Cryptocurrency Profits in Canada: Capital Gains vs. Business Income
I am asked all the time whether somebody has to pay capital gains tax on their cryptocurrency gains or whether they have to pay business tax. The answer invariably, is “it depends.”
It depends on a number of factors. There is no set formula as to determine the exact point at which a gain ceases to be a capital gain and instead is taxed twice as punitively under the banner of income tax. With one set of circumstances a taxpayer can get away with paying capital gains tax. And then without warning, like the tipping of a see-saw, the taxpayer finds that they must start paying business income tax.
To provide an analogy that may resonate, crypto trading is taxed by applying the same concepts applicable to the taxation of stock trading. That is to say that I expect to pay capital gains tax when I eventually sell my Apple shares which I have held for many years, and which make up my entire stock portfolio along with a few shares of Wells Fargo. I have made two trades in 5 years. One to buy the Apple and the other to buy Wells Fargo. I earn my living as a lawyer. Any gain that I derive from the sale of my stock will be treated as a capital gain and will be incidental to my income. On the other end of the spectrum, you have the professional stock trader who will certainly have their income from stock trading taxed as business income. But the problem is not with me or the professional trader. Our positions are clear. The problem lies with those people who are somewhere in-between.
The factors which lend to a classification of gains as business in nature vs a capital gain income include:
Increased frequency of trading
Larger number of trades
Shorter holding periods
Quitting one’s other job or Increasing proportion of income attributed to crypto trading
So it is clear to me that:
capital gains would apply in the situation of somebody who purchased a 100 Bitcoin way back when they were worth $1 and in turn held them until 2017 at which time they were sold for $2Million, and who works full-time as a chef in a restaurant, and who has no other cryptocurrency holdings, and who did not even make one crypto-to-crypto trade; and
the case would not be so clear if $1M of the $2M in Bitcoin were converted to fiat and the taxpayer quit their job and took the other $1M of Bitcoin and traded it tens or hundreds or even thousands of times back and fort between cryptocurrencies which are now valued at $3M. It may be that the initial $1M converted to fiat could be classified as a capital gain. But it is most likely that the $1M gain from trading the Bitcoin full-time would be taxed as business income.
When people find out that their income may be taxed as business income, invariably they ask me whether they must track all their individual trades and determine profit / loss for each individual trades. There are pieces of software that exist for this purpose, yet I advise people that if it becomes very cumbersome there alternatives.
While in a perfect world one would keep track of the profit and loss of each individual trade, there are a number of problems with this. Firstly the number of transactions sometimes makes the practice prohibitive, and the fact that multiple platforms and multiple sites are used, this adds to the mess. Compound this with the fact that there are different liquidities of cryptocurrencies which in turn affect one’s ability to make a trade at any point in time, which in turn arguably affects one’s fiat valuations – A token may be worth $1.50, but if the best buy order is for $1.30, what is the true valuation?
So instead of tracking each trade, an equally acceptable methodology to track business income over the course of the year is to determine the valuation in fiat (CDN) at the end of the year and subtract the value from January 1, accounting for exchanges to fiat.
But beware. Many Canadian taxpayers have found themselves in the position where they have significant cryptocurrency holdings with very little input cost. Those with straight capital gains have no issues: They pay capital gains with fiat once they have converted crypto to fiat. No conversion to fiat, no tax payable yet, and no need to liquidate. Conversely, those paying business income tax usually find that they are in the position where they are forced to liquidate crypto to generate fiat to pay the tax bill.
Dale Barrett is the bestselling tax author of Tax Survival for Canadians and the managing partner of Barrett Tax Law. He is also the General Editor of the Income Tax and Family Law Handbook published by LexisNexis.
Dale provides a broad range of tax advice to individuals and businesses, including many involved in the trading, mining, and investing in Bitcoin and other cryptocurrency.