The Difference Between Commercial and Hobby Bitcoin Miners and the CRA

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Due to the high market value of Bitcoin, users who are capable of consistently verifying transactions, called commercial miners, can make a considerable profit. These profit-oriented miners are the primary targets of the CRA’s rules which require mining profits to be reported as income. Hobby miners, on the other hand, are quite different in terms of the effort and skill they put into the mining process. The typical hobby miner can be described as an individual who uses his or her personal computer to slowly mine Bitcoins in their spare time, often as a part of a larger mining pool. The CRA has failed to adequately explain how it differentiates between commercial and hobby miners, a topic that will be subsequently explored in this analysis.

VI. Other Types of Digital Currency

Although Bitcoin is the dominant digital currency in the world of online transactions, there are in fact thousands of other types of digital currency which operate much in the same way, albeit with variations in terms of levels of encryption and market value.

A. Litecoin:

The second most popular type of digital currency is called “Litecoin”. The current market value of an individual Litecoin is $1.69 CAD.[1] Similar to Bitcoin, Litecoin is a peer-to-peer virtual currency that enables users to make instant, low-cost payments to anyone in the world.[2] It is also worthy of mention that the Litecoin block chain is capable of handling a higher transaction volume than Bitcoin.[3]

B. Darkcoin:

Darkcoin is one of the world’s fastest growing cryptocurrencies. The current market value for an individual Darkcoin is $3.74 CAD.[4] The most impressive feature of Darkcoin is the fact that it offers a higher degree of anonymity than Bitcoin due to its system of mixing up users’ transactions and thereby increasing the difficulty required to trace payments.[5] While Bitcoin users who desire a greater degree of privacy and anonymity must often use a “laundry” service that mixes up transactions,[6] Darkcoin achieves this automatically by combining every transaction with those of two other users (a feature called Darksend).[7]

C. Dogecoin:

Dogecoin emerged in late 2013, born from an internet meme involving Shiba Inu dogs which has since exploded into one of the world’s most valuable digital currencies. Dogecoin helped fund the Jamaican bobsled team for the 2014 Winter Olympics.[8]

VII. Legal Status in Canada

Digital currencies have not been recognized as legal tender in Canada. According to s. 8 of the Canadian Currency Act, a tender of payment of money is a legal tender if it is made: (a) In the coins that are current under section 7 (e.g. coins issued under the authority of the Royal Canadian Mint Act); and (b) In notes issued by the Bank of Canada pursuant to the Bank of Canada Act intended for circulation in Canada.[9] Digital currency does not fall within this definition of “Legal Tender” and is therefore not legally recognized as such in Canada. Rather, it is generally treated as a commodity for the purposes of the Income Tax Act.[10] This was confirmed in January 2014 when an official from Canada’s Department of Finance was quoted saying that: “only Canadian banknotes and coins are recognized as legal tender in Canada. Bitcoin digital ‘currency’ is not legal tender in Canada.”[11] This individual also indicated that Canada would continue to monitor developments involving “virtual currencies”.[12] Nevertheless, a report from the Wall Street Journal also quoted a spokesman for the Bank of Canada who stated that this may change if a digital currency such as Bitcoin becomes large enough to pose a threat to the stability of the established Canadian financial system.[13]

VIII. Tax Implications

A. Are Transactions Involving Digital Currency Taxable?

The Canadian Revenue Agency (CRA) is the federal tax authority in Canada and is governed by federal legislation called the Income Tax Act (ITA). The CRA has confirmed that taxes on Bitcoin can apply to certain transactions pursuant to the ITA, but no branch of the Canadian government has issued any official written guidance as to the state of the law in regards to digital currencies like Bitcoin.[14] Regardless, transactions involving digital currency are indeed taxable in Canada, which became the first country do so on June 19, 2014.[15] In paragraphs nine through 32 of the CRA’s IT-479R, Transactions in Securities, for example, Bitcoins sold for fiat currency are counted as either income or as capital gains. The CRA has explicitly stated that there are two general means by which digital currency can be taxed in Canada:
  1. When used in a barter transaction, and
  2. When bought and sold as a commodity.

