Bitcoins as "Property" for Tax Purposes

Everyone agrees: the CRA (CRA document no. 2013-0514701I7), foreign tax authorities (IRS Notice 2014-21), and many commentators tell us that bitcoins are property—a position that is intuitive and avoids many potentially inappropriate results. However, if the Canadian tax consequences of arrangements flow from the nature of the legal relationships involved (see, for example, Shell Canada, [1999] 3 SCR 622, at paragraph 39), one might wonder about the theoretical basis of the CRA's commendably pragmatic position, given bitcoin's (and certain other cryptocurrencies') apparent lack of legal structure.

At a high level, and omitting technological details, bitcoin's operations can be summarized as follows:
  • The bitcoin system operates through many computers owned by unrelated people who have independently chosen to run software that follows a common set of rules.

  • By following the rules in the software, the computers communicate with each other, and all of them reach a common conclusion about who "holds" which bitcoins from time to time. (The data structure in which this information is stored is normally referred to as a "blockchain.")

  • Bitcoins themselves do not have any independent existence and are simply, by definition, whatever it is that this system tracks.

  • To hold bitcoins is, essentially, to know certain secret information that, according to the rules of the system, allows a holder to cause the bitcoins to be transferred to other persons.

Explicit legal relationships are not evident: no one is required to run any particular software in any particular way, and no one is required to agree with or respect any particular results of the system. The fact that the participants keep running the same software (and that bitcoin holdings have any stability) is more in the nature of a social custom. But customs can change, and for some cryptocurrencies such changes in custom have at times been dramatic. (However, we believe that different conclusions might be reached for taxpayers that hold bitcoins through a cryptocurrency exchange rather than directly.)

One might wonder whether the apparently customary (rather than legal) nature of bitcoins implies that they are not property. If we were to accept that bitcoins are not property, anomalous results would follow: for example, a taxpayer who holds bitcoins might not be subject to a deemed disposition upon emigration or death; a taxpayer who mines bitcoins might not create inventory or realize income before the bitcoins' sale to a third party; and the making of payments with bitcoins might be viewed as a type of service. Indeed, for GST/HST purposes, a service could be nearly anything that is not property or money (whether bitcoins can be money is a separate question not addressed here), with implications for whether a cross-border supply of bitcoins is or is not zero-rated.

To avoid creating such anomalies, courts might be particularly diligent in seeking out legal relationships not evidenced in written agreements or other familiar ways. For example, some form of legal right might be found in the patterns of conduct and the expectations of reciprocal reactions that make up the bitcoin system, or in the protection of secret information associated with the holding of bitcoins. (But query whether such rights to secret information would satisfy the Manrell (2003 FCA 128) condition that property involve "some exclusive right to make a claim against someone else"—and note also that the transferring of bitcoins does not actually involve the transferring of the original holder's secret information.)

We are not sure whether the CRA based its statements on an implicit finding of underlying legal substance that justifies bitcoins' status as property, or whether the CRA simply acceded to the practical reality that bitcoins are now thought of by everyone firmly in property terms—as being "bought" and "sold," "owned" and "stolen." The latter possibility may be the most interesting, because it suggests the CRA's willingness (or perhaps its need) to show flexibility in adapting to the economic realities of new technologies that may transcend the need for traditional legal structures and relationships.

Ian Caines and Zvi Halpern-Shavim
Blake Cassels & Graydon LLP, Toronto

Canadian Tax Focus
Volume 8, Number 2, May 2018
©2018, Canadian Tax Foundation