Crypto-Exchange/Wallet Tax Issues
Crypto-Exchange/Wallet Tax Issues
Part 3 of the Smartblock Law "Crypto-Tax Primer" Blog Series
Chetan Phull · Feb 23, 2018
This blog post is part of our “Crypto-Tax Primer” series, which is comprised of the following parts:
Important tax-related questions for cryptocurrency exchanges, wallets, and their users
Trades on or through Canadian cryptocurrency exchanges or wallets can engage rules for both income tax and GST-HST, respectively pursuant to the Income Tax Act and the Excise Tax Act.
The following tax-purposed questions are material to any cryptocurrency exchanges, wallets and users to which the above Canadian tax statutes apply:
(a) Ownership vs. trust
1. does the user own the cryptocurrency on the exchange/wallet by contract, or is the exchange/wallet an express trustee of user funds?
2. which of the user or the exchange/wallet holds actual legal title to the cryptocurrency while it is accessible on the exchange/wallet?
3. is the exchange/wallet profiting in any form through its relationship with the user?
4. are the account holdings, whether held as cryptocurrency or fiat currency, being used by the exchange/wallet to: (a) satisfy any liquidity requirements of the exchange/wallet, or (b) fund third party loans?
5. is the value of cryptocurrency and fiat currency, as reflected in user account holdings, considered “realized” while such funds are accessible through the exchange/wallet?
6. is the user making trades, or is the exchange/wallet making trades?
7. does the user have full access to the private keys required to access the addresses holding cryptocurrency?
(b) Classification for tax reporting purposes
8. are trades made in a business capacity, or personal capacity?
9. if trades are made in a personal capacity, is the property income or capital?
10. if trades are made in a business capacity, is the property income or capital or inventory?
11. is adjusted cost base of the value held worth over $100,000 CAD, and therefore considered “specified foreign property”?
12. does the term “specified foreign property” consider different cryptocurrency coins distinguishable, such that $50,000 CAD of BTC and $50,000 CAD of ETH do not aggregate to trigger the $100,000 CAD threshold for “specified foreign property”? (Consider that the Income Tax Act, s.233.3(1) “reporting entity”, refers to “a” specified foreign property as opposed to “all” or “a collection of” specified foreign property.)
13. when a blockchain forks, is a new asset created that gives rise to a gain, whether in income, capital, or inventory?
(c) Quantification for tax reporting purposes
14. in the context of trades for crypto-crypto, crypto-fiat, and fiat-crypto, what is the basis for quantifying value in CAD for tax purposes?
(d) Administrative issues
15. since cryptocurrency is considered a bartered commodity in the context of each and every trade, must realized gain or loss in the cryptocurrency markets—whether considered income or capital or inventory—be tracked for income tax reporting purposes?
16. for each and every trade in which cryptocurrency is supplied by a business on or through an exchange/wallet, must the businesses remit GST-HST on the transaction?
Does the exchange/wallet have tax-related obligations under a trust?
Questions #1-7 and #15-16 imply an important administrative issue for cryptocurrency exchanges and wallets. If the operations of a cryptocurrency exchange/wallet give rise to a trust, the exchange/wallet—as trustee—may have obligations associated with tax remission, charging, and reporting.
Here's why.
As previously discussed in this blog series, the CRA’s guidance to date implies tax consequences for cryptocurrency transactions, gains, and losses (see Part 1: the CRA’s Present Position on Crypto-Tax).
The question is, which party bears tax remission, charging, and reporting obligations? The answer arguably depends on whether the cryptocurrency is in fact legally owned by the user, as opposed to being the subject of a trust for the user’s benefit.*
Even without an expressly stated intention to form a trust, a resulting trust is presumed to exist in certain cases when one person buys property in the name of another (see Nishi v. Rascal Trucking Ltd., 2013 SCC 33 at paras. 1, 21; Belokon v. Krygyz Republic, 2016 ONCA 981 at paras. 55-56).
It is instructive that a Schedule I or II bank, which by statute "is not bound to see to the execution of any trust to which any deposit [is] made" (Bank Act, s.437(3)), may still be found to be a constructive trustee (see M.H. Ogilvie, Bank and Customer Law in Canada, 2nd ed. [Toronto: Irwin Law Inc., 2013] 227-34).
Questions #2-6, above, are a starting point to assess whether a resulting trust exists in the context of crypto exchanges/wallets.
The existence of a trust could trigger exchange/wallet obligations to remit GST-HST on all on-platform trades where cryptocurrency is supplied (see Part 1: the CRA’s Present Position on Crypto-Tax).
If GST-HST is remitted, it is required to have also been previously charged on the transaction. If GST-HST is remitted without being charged, the net value received in the transaction will be less than expected. This would likely result in a breach of the trustee's duties on grounds including negligent depletion of trust assets.
Therefore, any obligation on an exchange/wallet to remit GST-HST likely also triggers the additional obligation to have previously charged GST-HST on the transaction. The former duty is owed to the Federal Government via the trust. The latter duty is owed to the trust itself.
The exchange/wallet as trustee could also bear the obligation to disclose all on-platform trades to the CRA, pursuant to the rules applicable to the income taxation of trusts, if the trust is audited by the CRA.
If the controlling minds of a crypto exchange/wallet do not intend to form a trust (notwithstanding how a court would rule on this issue), the exchange/wallet should consider taking steps including the following:
1. Obtain user agreement that the parties’ intentions expressly exclude the formation of any trust, whether a resulting trust or otherwise. One means of obtaining such agreement is through a properly implemented End User License Agreement (EULA), or a binding policy on platform use.
2. Tweak the operations of the exchange/wallet to minimize interactions between the parties that suggest the presence of a resulting trust.
These steps do not constitute a closed list. A cryptocurrency taxation lawyer should be consulted for a full opinion of tax obligations arising from any business plan involving cryptocurrency activity.
We consider cryptocurrency taxation issues further to our services in "Crypto trading and related tax issues", and "Financial institution regulations and fiduciary obligations".
* A bailment in place of a trust is probably not possible for a cryptocurrency exchange, since commodity exchange is anticipated in the business model. (Consider Crawford v. Kingston and Johnston, 1952 CanLII 125 (ON CA); Coro (Canada) Inc. (Re), 1997 CanLII 12187 (ON SC)).
In contrast, a cryptocurrency wallet could likely establish a bailment with less difficulty, depending on the business model.
Continue to Part 4: What's Next in Crypto-Tax?
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