B. Digital Currency in the Context of Barter Transactions:

The CRA has indicated that where digital currency is used to pay for goods and services, it is governed by the rules surrounding barter transactions.[16] Barter transactions occur when two persons agree to exchange goods and services without using legal tender, including Canadian dollars.[17] Barter transactions in Canada are governed by Interpretation Bulletin IT-490, Barter Transactions. IT-490 indicates that barter transactions occur when there is an exchange of one commodity for another, and it “is effected when any two persons agree to a reciprocal exchange of goods and services and carry out that exchange usually without using money.”[18] This document also clearly indicates that barter transactions are within the purview of the Income Tax Act, and that they can therefore result in income or expense, or in the acquisition/disposition of “capital property, eligible capital property, personal-use property, or inventory depending upon the circumstances of the persons who are bartering and the nature of that which is bartered, on the same basis as if cash was the consideration.”[19] In the context of barter transactions, the exchange of digital currencies for goods and services and the resulting tax implications are calculated as follows. Consider that Alice sells widgets to Bob for a price of 1 Bitcoin per widget. The current fair market value for Bitcoin is approximately $300 CAD, but is highly volatile and prone to wild fluctuation. In this scenario, assume that $300 is the actual market price of 1 Bitcoin at the time of the transaction and no market fluctuation occurs. Each of these widgets costs $60 to produce. Upon selling the widget to Bob for the aforementioned price, Alice has earned a net business income of $240 ($300 from the purchase price of the widget minus the $60 production cost). As such, Alice has earned a net business income of $240 and will pay taxes on 100% of that to the Canadian government. Of course, wild fluctuation of Bitcoin’s market value will add substantial uncertainty to this situation in reality. Another interesting example of how digital currency is taxed in the context of barter transactions is how it is taxed when used by employers to pay employees. As Canada moves forward in the digital age, it is nearly inevitable that some businesses will choose to compensate employees in the form of a digital currency such as Bitcoin. Although the CRA has provided little guidance on the tax implications of doing so, they have issued an information bulletin that sheds some light on the matter. To begin, the exchange of an individual’s services at work for a salary paid in Bitcoin will be viewed as a barter transaction. Under s. 5(1) of the Income Tax Act, an individual’s income from employment includes “the salary, wages, and other remuneration, including gratuities, received by the taxpayer in the year.” As such, salaries paid and received in Bitcoins are appropriately taxable under this provision.[20] Tax on salaries paid in Bitcoin is calculated as follows. To begin, it is the value being provided in exchange for the Bitcoin that will be calculated as part of that individual’s income. For example, consider that Alice is an articling student whose services for the year are valued at $50,000 but paid in Bitcoin. In such a case, it is the $50,000 in value, not the current market value of the Bitcoin, that will be considered as income for tax purposes. However, due to the fact that digital currency also fluctuates widely in value, employees earning their salary from employers in Bitcoin but also be cognizant of capital gains and losses. Tax compliance software such as US-based LibraTax would be a valuable asset in this case, as it automatically imports transactions of these kind from digital currency exchanges like Coinbase and calculates the resulting capital gains and losses in USD. At this point, a Canadian employee in this situation can then convert these capital gains/losses to Canadian dollars for tax purposes.

