What are the tax implications of digital currency?
It’s official: the world has started to go bitcoin crazy. It’s exciting times no doubt, but there is one area to pay attention to: tax. So just what are the tax implications of digital currency?
Since my last Techvibes article discussing the (limited) tax guidance the Canada Revenue Agency has issued Canadians with regards to digital currencies, namely bitcoins, the value of many digital currencies has skyrocketed. At the time of my article, bitcoins were sitting at around $300, have since shot up over $1,100 in just a few short weeks from when I started writing this article, and have since dropped to as low as $580. It’s a rollercoaster ride, no doubt about it.
Also since then, I have spoken with business owners across the country, many of whom are interested in getting in on the cryptocurrency explosion. Honest entrepreneurs are looking to get involved in something that could be one of the more massively disruptive things this generation has seen since the creation of the internet.
But they have concerns, and rightly so. Why? Because the tax situation behind all these digital currencies is a total mess.
The Bitcoin Brains, a client of mine, is Calgary’s first bitcoin store, which provides safe and secure virtual currency trades. They are among the many digital currency businesses across the country that are worried about the current lack of guidance provided by the government in terms of taxes.
“We want to do the right thing and pay our taxes. We just aren’t sure what those will be yet as there isn’t a lot of information to go on,” says Andre Gagnon, director of The Bitcoin Brains.
Guillaume Babin-Tremblay is the Executive Director at Montreal’s Bitcoin Embassy, a not-for-profit organization which occupies 3 floors of real estate in downtown Montreal is geared towards facilitating and accelerating the adoption of bitcoin usage. They are also frustrated with the current situation.
“We are continuously and actively seeking guidance to some of the questions involving bitcoins and taxes. The more we know about taxation in this space, the faster we can promote adoption of bitcoins across Canada,” says Guillaume.
There are a lot of questions that have been left unanswered. Each and every single one of these business owners I spoke with just want to do the right thing. They want to follow the rules. Unfortunately, there are very few rules to follow as the CRA has practically left many of these Canadians in the dark when it comes down to how these digital currencies should be treated in many areas of taxation.
Throughout this article I will outline several areas of concern and confusion for those across Canada involved in digital currencies.
One of the more popular questions that I get is, “how are my mined bitcoins treated for tax purposes?” Good question! And I wish I could give you a definite answer.
For all of you that don’t know, mining is the processing of transactions where complex mathematical equations are solved by computers. Those with the computers solving these equations are known as miners and are rewarded with bitcoins (or other digital currency) for their efforts.
In terms of the taxation consequences of mining, we are dealing with completely uncharted territories here. There is absolutely no guidance, no hints and no precedent to go on, so of course this is a challenge for many digital currency miners (and accountants as well).
One can logically make the assumption that the activity of mining could constitute a business in the eyes of the CRA as the Income Tax Act defines a business as one that is, “a self-sustaining integrated set of activities and assets conducted and managed for the purpose of providing a return to investors.” As such, mined bitcoins may very well be considered as business income and would therefore be taxable. The question is, should mined bitcoins be treated as income upon mining or upon their ultimate disposal?
If I had to make a judgment call, I would assume that at some point the CRA will eventually come out and say that mining activities are taxable. Whether they will be considered business income and at what point they will need to be declared for tax purposes are other questions.
Of course, if mining activities are taxable then you would also be able to deduct a reasonable amount of expenses associated with these business activities. Computer equipment, computer supplies and electricity are a few expenses that come to mind when discussing mining activities.
What we are seeing here is is really just the tip of the iceberg and there are many other complexities involved. Hold on to your seats, it’s going to be a bumpy ride.
Again, this is a very tricky situation. We all know that sales tax needs to be charged on sales and remitted back to the government, but what part of the transaction is liable for sales tax? If you are in the business of selling bitcoins, do you charge sales tax on the entire transaction or simply on the commission?
I know some that are charging just on the commission while others are charging on the bitcoin itself plus the commission. Arguments can be made for both tax treatments however there seems to be a consensus among many, at this point in time, that charging simply on the commission itself is the most appropriate way to handle this.
The argument here is that those buying and selling bitcoins are a broker and are simply facilitating the sale of bitcoins for a commission, as such, only the commission is looked upon as subject to sales tax. Does this mean this is how the government will view it? Not necessarily. So beware.
CAPITAL GAINS OR BUSINESS INCOME
The CRA has already stated that if you are buying and selling virtual currencies like a commodity then any gains or losses upon disposal of these currencies would be taxable. Fine, that’s easy enough to understand. But when is a digital currency considered a commodity and when is it not?
The question becomes whether gains on the sale of these virtual currencies are considered business income or capital. Making the distinction between considering these gains as business income or capital has an important impact on your bottom line. If they are considered to be capital, then the gains will only be 50% taxable, resulting in a lower amount of tax to pay.
There are many factors to take into account when trying to make the distinction as to whether these gains should be treated as business income or capital but at the core of it, one must consider whether the buying and selling of these digital currencies are done in the normal course of operations or not. If you run a business that buys and sells bitcoins as its core business activity and these activities are happening frequently then it is likely that gains on the sale of these virtual currencies should be considered as business income and are therefore fully taxable.
Again, there are many factors to consider, so speak with a professional if you need help making the differentiation.
NEW DIGITAL CURRENCIES = NEW HEADACHES
There are a plethora of digital currencies right now on the market. Most are an off shoot of the bitcoin process to a certain extent where mining is taking place. Litecoins, namecoins, peercoins and countless other altcoins, the list goes on.
Some digital currencies, however, are completely different in that no mining is involved. One of the up and coming digital currencies, called XRP or ripples, is a digital currency that is part of the Ripple network, which is essentially a network that facilitates trading any currency to anyone in the world.
Haven’t heard of Ripple? Well Google has. Google Ventures along with several other venture capitalists have invested close to $10 million dollars in the Ripple team already.
Explaining how Ripple works is like explaining business accounting consolidations to a family doctor, it’s extremely complex and will likely lead to confusion. I just started looking into Ripple and I still can’t wrap my head around it completely. And if it’s hard to just understand the concept alone, imagine the accounting behind it, yikes!
The point is, what we are seeing happening right now with the bitcoin explosion is just the beginning. No doubt new digital currencies with completely new concepts will spring up resulting in major question marks about how these should be treated for tax purposes.
CAN I PROTECT MYSELF?
We are in a new day and age where we need answers quickly and we cannot afford to wait months or even years for the government to comment on how to treat these new digital currencies in terms of taxation.
We need answers and we need them fast.
WHAT CAN I DO FOR NOW?
At the end of the day, the important thing to be is vigilant. Speak to those in the community and speak to professionals knowledgeable in these areas. Gather the information and make the best informed decisions you can about how to report your taxes on these digital currencies, because in the end, that’s just about the only thing you can do.
There will come a time when the CRA will step in and, for better or worse, lay down the ground rules. Some will pay, while others won’t. Just about the only thing you can do is to try and be as prepared as possible.
Digital currencies are not going to disappear, they are only getting started. And one thing is for sure, when my grandmother starts talking about bitcoins, you know they are becoming mainstream.