Investors are always looking for new ways to invest and make money. If you have been on the hunt for a new investment opportunity in the recent past, you might have come across investing in cryptocurrencies. Cryptocurrency investing is still relatively new and so the question a lot of investors have is whether they have to pay tax on their holding and how this tax is calculated and realised. We are going to look at cryptocurrency gains taxation and help investors understand how to comply with their taxation.
How Cryptocurrency Gains are Treated
The government of Canada through the Canada Revenue Authority (CRA) treats cryptocurrency as more of a representation of value in digital form rather than a legal tender. Cryptocurrency is also regarded as a medium of exchange of both goods and services between parties who enter into a trade or exchange. Both parties must agree to use a specific cryptocurrency for the exchange to be regarded as a trade, although there is no legal standing for such trades and this is why this area can be so confusing.
Cryptocurrencies rely on encryption and blockchain technologies to keep ledgers of who owns what as well as records of all transactions. In addition to their decentralised and anonymous nature, cryptocurrencies are not controlled by any bank or government agency.
For Taxation Purposes
The CRA treats cryptocurrencies as a commodity. In the context of taxation, the government treats cryptocurrencies as either capital gains or business income depending on the specific circumstances. In addition to gains, the government also recognises cryptocurrency trade losses the same way it recognises gains.
Because not everyone who buys, sells or exchanges cryptocurrencies does so in their capacity as a business, taxpayers have to say where they do so as a business or as individuals. This is what helps the government differentiate between capital gains and legitimate business income.
For individuals using cryptocurrencies to pay for goods and services, the government regards this as bartering. Bartering is defined as transactions where people exchange goods or services with a currency that is not recognised as legal tender. This currency can be anything that the parties involved in the trade or exchange agree to but it is cryptocurrency in this context.
For taxation purposes, the government regards the fair market value of the cryptocurrency as the highest amount that both parties agree to. These parties must be informed and knowledgeable about the currency in use, have consented to its uses and must operate in a free, unrestricted and open market. Consistency is key when choosing a valuation method as taxpayers can decide to use the highest value of a cryptocurrency at a single exchange, or the daily averages of a cryptocurrency.
It is important to note that the government requires that you have a separate valuation for the different types of cryptocurrencies you hold in a single wallet. Each of these cryptocurrencies is regarded as individual digital assets and so Bitcoin would be valued differently from Ethereum if you hold both in the same wallet.
Taxation of Capital Gains and Business Income
For taxation purposes, business income is income generated if: you operate a commercial business; you operate like a business through taking loans or having a business plan; you promote any product or services and you show an intention to trade for a profit, even if that profit is not realised in the short term.
If you sell or dispose of cryptocurrencies as part of your business, you need to report the profits and revenue from the sale as business income. One area of confusion is that you may still have to report a business income if you do a single trade of cryptocurrency. This is because the CRA considers this an exploration of a business venture or a notable concern in a trade nature.
Capital gains, on the other hand, are increases to the value or price of a digital asset that you hold. Capital gains are considered when you invest in cryptocurrency without selling it and are calculated when you sell your digital assets.
If you decide to sell your cryptocurrency without carrying a business or showing an interest in trade, then you only have to report capital gains. The main difference between a business income and capital gains in the eyes of the tax authority is the portion of the gains that will be taxed.
For capital gains on cryptocurrencies, the government taxes half of your capital gains at the prevailing tax rate in your province or territory. So, if you live in Ontario and make $1000 in capital gains, then you pay the marginal tax rate for Ontario on $500. Taxation of business income is a lot less forgiving because you have to pay tax on 100% of your income tax.
This difference in the percentage of the income or capital gains taxed is the main difference why you should be careful about trading cryptocurrency as a business. If you have a business like a mining business, a trading business or an exchange, you have to pay the full business income tax. You also have to do it if you are an individual who mistakenly invested in cryptocurrency in a way that would make it seem like you did so with the intention of trade.
Exchanging Cryptocurrencies
Taxation rules still apply when you exchange one cryptocurrency for another. Barter rules apply where you have to convert the value of both cryptocurrencies into Canadian dollars depending on their best fair market value. The transaction is considered disposing of cryptocurrency and so you have to report either capital gains or losses, or business income or losses.
To get the best prices for your crypto tax fair market value calculations, you can use a reliable platform like Wealthsimple Crypto. Through this platform, you can sell and buy cryptocurrency instantly. Wealthsimple also has a suite of other investment and financial tools for investors and those looking to grow their money. You can also use their Wealthsimple Tax tool to file your taxes easily and securely. If you have any questions, reach out to their team of real humans standing by to help with your questions or investments.
Once you get the rate, you can start doing your calculations with the actual Canadian dollar amount of the cryptocurrencies being exchanged. To do this, you need to find the difference between the initial value of the first cryptocurrency and the value of the second cryptocurrency at the time of the transaction. Because of how the price of cryptocurrencies fluctuates, the trade can result in either a net gain or net positive.
Taxation on Mining
Mining is another grey area where things can get complicated. Mining involves using specialised computer equipment to confirm cryptocurrency transactions. These transactions are broken into blocks and miners have to calculate values that will complete a block. Valid values gotten from complex calculations are accepted into the corresponding crypto network and go into a ledger. Once a successful calculation is completed and the block is accepted, the miner is paid the price for creating the new cryptocurrency and the fees from transactions in the blocks they just validated.
It is these payments that are considered when talking about taxation on mining. If you are mining as a hobby and make some money out of it, then that is treated differently from when you carry out mining as a business. The Canadian government recognises mining activity that constitutes business activity as an activity that is pursued in a businesslike or commercially sufficient way.
Holding Cryptocurrency without Taxation
One thing a lot of people do not know is that it is possible to hold cryptocurrencies without being taxed. Granted, this requires the knowledge of some loopholes, but we will explain those below.
A tax-free savings account (TFSA) is an account whose interests, contributions, dividends and gains are not taxed. What people do not know is that they can hold a cryptocurrency ETF (exchange-traded fund) in their TFSA and some Canadian banks will let you put a crypto ETF into your TFSA.
The best ETFs to do this include those that track the price of a cryptocurrency such as bitcoin. Because these ETFs have a 100% crypto portfolio, investing in them is the same as holding a cryptocurrency. This means you can essentially hold a cryptocurrency in your TFSA and not be taxed for it.
There are a few things to note when you do this. First, no one knows if or when the government might decide to look into this. Second, there are only a few banks that let you hold a crypto ETF in your TFSA, and third, you have to pay a holding fee for the ETF every year. The holding fee is usually 1-2% of your holding and this beats holding actual cryptocurrency and paying business income or capital gains tax on it.
No matter how you hold your crypto, you will be taxed unless you are clever about it. The tax you pay will either be capital gains or business income depending on your set up and how you trade or exchange cryptocurrencies.