C. Digital Currency in the Context of Capital Gains & Losses:

Capital gains in digital currency are primarily taxable when they are converted into fiat through a disposition. This raises an interesting question: What happens when an individual exchanges one type of digital currency for another? It is possible that the CRA will treat this kind of transaction as a barter transaction, but is still unclear on this particular point.[21] Generally speaking, if digital currency like Bitcoin is purchased and then sold as a commodity, any resulting gains or losses can be taxed as income or capital gains.[22] Digital currency is an asset that can be taxed as capital gains, analogous to capital gains derived from stocks, bonds, or dividends. The CRA has stated that usually, a capital gain or loss occurs when an individual is considered to have sold capital property, such as by exchanging one property for another.[23] Due to the fact that digital currencies are essentially a form of capital property, they cannot generally be exchanged for property without incurring a capital gain or loss. In order for users of digital currency to determine whether or not they have incurred a capital gain or loss, they must know: (1) the proceeds of the disposition, (2) the Adjusted Cost Base (ACB); and (3) the outlays and expenses incurred to sell [the] property.[24] The capital gain or loss is then calculated by “subtracting the total of your property's [ACB], and any outlays and expenses incurred to sell your property, from the proceeds of disposition.”[25] For example, consider that Alice wants to sell 1 Bitcoin in exchange for Canadian dollars. The value of the digital currency sold will act as the Adjusted Cost Base. At current market value, 1 Bitcoin is worth approximately $300, so the ACB of 1 Bitcoin is $300. Alice then sells 1 Bitcoin to Bob for $350, so $350 is the “proceeds of disposition” in this case. Assuming that Alice has not incurred any outlays or expenses to sell their Bitcoin, Alice must subtract the ACB of $300 from the overall proceeds of sale, $350, to arrive at a capital gain of $50. Considering that capital gains in Canada are 50% taxable, Alice must pay taxes on $25.00 of her capital gains (assuming that Alice has made no other similar transactions throughout the year and has used all other cumulative life time capital gains exemptions – if she qualifies for those exemptions).[26] If, however, Alice incurred a loss of $50 (say, to a market fluctuation in the price of Bitcoin), it can be used to offset any capital gains that were had during the year.[27] Regardless of whether Alice incurred a capital gain or loss, she is obligated to report the disposition of this property in the calendar year that she sold, or is considered to have sold, the property.[28] Accordingly, she must also file an income tax return to report the transaction.[29] If Bitcoins are held as inventory, however, capital gains are not possible. As such, upon their sale the Bitcoins will be taxed on their fair market value at the applicable tax rate.

D. Digital Currency as a Gift:

Digital currency given as gifts generally cannot be taxed by the CRA. According to Interpretation Bulletin IT334R2, Miscellaneous Receipts, voluntary transfers of real and personal property without consideration are not subject to tax in the hands of the recipient.[30] Nevertheless, if a voluntary payment or other valuable transfer is received from an employee by an employer, the amount given as voluntary payment will generally be included as income pursuant to subsection 5(1) or paragraph 6(1)(a) of the ITA.[31] Furthermore, IT334R2 states that voluntary payments received by virtue of a profession or carrying on a business is also taxable. As such, Bitcoins received as voluntary payment for a good or service are indeed taxable as income according to the CRA.[32]

