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Bitcoin: Taxation Unclear

How can business transactions and activities be taxed in respect of an online currency that it is not government-issued or regulated by a central political or banking authority? This is just one of many tax questions that arise in respect of the bitcoin, a virtual currency created in 2009 by an anonymous computer programmer using the pseudonym Satoshi Nakamoto.

Bitcoins may be acquired in one of three ways: (1) through an online process known as "mining"; (2) by purchase from an online exchange; and (3) as a gift or a means of payment. Bitcoin miners use computer software to solve complex mathematical equations and in return are rewarded with newly "unearthed" bitcoins.

Bitcoin transactions are intended to be as nearly anonymous as possible. Users are identifiable only by a computer code, which may change for each transaction and is not associated with any personal information, such as a name or address. Thus, the bitcoin offers cash-like privacy in electronic form and consequently is alleged to be frequently used in the criminal marketplace. Its commercial legitimacy is further undermined by its wild fluctuations in value. The first bitcoin valuation crash occurred in 2011; in the second crash in early 2013, the value of one bitcoin dropped by 50 percent in a single day. Market rates differ among the various independent online exchanges at any given time. Interestingly, Germany recognizes the bitcoin as a "unit of account"; Thailand, by contrast, has banned trade in the virtual currency.

Importantly, there remains the question of how, if at all, bitcoin transactions may be taxed. Even bitcoin.org has posted a warning to bitcoin users: "Bitcoin is not an official currency. That said, most jurisdictions still require you to pay income, sales, payroll, and capital gains taxes on anything that has value, including Bitcoin."

The CRA has yet to issue any technical interpretations or rulings on the topic, but the CBC has reportedly been told that a bitcoin transaction would be subject to tax in the following ways (CBC News, "Revenue Canada Says BitCoins Aren't Tax Exempt," published April 26, 2013):

  1. Bitcoins traded in exchange for goods or services will be subject to the rules governing barter transactions (see Interpretation Bulletin IT-490, "Barter Transactions")--the taxpayer must include in income the FMV of bartered goods or services received in return.

  2. Any gains or losses that arise when bitcoins are bought or sold as a commodity may be income or capital.

Although the CRA's reported comments regarding the bitcoin are instructive, other tax consequences are still uncertain. For example, how do the foreign currency rules apply to bitcoin transactions? How will an employer withhold and remit amounts from an employee's wages paid in bitcoins? Will a bitcoin miner be earning income when it unearths bitcoins, or will taxation be deferred until the bitcoins are converted to a government-issued currency or exchanged for other goods or services (if the mining of bitcoins is taxable at all)? The answers to these questions may also have tax implications for virtual currencies used in multiplayer online games, such as World of Warcraft and Second Life. For now, the taxation of the bitcoin and other virtual currencies remains unclear.

Christopher Payne
Dentons Canada LLP, Toronto
christopher.payne@dentons.com

Canadian Tax Focus
Volume 3, Number 4, November 2013
©2013, Canadian Tax Foundation

Comments

  • Jas Butalia 11/6/2013 1:14:28 AM

    Intersting questions that have been raised in regards to the effect on FX etc. However, is the incidence of tax not when the transaction takes place, subject to any deferred taxation rules that specifically allow for the incidence of the recognition of taxable income to be deferred? Thus, why does it matter how the withholding tax, as an example, is to be remitted when transactions are settled by bitcoins? Thanks.
    Jas Butalia.
    Butalia Raymond & Co LLP,
    Calgary, AB

  • Andrew Morreale 11/6/2013 10:42:58 AM

    Well timed - on November 5th, the CRA issued a news release re “what you should know about digital currency” – such as bitcoins: http://bit.ly/CRAbitcoin

    It is interesting to note that this this news release is silent on the treatment of ‘bitcoin mining’ (http://codinginmysleep.com/bitcoin-mining-in-plain-english/) – which is how the coins are created (much like how a central bank creates traditional money supply).

    Basically, the ‘mining’ requires considerable computing power to solve complex mathematical problems. However, the cost of the hardware, plus the cost of electricity to run it makes it questionable of whether profits can be had mining. It is interesting to consider whether these equipment costs and electricity costs are deductible in view of any mining profits? Or if in the alternative, these are merely windfall gains as only math is being solved (Isn’t that the requirement to claim on a lotto ticket??)

    Andrew Morreale

5/28/2016 9:48:34 PM