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The world of cryptocurrency and non-fungible tokens (NFTs) is booming. Conceptually, they are similar in that both are traded on the blockchain. What distinguishes non-fungible tokens is their uniqueness — their own distinct identity—whereas one bitcoin is identical to another, much like one euro or one dollar.

Tax authorities (Revenu Québec and the CRA) are allocating significant resources to ensure that taxpayers involved in cryptocurrency are meeting their tax obligations properly. The broad audit powers granted under applicable legislation are used to scrutinize reported data and assess the good faith of cryptoasset investors (tax payable is based on the principles of self-reporting and self-assessment).

For example, with the introduction of form TP-21.4.39 (Cryptoasset Return), which must be filed with a Quebec income tax return, the authorities are formalizing an obligation to inform Revenu Québec of the mere holding of various cryptoassets — even if no transactions have occurred. Failure to do so may result in penalties.

The form must be filed by any taxpayer or partnership that, in a taxation year or a fiscal period, as the case may be, owns, receives or disposes of a cryptoasset, or uses a cryptoasset in the context of a transaction. The information to be disclosed includes, in particular, capital gains and losses, business income and losses, and interest income related to cryptoassets (such as Bitcoin, NFTs, Ether, etc.).

A tax audit may be conducted to verify the accuracy and compliance of the information reported on Form TP-21.4.39.

In addition to income tax considerations, consumption tax laws have also been amended to account for these products. Notably, section 188.2 was added to the Excise Tax Act (GST) to define “cryptoassets” specifically for the purpose of applying GST/HST to crypto mining activities in certain circumstances.

Moreover, if you are engaged in cryptoasset mining activities, the value of the cryptoassets received in exchange for such activities must be included in your business income at the time it is earned.

To help ensure a tax audit proceeds as smoothly as possible, certain elements should be considered to be prepared to defend your position — whether it concerns business income (or loss), capital gains (or losses), or the collection (or non-collection) of consumption taxes.

-1- Maintain clear and relevant records

In general, every person who carries on a business or is bound under a fiscal law to deduct, withhold or collect an amount must keep records (registers) containing information that supports the calculation of any amount that must be deducted, withheld, collected or paid under a fiscal law.

To facilitate any cryptocurrency audit, it is important that accounting records allow for the identification of revenues received and operating expenses incurred to calculate the net income generated from crypto activities.

Deficient records invite tax authorities to ask more questions or even to “reopen the limitation period” for reassessments.

Ensure that your records include, for each transaction, the number of units, the precise nature of the crypto asset, the date and time, the value in Canadian dollars, a description of the transaction and the counterparty involved, the addresses of each digital wallet, the initial wallet balance, its cost, and the final balance.

-2- Determine whether a disposition of cryptoassets has occurred

Certain less traditional cryptoasset transactions may generate a capital gain or loss, business income or loss, or even have no tax consequences at all.

For example, in the context of a cryptoasset exchange and lending platform that allows the deposit of bitcoins in exchange for a variable return, the CRA has indicated that the deposit is likely to constitute a true disposition of bitcoin under the applicable legislation (Cf. 2023-0993641C6). Indeed, in this case, the CRA appeared to view it as a transfer of ownership of the bitcoins, considering the platform’s right to use the bitcoins, derive profits from them, and dispose of them at its discretion.

Similarly, fraud or theft causing a taxpayer to lose access to their cryptocurrency may result in a deductible loss according to the CRA, depending on the circumstances (Cf. 2023-0982911C6).

When a taxpayer adopts a particular reporting position, having documentation related to the transaction is essential to support their position with an auditor, such as any contract with a centralized platform, or a clear and documented statement of facts surrounding the cryptoasset theft.

-3- Document the value of your portfolio

The tax implications related to cryptoassets directly depend on their respective values.

For example, regarding the application of GST/HST and QST, when a business receives payment in cryptocurrency for taxable goods or services, it must determine the value of that cryptocurrency. The taxes to be collected will be calculated based on the fair market value of the cryptocurrency at the time the transaction occurs. In this context, using cryptocurrency to pay for goods and services is a common example of a disposition of a cryptoasset. Since the CRA does not consider cryptocurrency to be government-issued currency, using cryptocurrency as payment for goods or services is treated as a barter transaction for income tax purposes. The CRA considers that you have disposed of cryptocurrency if you use it to pay for goods and services from a vendor. Conversely, the vendor must include in their income either the value of the goods or services provided or the value of the cryptocurrency received as payment, whichever is easier to determine.

Keeping all relevant documentation that establishes how the value of a cryptoasset portfolio was determined is essential and should be provided during an audit, kept in advance.

The CRA states that “you could choose an exchange rate taken from the same exchange broker you are using or an average of high/low/open/close values across a number of high-volume exchange brokers to determine the value” (Information for crypto-asset users and tax professionals).

-4- Keep your supporting documents

Some taxpayers may finance their cryptoasset purchases through debt or use effective marketing strategies to promote their NFT inventory. Expenses related to business income derived from cryptoassets can be varied.

Being able to provide supporting documents upon request to any tax auditor will help avoid the easy denial of an expense due to lack of documentation. Examples include loan agreements, invoices from web service providers, or bank statements.

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Me Jonathan Ethier is a tax litigation partner at Spiegel Ryan LLP. He can be reached at 514-875-7878 or by email at jethier@spiegelsohmer.com

Me Marjorie Bergeron is a tax planning lawyer at Spiegel Ryan LLP. She can be reached at 514-808-4007 or by email at mbergeron@spiegelsohmer.com