E. Losses from Theft, Defalcation or Embezzlement:

According to CRA Interpretation Bulletin IT-185R (Consolidated), Losses from Theft, Defalcation, or Embezzlement, “a loss of trading assets such as inventory or cash, through theft, defalcation, or embezzlement is normally deductible in computing income from a business if such losses are an inherent risk of carrying on the business, and the loss is reasonably incidental to the normal income-earning activities of the business.”[33] Accordingly, it appears that digital currency miners would be able to deduct losses from theft, defalcation or embezzlement so long as their mining activities meet the requirements set out in IT-185.
[1] Litecoin Exchange Rate (2014), Online: Litecoin Exchange Rate <http://litecoinexchangerate.org/c/CAD/1> [2] Litecoin.org, “What is Litecoin?” (2014), Online: Litecoin.org <https://litecoin.org/> [3] Ibid. [4] CoinGecko, “Dash (Darkcoin)/Canadian Dollar (DASH/CAD) Price Chart” (2014), Online: CoinGecko<https://www.coingecko.com/en/price_charts/darkcoin/cad> [5] Andy Greenberg, “Bitcoin’s Nefarious Cousin Darkcoin is Booming”, Wired (22 May 2014), Online: Wired <http://www.wired.co.uk/news/archive/2014-05/22/darkcoin-is-booming> [6] Andy Greenberg, Supra note 45. [7] Ibid. [8] CoinDesk, “Dogecoin News and Analysis” (2015), Online: CoinDesk <http://www.coindesk.com/technology/altcoins/dogecoin-news/> [9] Currency Act, RSC 1985, c. C-52 [10] Timothy Fitzsimmons, “Bitcoins: More Guidance from the CRA” Canadiantaxlitigation.com (22 January 2014), Online: Canadiantaxlitigation.com <http://www.canadiantaxlitigation.com/wp-content/uploads/2014/01/2013-0514701I7.txt> [11] David George-Cosh, “Canada Says Bitcoin Isn’t Legal Tender” The Wall Street Journal (16 January 2014), Online: The Wall Street Journal <http://blogs.wsj.com/canadarealtime/2014/01/16/canada-says-bitcoin-isnt-legal-tender/> [12] Ibid. [13] Ibid. [14] Matt Burgoyne, “All you need to know about federal bitcoin law in Canada” Coin Desk (23 October 2013), Online: CoinDesk <http://www.coindesk.com/federal-bitcoin-law-canada/> [15] MNP LLP, “Canada Implements First Bitcoin Legislation” MNP (23 June 2014), Online: MNP <http://www.mnp.ca/en/media-centre/news/2014/6/24/canada-implements-first-bitcoin-legislation> [16] Canada Revenue Agency, “What you Should Know about Digital Currency” Canada Revenue Agency (3 December 2014), Online: Canada Revenue Agency <http://www.cra-arc.gc.ca/nwsrm/fctshts/2013/m11/fs131105-eng.html> [17] Ibid. [18] Canada Revenue Agency, “ARCHIVED - Barter Transactions” Canada Revenue Agency (5 July 1982), Online: Canada Revenue Agency <http://www.cra-arc.gc.ca/E/pub/tp/it490/README.html> [19] Ibid. [20] Gaming Counsel, “Canada will tax your Bitcoins” Pokerati (7 November 2013), Online: Pokerati <http://pokerati.com/2013/11/canada-will-tax-your-bitcoins/#sthash.ovOJu5EJ.dpuf> [21] Gaming Counsel, Supra note 60. [22] Canada Revenue Agency, Supra note 56. [23]Canada Revenue Agency, “Do you have a gain or loss?” Canada Revenue Agency (2 December 2014), Online: Canada Revenue Agency <http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/ncm-tx/rtrn/cmpltng/rprtng-ncm/lns101-170/127/gns/whn/menu-eng.html> [24]Canada Revenue Agency, “How do you calculate your capital gain or loss?” Canada Revenue Agency (5 January 2015), Online: Canada Revenue Agency <http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/ncm-tx/rtrn/cmpltng/rprtng-ncm/lns101-170/127/gns/clclt/menu-eng.html> [25]Ibid. [26] Canada Revenue Agency, “What is the Deduction Limit?” Canada Revenue Agency (20 January 2014) <http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/ncm-tx/rtrn/cmpltng/ddctns/lns248-260/254/lmt-eng.html> [27]Canada Revenue Agency, Supra note 64. [28] Ibid. [29] Ibid. [30] Canada Revenue Agency, “ARCHIVED – Miscellaneous Receipts” Canada Revenue Agency (6 September 2002), Online: Canada Revenue Agency <http://www.cra-arc.gc.ca/E/pub/tp/it334r2/it334r2-e.html> [31] Income Tax Act, RS C 1985, c 1 (5th Supp.) [32] Kenda Shaheen, “Regulation of Bitcoin Around the World” Taxlitigation.com (22 May 2014), Online: Taxlitigation.com <http://www.canadiantaxlitigation.com/category/bitcoin-2> [33] Canada Revenue Agency, “ARCHIVED – Losses from Theft, Defalcation or Embezzlement” Canada Revenue Agency (4 September 2002), Online: Canada Revenue Agency < http://www.cra-arc.gc.ca/E/pub/tp/it185r-consolid/it185r-consolid-e.html>
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