In 2017, bitcoin reached new highs. The cryptocurrency’s value increased by more than 1,300% over the year, and at the same time, all kinds of new cryptocurrencies were entering the marketplace. If any of your clients are buying or selling bitcoin or other digital currencies, you need to ensure you’re handling the tax reporting requirements correctly.
Income or Capital Gains?
The first and arguably most important angle you need to consider is whether the sale is income or capital. To draw this distinction, the Canada Revenue Agency uses basically the same rules as with most other sales of property. To explain how that works, consider the following two examples.
Bitcoins as Capital Gains
Say your client buys two bitcoins when they’re worth $1,000. Your client wants to see how much it can earn so it holds onto the bitcoins for a couple years and sells them when their value reaches $22,000. In this situation, your client has made $21,000. That’s the difference between the price it paid for the bitcoins and the money it received from the sale. Your client should report this income as capital gains.
Bitcoins as Income
In contrast, imagine your client runs an online business and accepts bitcoins as payment. It receives three bitcoins from a customer. When it notes the revenue in its accounting books, it converts the funds to Canadian dollars based on the exchange rate on the day of the sale, just as with transactions using foreign currency. As the bitcoins are worth $1,500 at the time of the transaction, your client notes that amount in its records.
At the end of the week, your client converts the bitcoins to Canadian dollars so it can deposit them in the bank. The value has increased, and at this point, the bitcoins are worth $3,000. Technically, your client has earned $1,500 through this transaction, but that isn’t a capital gain. Instead, it’s income.
Assessing the Difference
Unfortunately, not all situations are as cut and dried as the above examples. When transactions aren’t as clear, the CRA takes into account several different elements. It looks at the buyer’s intent. As you can see in the first example, your client’s intent was speculation to see if it could earn money. This indicates that any income or losses are capital gains. In the other situation, your client was using the funds as currency for business transactions. By extension, any money generated from those transactions is probably just income.
The CRA also looks at the relationship between the transaction and your client’s business. Say the individual in the first example owns rental properties. The bitcoin doesn’t relate to that business, and that helps to establish it as a side investment which leads to a capital gain. In contrast, the second business runs an e-commerce shop where it accepts a wide range of foreign and digital currencies. That indicates the bitcoins are part of the regular income flowing in and out of the business.
The CRA also considers the number of transactions, the length of time the individual has the cryptocurrency, and the reasons for the sale. To explain, numerous transactions generally indicate income. Holding the cryptocurrency for a long time indicates capital gains. Additionally, selling when the exchange rate is favourable indicates capital gains. But on the other hand, if your client has the bitcoins in a wallet and sells them at the end of every week, regardless of value, this may indicate income. Of course, there are exceptions to all these rules. For instance, some investors end up selling their bitcoins quickly.
If your clients aren’t using bitcoins now, there’s a good chance they might in the future. The popularity of these currencies seems to be increasing. Ideally, you should be ready to advise your clients so they know what to expect.