The tax implications of Bitcoin’s mercurial rise in value during 2020 is one of several taxation issues faced by investors and businesses following Year 1 of the COVID-19 global pandemic.
The cryptocurrency stutter-stepped with volatility to a 301% rise in 2020, and ended the year at US$29,001. It has since more than doubled that value, and in the last week touched an all-time high above US$61,000.
As tax time draws near, a key question for Bitcoin investors will be, should they report gains or losses realized from buying and selling the cryptocurrency?
“Yes,” is the short answer, say accountants, lawyers and industry insiders. Exactly how to report those gains, however, may differ.
Bitcoin transactions are recorded, and owners’ personal identities are known by companies that facilitate the transactions.
Failing to report transactions may result in penalties down the road – if the Canada Revenue Agency (CRA) discovers them.
MOGO (TSX:MOGO) vice-president of product and engineering Macully Clayton told BIV that all customers who create digital wallets at his company must have their identities verified, either by Equifax or by a drivers’ licence or passport.
BIV tried to create an account for a fictitious person, but it was rejected because Equifax had no record of the individual.
All money transferred into a MOGO wallet must also originate from a Canadian bank account linked to the identical customer name. MOGO then sends all customers annual notices to remind them to declare transactions on tax returns.
MOGO’s facilitates buying Bitcoin through Toronto-based partner Coinsquare, which also records transactions, Clayton said.
The CRA could theoretically achieve a court-approved warrant to get MOGO or Coinsquare records, so Baker Tilly certified professional accountant and tax principal Gary Chow advises that all clients be upfront on tax returns.
“This is not a police state, where they are going to go marching in to grab people’s records – that’s not Canada,” Chow said.
He said he likes the U.S. Internal Revenue Service’s approach this year to ask all tax filers on the first page of income-tax paperwork if they have received, sold, sent, exchanged or otherwise acquired any financial interest in any virtual currency.
“If we take the U.S. approach, where there’s an explicit question, right underneath your address, asking you point blank, ‘Are you doing this?’ And you sign your return under threat of penalties for perjury, that would make people think twice and be more honest,” he said.
Declaring on tax forms that tax filers have interests in cryptocurrencies would not mean that they would owe taxes. No tax would be charged unless the filer realizes a gain, Chow said.
In addition to profiting from selling Bitcoin, tax filers may have achieved financial rewards by being paid for work in Bitcoin, by mining it or by trading it for a tangible item.
The most common way of disposing of Bitcoin is to sell it for cash, and here it is a simple transaction where the amount spent and the return generated are clear.
As long as a person is not making transactions deemed to be excessive, the CRA is likely to consider the Bitcoin owner an investor. If a considerable number of transactions are made, such as one each day or each week, the CRA may consider the trading to be a business.
This is a key point because if an investor realizes a profit, he or she would record the profit as a capital gain on tax forms. This would prompt the person to apply his or her marginal tax rate to 50% of the capital gain, or profit.
If the person trades enough that the CRA considers it a business, then the person’s marginal tax rate would be applied to 100% of the profit, Chow said.
The next category of taxation applies to people compensated for work in Bitcoin. Here, 100% of the value of the Bitcoin would be taxable income.
The taxpayer would value his or her Bitcoin earnings in Canadian dollars at a rate that is either an average for all days of the year, or it could be at the spot rate for the Bitcoin on the day of each paycheque, Chow said.
The key, he added, is for the tax filer to be consistent in the valuation.
Buying items with Bitcoin can be complicated.
If investors sell Bitcoin holdings and buy Ethereum, they have to calculate the sale price for the Bitcoin, determine their capital gain, and then start fresh with a strike price for the Ethereum.
If, instead, they trade one Bitcoin for a luxury car, they could record the value of the Bitcoin as the retail price of the luxury car plus the cost of the provincial sales tax (PST) and the goods and services tax (GST) because that is the total compensation they are getting in exchange for their Bitcoin, Chow said.
Boughton Law associate Bill Cooper, however, said the best policy when conducting barter transactions is to convert the Bitcoin to a cash value, and then to use the money to buy the item.
“Bitcoin is like a sack of gold or a sack of wheat or some other unit that you have to put a value on,” he said.
Tax filers are also technically required to declare profits on sales of collectibles, such as hockey cards, he said. The reality, however, is these minor cash transactions are challenging for the CRA to track down.
Finally, there is a way for investors to achieve gains from Bitcoin without paying taxes.
While Chow said that it is not possible to put Bitcoin in a tax-free savings account (TFSA,) there are a range of equities that trade on stock exchanges that have as their underlying values their Bitcoin holdings.
Grayscale Bitcoin Trust (OTCBB:GBTC) is the largest and most traded of the trusts.
The Toronto Stock Exchange recentlly listed a flurry of North America's only Bitcoin ETFs.
Conventional wisdom is that trusts can trade at a significant premium, or discount, to the net asset value of the vehicle's holdings, while ETFs are supposed to track net asset values of holdings more closely. It remains to be seen if that will be the case with the current ETFs, which launched in the past month.
There are multiple Bitcoin trusts, and there have been some recent days when they showed significantly different returns. Sometimes one trust could be down 40%, while another is up a few percent.
Some of the new Bitcoin ETFs in Canada are the Purpose Bitcoin ETF that is hedged to Canadian dollars (TSX:BTCC), the Purpose Bitcoin ETF that is not hedged to Canadian dollars (TSX:BTCC-B), the non-Canadian-dollar hedged Evolve Bitcoin ETF (TSX:EBIT) and the non-Canadian dollar hedged CI Galaxy Bitcoin ETF (TSX:BTCX) •
