as a commodity for the purposes of the Income Tax Act. Indeed, the CRA does not consider cryptocurrency as legal tender.  Legal tender is a government-issued currency such as the Canadian dollar, which is a fiat currency. The CRA bases its recognition of cryptocurrencies on the unanimous definition of them as digital assets, sometimes also referred to as “crypto assets.”

What is a cryptocurrency transaction?

To speak of a transaction is to define how an individual uses their cryptocurrencies. Generally speaking, the possession and holding of the cryptocurrency is not taxable. However, the following is taxable and you must report it:

• The sale or donation of cryptocurrency;
• The exchange of cryptocurrency that also includes obtaining another cryptocurrency;
• The conversion of cryptocurrency into a currency, such as Canadian dollars;
• Using the cryptocurrency to purchase goods or services.

How do you report your cryptocurrency earnings?

First, you should know that the CRA distinguishes between business income and individual capital gains when it comes to taxation. It’s important to realize that a day trader can classified as a  business instead of an individual. 

Business Income

In general, this seems to be more-or-less clear to the CRA, who mention on their site that some exceptions may apply. You trade cryptocurrency as part of a business plan. Or you trade cryptocurrency every day for the purpose of making a profit. In either case, you most likely classify yourself as business income in the CRA’s eyes. Be aware that the Canada Revenue Agency will tax 100% of your earnings at your marginal tax rate. 

Capital gains for Individuals

There is an important distinction between business income and capital gains. The CRA will only tax individuals at their marginal rate on only 50% of the capital gains. Owning cryptocurrency is not taxable in the eyes of the CRA. It is the trading and transactions that are taxable as they involve taxable items in the eyes of the law.

How are GST and PST calculated on cryptocurrency?

If you are a business owner engaging in crypto transactions either through your services or through your products, you should know that the GST/PST is calculated based on the fair market value of the cryptocurrency at the time of the exchange.