Cryptocurrencies and their Tax Implications

The cryptocurrency phenomenon has taken the world by storm especially thanks to the surging numbers of investors who increasingly put their money in there. It is, however, interesting that the cryptocurrency world still retains a certain aura of mystery and imperceptibility. Folks are yet to understand what cryptocurrencies are, with several analysts warning it is a bubble; still fewer people are yet to understand the tax implications of trading in cryptocurrencies. Below is a brief exposition of what
cryptocurrencies are, how to trade in them, as well as the tax implications of the same in Canada:

What are Cryptocurrencies?

In a nut shell, a cryptocurrency is a virtual currency that is created to be a medium of exchange. It employs a system called cryptography in order to confirm and secure transactions. It also uses cryptography to create new units of a specific cryptocurrency. The created units are limited, and no one can change the value without first meeting certain specified conditions.

Every transaction is a file containing the sender’s and recipient’s wallet addresses as well as the amount of coins transferred. The sender has to sign off every transaction with his or her private key in order for it to be authentic. Once the transaction is complete, it is confirmed and then broadcasted in the network.

Now, in order to prevent fraud, it is only miners who possess the ability to solve a cryptographic puzzle. They take transactions, certify them as legitimate, and broadcast them across the network. It is then that the node of the network adds the transaction to the database. Once the miner confirms a transaction, the transaction basically waxes irreversible and unforgeable, and for the work, the miner receives both a reward and transaction fees.

The network relies on absolute consensus or agreement of all participants as to the authenticity of the balances and transactions. In case the network’s nodes disagree on even a single balance, then that would be disastrous as the system might break. Thankfully, there are several inbuilt features that ensure the network does not break unnecessarily.

The Canadian Tax Implications

While cryptocurrencies are mostly anonymous, with each exchange offering varying degrees of anonymity, the anonymity usually comes off each moment you want to realize your gains in the cryptocurrency world. Yes, you can keep the cryptocurrency in the virtual world, refusing to identify yourself as the true owner, the mask will come off the moment you buy something real in a real world, say a software – or when you convert your virtual currency to hard cash. So, if you for instance acquired a cryptocurrency for, say, five dollars, and later you used the same to buy software worth about $1000, that means you have a gain of $995. The Canadian Revenue Agency requires you to report the gain in your income tax when it’s realized. Further, depending on the volume of your purchases or sales, you might also be required to collect or pay HST/GST taxes since cryptocurrencies are often regarded as barter transactions– meaning, both the product that is subject of a sale and the proceeds from the sale are subject to the GST/HST taxes.

The Canada Revenue Agency has been harping in its policy statements since 2013 that cryptocurrency is a type of property and not a form of money; therefore, it needs to be reported as capital gain or income, depending on your circumstances. That means, if you sold a cryptocurrency for profit, the gain must be reported in your tax return.

The requirement to pay taxes extends even to miners of cryptocurrencies. Miners, as already stated, are the people who solve convoluted computer problems and are rewarded with a token or coin. To solve these problems requires a huge investment in terms of electricity and computing power. Miners get rewarded for their work with cryptocurrency coins. They are required to report the cryptocurrency coins they earn as income, and they are permitted to deduct the electricity costs they incur as associated losses.

So pervasive is the tax regime that even when you are paid in cryptocurrency, you are still required to pay income tax on the earnings. In case you are an independent contractor and you’ve been paid with cryptocurrency, which is the same thing as being paid with money. You will need to report that income and charge GST/HST tax, but you are also permitted to subtract the associated losses or expenses and request for input tax credits.

The same thing applies to purchasing Ethereum or bitcoin or other form of cryptocurrency with the monies. Just like in the purchasing of software scenario, the CRA regards the transaction as barter and every disposition is taxable as income or capital gain depending on the market value of the respective cryptocurrency.

These are only the earliest signs that the authorities are responding to the cryptocurrency wave that is sweeping the world. Soon, parliament is going to legislate, and courts are going to share their opinions.

In the meantime, remember that all cryptocurrency gains and losses are subject to taxation.