Proposed Amendments To GST/HST Rules For Cryptocurrency ... - Mondaq

In February 2022, Canada's Department of Finance released draft GST/HST legislation covering cryptocurrency mining. The proposed rules will effectively treat cryptocurrency mining as an exempt supply: the cryptocurrency miner need not collect and remit GST/HST on the miner's compensation from mining, but the crypto miner also cannot claim input tax credits (or ITCs) for the expenses relating to the cryptocurrency-mining operation.
These proposals have not yet taken effect. But in anticipation of that possibility, Canadians who deal in cryptocurrency, non-fungible tokens, and other blockchain-based assets should educate themselves about these new potential GST and HST rules.
This article first gives a brief overview of Canada's GST/HST system. It then examines the proposed GST/HST rules for cryptocurrency mining and concludes by offering pro tax tips from our expert Canadian crypto-tax lawyers.
Subsections 165(1) and (2) of Canada's Excise Tax Act levy GST/HST on “every recipient of a taxable supply made in Canada.” A “taxable supply” captures most business transactions-e.g., a sale, transfer, barter, exchange, rent, or donation of a property or a service if the transaction occurred in the course of conducting business.
Yet although the recipient of the property or service (the purchaser) bears the obligation to pay GST/HST, the obligation to actually collect and remit the GST/HST falls on the person who makes the supply (the vendor). To this end, qualifying commercial vendors must register for a GST/HST number with the Canada Revenue Agency, charge GST/HST on their services or sales, and remit that GST/HST to the CRA.
That said, the Excise Tax Act exempts various businesses from the obligation to collect GST/HST. For example, a taxpayer need not register nor collect GST/HST if its worldwide revenues didn't exceed $30,000 during the last four fiscal quarters combined. (The threshold is increased to $50,000 if the taxpayer is a public service body-e.g., a non-profit organization, a charity, a municipality, a school authority, a hospital authority, a public college, or a university.)
Another example of a business that need not charge or collect GST/HST is a financial-services business. The Excise Tax Act's definition of a “financial service” captures various transactions involving money or a “financial instrument”:
A “financial instrument” generally refers to securities, insurance policies, precious metals, and similar instruments. In June 2021, Canadian Parliament amended the Excise Tax Act's definition of financial instrument to include a “virtual payment instrument.” A virtual payment instrument refers to “property that is a digital representation of value, that functions as a medium of exchange and that only exists at a digital address of a publicly distributed ledger.” So, fungible cryptocurrency-like Bitcoin, Ethereum, or Chainlink-falls squarely within the definition of a virtual payment instrument. As such, cryptocurrency trading or the use of cryptocurrency as a method of payment are GST/HST exempt because they each qualify as a “financial service” under the Excise Tax Act.
But a virtual payment instrument explicitly excludes the following:
The definition of a virtual payment instrument may therefore exclude specialized tokens that cryptocurrency platforms issue to investors under DeFi arrangements. In cryptocurrency liquidity mining, for example, an investor gives capital to a cryptocurrency platform in need of liquidity and, in exchange, the platform may issue to the investor a specialized token giving the investor the right to redeem that token for a certain number of cryptocurrency units. The definition of a virtual payment instrument excludes specialized liquidity tokens with these attributes.
In addition, non-fungible tokens (or NFTs) don't clearly fall under the definition of a virtual payment instrument. NFT artwork, for instance, often consists of a digital representation of a piece of art or music, not a “digital representation of value.” As such, it arguably doesn't “function as a medium of exchange.” So, although a cryptocurrency-trading business qualifies as a GST/HST-exempt supply of financial services, commercial NFT sales remain a taxable supply under Canada's Excise Tax Act.
In February 2022, Canada's Department of Finance proposed the addition of section 188.2 to the Excise Tax Act. If enacted as law, section 188.2 will address the GST/HST treatment of cryptocurrency mining. These proposals have not yet taken effect. According to the Department of Finance, if the legislation is passed, these tax rules will retroactively come into force as of February 5, 2022.
