Taxing cryptocurrency

Digital currencies like Bitcoin are becoming popular in Canada. In fact, Vancouver-based Bitcoiniacs and Nevada, U.S.-based Robocoin recently launched the world’s first Bitcoin ATM in Vancouver.

And it seems CRA took note. In November, the agency issued a fact sheet reminding taxpayers of reporting requirements when using digital currencies, often called cryptocurrency.

Background on digital currency

A traditional currency like the Canadian dollar has value because a country’s government declares it to be legal tender and guarantees its value. However, as the fact sheet points out, most digital currency “is not controlled by central banks or any country” but is otherwise “virtual money that can be used to buy and sell goods or services on the Internet.”

Many early versions of digital currencies (not all of which survive today) were backed by some kind of precious metal reserve. Interestingly, there is a made-in-Canada digital currency that pegs back to the Canadian dollar—Internet rumour mills suggest the Royal Canadian Mint’s “MintChip” may be in limited use as early as the end of this year.

More recently developed types may be cryptocurrencies, which go beyond merely being countable units, employing cryptography to create currency units, secure transactions and guard against digital counterfeiting. The fact sheet uses Bitcoin as an example. It gained some unwelcome notoriety earlier this year when the IRS shut down Silk Road, an online illegal drug market, and in so doing came into possession of 1.5% of the world’s Bitcoins.

Tax reporting

We’re required to calculate and report taxes in Canadian dollars. Where business or investments have been transacted in other currencies, there must be a conversion back into Canadian dollars. With traditional currencies, there are published exchange rates with other central banks to facilitate this process. Though there are online exchanges that will quote digital currencies in Canadian dollars, these are not directly recognized for tax purposes.

Instead, CRA considers these types of transactions to fall under the barter rules, which in its simplest form is the exchange of one commodity for another without using money. The value of the exchange is fair market value in Canadian dollars, on the same basis as if cash was the consideration. Apart from being used in exchange for goods and services, digital currencies can also be bought and sold as commodities.

Depending on who is involved and how the transaction is carried out, the tax treatment may be:

current income or expenses;
acquisition or disposition of capital property;
eligible capital property (goodwill);
personal-use property; or
inventory.

More tax complications ahead?

One last nuance with cryptocurrencies is how currency units are created. For example, Bitcoins are mined into existence when someone directs a computer to solve a very complex computer puzzle across the Internet (apologies to techies for my simplistic explanation). In some places it’s described as converting electrical power into currency. Earlier this year, Germany decided to recognize the mining process by imposing a 25% capital gains tax on these units if they’re held for less than a year. As well, algorithms are beginning to pop up on some websites, asking visitors whether they would like to participate in a mining consortium. If the visitor agrees then, while he remains on the webpage, some of his computing power may be used to help mine Bitcoins. Would these people have to pay capital gains taxes? This may sound like science fiction, but it is reality. We’ll have to stay tuned to see how CRA may address this latest aspect of digital currencies.

Doug Carroll, JD, LLM (Tax), CFP, TEP, is vice president, Tax and Estate Planning, Invesco Canada.