Canada Revenue Agency Falls Short on Bitcoin Mining Tax Interpretation
Tax season came and went and those involved with bitcoins in 2013 had the frustration of having to interpret just how they will include their bitcoin related activities on their tax returns, especially those with bitcoin mining activities.
We at Xen Accounting have seen first hand just how frustrating this can be for taxpayers due to the (almost) complete lack of guidance from the Canada Revenue Agency in regards to how a lot of this bitcoin activity should be treated for tax purposes.
The last, and only, time that the CRA commented on digital currencies, such as bitcoins, happened back in November. Since then… silence. It was only a matter of time before we would receive a bit more guidance, and that came recently in a new CRA technical interpretation regarding the tax consequences of mining bitcoins. The concept of mining was briefly explained in a previous article.
Simply put, upon successful mining on the bitcoin network, one is rewarded with a certain amount of bitcoins. But just how these mined bitcoins should be treated for tax purposes is one of the causes for confusion at the moment as mining is a completely new concept with no tax legislation to support it. Does it need to be included in our income? At what point? At what value? And when exactly? All of these questions were unanswered and open to interpretation.
Recently a new technical interpretation released by the CRA attempts to respond to a similarly confused Canadian resident regarding some of the taxation implications of bitcoins, largely relating to mining.
Does the new tax interpretation help give a bit more clarity? Unfortunately, things are still wishy-washy. Here’s why.
Classification of mining activities
The tax interpretation starts off by saying that mining activities can either be be classified as a hobby or as a commercial activity. They point to case law in regards to how one could make this determination. It is a question of fact and numerous factors are considered, which I won’t go into detail here.
Generally, in commercial activities, you can deduct business expenses. This is not true with a hobby. In most instances, I would expect that if you are getting rewarded with bitcoins for mining, this would be considered a business activity for the reasons explained in this article I wrote back in December.
Here’s where the CRA is attempting to provide some guidance, but in our opinion (and we have debated this quite a bit at the office!), they fail to actually do so.
Inventory valuation for mined bitcoins
The CRA says that if your bitcoin mining activities are considered to be a commercial activity, then you need to value your bitcoins at year-end using an accepted inventory valuation method in order to compute your income for tax purposes. Typically, this would mean you would value your inventory at either the lower of:
- The cost at which they were acquired (ie. the cost to acquire them would be any direct costs associated with your mining activities, such as cost of electricity, for example); or
- Their fair market value as at year-end.
They also say you have the option to simply value your inventory at fair market value at year-end if you don’t want to follow the lower of cost or market rule listed above.
This all suggests that you have the option to determine how you want to value your inventory, which are essentially your bitcoins from mined activities, even though they stop short of calling all your mined bitcoins inventory (whether mined as a hobby or commercial activity). The method you choose to value your bitcoins will have direct tax implications.
Nine times out of 10, the cost to acquire/mine bitcoins will be lower than their fair market value (especially given the current market rates), and essentially, you could defer tax on mining operations by simply choosing to value your bitcoin inventory from mining at their cost. In a very simple example, if it costs you $10 worth of electricity to mine a bitcoin but the market value of that very bitcoin at year-end is $500, essentially you would defer tax on $490 of revenues by selecting to value your mined bitcoins at their cost of acquisition.
In most instances, the cost method of valuing inventory is preferable for tax minimization purposes. Whatever method you choose, you need to remain consistent.
IRS guidance a lot more clear
The IRS recently put out a publication which states that mined coins need to be included as income in your tax return at their fair market value at the time they are mined. Easy peasy.
Although the IRS and the CRA are two different organizations with two completely different sets of tax legislation, I would have actually expected the CRA to say something more along these lines. Instead, we get a wishy-washy response saying that mined coins need to be valued for inventory purposes at year-end.
CRA technical interpretation is insufficient
We’re going to need much clearer guidance from the CRA in regards to bitcoin mining and we’re going to need this soon.
Questions that still need to be answered include:
- The interpretation talks about classifying the mining activities between hobby and commercial. It says what you should do if the activities are considered commercial but makes no mention of what should happen if the activities are a hobby.
- What happens after you’ve mined your bitcoins? Many sell them and the CRA has spoken about as either treating them as capital gains (ie. 50 % taxable) versus straight income (ie. 100% taxable). However, if we hold these bitcoins as inventory, the very properties of inventory suggest that capital gains are not possible and therefore upon their ultimate sale, one would be taxed at 100%, leaving many Canadians with a much higher tax bill.
Technical interpretations are nice to have but only if they can actually guide us. This technical interpretation does none of that in regards to bitcoin mining. Instead, it simply gives us part of the picture and leaves us to interpret an illogical explanation with many inconsistencies. All those involved with bitcoin mining can use this technical interpretation to the best of their abilities going forward, but I’d expect the CRA to come out with something revised, and hopefully soon.
(Note: the above does not constitute accounting advice and readers are cautioned against basing any decisions from this article alone.)