The way your crypto earnings get taxed in Canada depends on how the CRA classifies your crypto activity.
There are two classifications-passive hobby investor and expert day trader. This may seem like a simple distinction but it’s far from straightforward. Figuring it out and being able to support your claim is crucial for 3 reasons:
It determines how you calculate your crypto income.
It determines how you report your activity on your Canadian tax return.
It determines how much tax you will have to pay on your crypto earnings.
Here’s where it gets tricky. The CRA does not have a simple rule of thumb to help you answer it- like they do for regular, mainstream investments. There’s no benchmark, there’s no cutoff and worst of all- not much guidance.
Instead, the CRA looks at this as a “question of fact” and makes its decision based on all of the facts and circumstances of a particular case. The onus is on the investor to make a case and back it up with proof.
If you have a weak case or you have sloppy reporting it can lead to a tax audit. Investors need to be prepared to defend their position. This involves a sound argument and supporting documentation. If you can’t back up your claim the CRA can and will adjust your taxes based on what they determine is “fact”. The fact that you see yourself as a passive investor will not hold any water unless you back it up. The CRA can easily decide to treat you as a day trader. This could mean double the tax and in some cases penalties and interest.
The onus is on the investor to make a case and back it up with proof.
If this has made you a little nervous- good. It’s important to know what you are getting yourself into.
Crypto Investment as Hobby Investing
If you own some crypto assets as part of your investment portfolio and your intention is to hold them for a long term, you are probably not running a crypto business as far as the CRA is concerned.
In this scenario, your crypto investments are capital assets. Disposing of capital assets generates capital gains or losses. This depends on whether you sell them for more or less than what you originally acquired them for. In other words, when you do end up selling or swapping your crypto investments, and their value has gone up, you’ll have a capital gain. This is the same as all other assets.
The crucial thing is that capital gains are only partially subject to tax, only half of the gain is taxable(for now). Here’s an example: You bought some tokens for $2,000 and later sold them for $3,000. Although you’ve made $1,000, you’ll only need to pay tax on half ($500).
You’d report your disposition on Schedule 3 of your tax return. This is the same place you’d report any capital gains or losses. Some of your transaction fees could reduce the capital gain. This is only if they are related to the specific disposition transaction you’re reporting (or the original transaction when you acquired the crypto assets that you’ve now disposed of).
If you are investing in crypto you need to be careful of how you report your gains or losses.
Crypto Investment as a Business
Now imagine instead you are invested in dozens of crypto tokens on various platforms. You are spending hours each day checking your positions. You make frequent swaps and rebalancing your portfolio. You’re well versed in the space and frequently check the market values on your phone.
It’s pretty likely that in the eyes of the CRA, you’re not just a passive investor in crypto. Instead, your level of sophistication and activity would render your crypto trading a commercial activity. In other words, you’re running a crypto trading business as far as the CRA is concerned.
In this scenario, whenever you make a swap (or in any other way dispose of a crypto token) and make a profit, your earnings are not considered capital gains - they are business income. Big difference.
There are several consequences here. The main one is that you don’t get the benefit of partial taxation like you did with the example above. The entire gain gets taxed, not just half.
To use the example from above, your $1000 gain will be taxed fully (not just $500 of it).
If you are investing in crypto you need to be careful of how you report your gains or losses. You have to be aware that you will fall into one of two camps. In either case you need to file properly to avoid any ongoing issues with the CRA. Unfortunately, there is no clear line that I can share with you. It’s all determined on a case by case basis. Proof and proper record keeping is key as well. If your activity is deemed to be a business, your taxes will typically be higher. The way you’d need to calculate and report your activity will be very different in each case as well.
About the author: Yuriy Lozynsky is a CPA and the founder of Deixis, a Canadian accounting firm specializing in crypto currency tax compliance.
The information provided in this blog is general in nature and solely for educational purposes. Viewers use and implementation of the information comes at their own risk and is their own responsibility.