Canada has a bipolar history with cryptocurrencies. In 2013, she saw both the world’s first bitcoin ATM and the federal government rushing to tax crypto-assets. Now, Canadian accountants (CPAs) have issued a warning that onerous tax rules will scare away entrepreneurs.

Over the past decade, Canadians have been quick to embrace crypto and blockchain initiatives, leaving authorities scrambling for ways to tax and regulate the rapidly evolving market. In 2017 to 2018 alone, there was a 25 per cent jump in adoption, and a recent survey found 76 per cent of Canadians are aware of cryptocurrencies.

Not one to miss a piece of the pie, the Canadian Revenue Agency (CRA) issued a tax guide on crypto-assets six years ago and has recently increased audits to close in on potential tax evaders.

Collateral Damage

Seeking to clarify the status of crypto-assets, Finance Canada has embarked on a mission to update applicable tax rules. Its latest proposal includes classifying select cryptocurrencies as financial instruments. However, the attempt to fix one problem is creating new ones with far-reaching consequences.

The tax treatment of cryptocurrencies in Canada is complex, to say the least. Rather than treating them as money, the CRA views them as investment commodities. When filing income taxes, Canucks are supposed to report gains and/or losses by estimating “fair market value.” Consider someone who purchased bitcoins eight months ago for $10,000. If bitcoin’s value has since doubled, that person owes income taxes on $5,000 (half of capital gains are deductible).

However, the status of cryptocurrencies for the goods-and-services tax and harmonized sales tax (GST/HST) is more problematic. Since cryptocurrencies are not money to the CRA, using them to purchase goods and services is a barter transaction. This could lead to instances of double taxation: GST/HST being charged every time a cryptocurrency changes hands.

Complicating things even more, GST/HST rates vary depending on the place of supply. A business must charge different rates to customers from participating and non-participating provinces.

To solve this conundrum, Finance Canada has sought to classify crypto-assets as financial instruments under a new category: virtual payment instrument (VPI). Transactions with VPI would be exempt from the GST/HST.

Adding Epicycles

There’s just one problem. Treating cryptocurrencies as financial instruments would require entities dealing them to be registered as financial institutions—a threshold far too burdensome for most businesses and individuals.

According to PwC Canada, a company that provides professional accounting services to businesses and individuals across Canada, “a financial institution for GST/HST purposes must follow the rules that apply to financial institutions, which may result in changes to input tax credit (ITC) eligibility, additional apportionment and annual reporting requirements, among other changes.”

Also, the VPI designation only applies to select cryptocurrencies, with an explicit list in the works. The draft legislation states a VPI is a digital representation of value that functions as a medium of exchange and exists at a unique address of a publicly distributed ledger.

This definition ignores digital currencies created for a particular goal—not just a medium of exchange—or those built on private ledgers. In other words, utility tokens sold through ICOs, centralized stablecoins, and closed-blockchain initiatives such as Facebook’s libra fall outside VPI scope.

The crypto space is constantly evolving. Compiling any predefined list of approved cryptocurrencies is a fool’s errand and risks tilting the balance in favour of incumbents.

Finally, the draft legislation does not address cryptocurrency mining, the process by which many new coins come into existence. Given the layers of complexity, both CPAs and PwC Canada recommend new legislation to deal with it.

Taxing Crypto Owners at All Costs

Canada is part of J5, a cross-border task force targeting international tax evasion that includes law-enforcement units from the United States, the United Kingdom, Australia, and the Netherlands.

Tax evasion, the J5 contends, is becoming more sophisticated due to “a cyber or crypto component.” Even though financial crimes involving cryptocurrency are far fewer than those involving fiat currency, the CRA has been threatening individuals and businesses across the country with criminal prosecution if they do not declare their crypto assets. Since the launch of its specialized crypto unit in 2017, the CRA has conducted around 60 audits.

This year the CRA took monitoring too far. The tax agency sent a questionnaire with probing questions to citizens allegedly in possession of cryptocurrencies. The document demanded to know whether individuals use mixers—services that allow a pool of users to mix their coins to enhance privacy—and if so, which and why. The CRA also requested a full history of each person’s cryptocurrency trades or payments.

Cryptocurrencies and blockchain have demonstrated their capacity to disrupt borders and outdated legislation. Six years ago, Canadian authorities acknowledged their potential and welcomed them, but by overreaching now they risk missing out on all the opportunities at the forefront of fintech. The prospect of increasing red tape and less privacy is contrary to the very ethos of blockchain entrepreneurship and enough to make Canada a no-go zone akin to New York.

If Canada keeps enacting such burdens and confusion, she will show the power to tax really is the power to destroy. Crypto holders—around 1.9 million residents—and blockchain entrepreneurs—of at least 400 ventures—will either slide into the shadows of the black market or vote with their feet and take their money and jobs elsewhere.

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