Section 188.2 deems the provision of “mining activity” to not be a supply for GST/HST purposes. Under the proposed legislation, mining activity covers three pursuits:
Thus, according to the proposed tax rules, Canadians engaging in cryptocurrency mining, cryptocurrency nodding, or cryptocurrency pool mining need not remit GST/HST on the mining rewards or other remuneration that they receive for those activities.
The corollary is that, if a cryptocurrency miner, cryptocurrency node, or cryptocurrency pool miner acquires, consumes, or uses any property or service in relation to the cryptocurrency-mining activity, section 188.2 deems the taxpayer to not have used that property or service in the course of a commercial activity. This denies cryptocurrency miners, cryptocurrency nodes, and cryptocurrency pool miners from claiming input tax credits (ITCs) for their cryptocurrency-mining operations. The proposed section 188.2 will, for example, prohibit a Canadian cryptocurrency miner from claiming ITCs for the GST/HST payable on the electricity costs arising from cryptocurrency mining.
In other words, section 188.2 effectively treats cryptocurrency-mining activities as exempt supplies: On the one hand, the cryptocurrency miner need not collect and remit GST/HST on the miner's compensation from mining. On the other hand, the crypto miner also cannot claim input tax credits for the GST/HST incurred by the miner when running the cryptocurrency-mining operation. This matches the GST/HST treatment of exempt supplies, which include, for example, financial services, health-care services, medical services, and dental services. An exempt supplier doesn't charge GST/HST but cannot claim ITCs to recover the GST/HST that the supplier paid on its business expenses. A zero-rated supply, by contrast, is still a taxable supply, but the GST/HST rate is 0%. So, while a zero-rated supplier need not charge GST/HST, the zero-rated supplier can still claim ITCs to recover the GST/HST that the supplier paid on its business expenses.
The proposed rules for cryptocurrency mining tax in Canada contain an exception: They don't apply when a person performs the cryptocurrency-mining activity for another person whose identity is known to the first person and who doesn't qualify as a “mining group operator,” which basically refers to a coordinator of a mining pool. In these limited circumstances-when someone mines cryptocurrency for a known person who doesn't coordinate a mining pool- section 188.2 doesn't apply, and cryptocurrency miner may need to charge GST/HST on that supply of mining services.
The key definition under the proposed section 188.2 is that of a “mining activity.” Under the proposed tax rule, a “mining activity” is deemed to not be a supply for GST/HST purposes.
The definition of “mining activity” seems to clearly contemplate the mainstream understanding of what constitutes cryptocurrency mining-namely, the verification process in blockchain protocols that rely on the proof-of-work validation mechanism. Under the proof-of-work system, the validator-i.e., the cryptocurrency miner-devotes computing power toward solving mathematical problems. By doing so, the miner verifies new cryptocurrency transactions and shares the results with other network participants by recording the verified transaction as a new block on the blockchain.
Yet one might wonder whether “mining activity” also intends to capture verification process in blockchain protocols that rely on the proof-of-stake validation mechanism. This verification process is known as “staking” or “forging.” The proof-of-stake system assigns validation rights to users in accordance with their stake in the blockchain. The proposed legislation doesn't mention the words “staking” or “forging.” Nor does it distinguish between proof-of-work validation mechanisms and proof-of-stake systems.
The proposed legislation presumably aimed to capture cryptocurrency activities relating to blockchain-transaction verification, regardless of which verification process the blockchain protocol invokes. On the other hand, unlike cryptocurrency mining, cryptocurrency staking exhibits characteristics of an investment. Unlike a cryptocurrency miner, who can receive a mining reward without having previously owned any of the blockchain's native tokens, the cryptocurrency staker cannot earn staking rewards without making a prerequisite investment in the cryptocurrency platform's native tokens. Perhaps this distinction justifies some differential GST/HST treatment. In any event, the Department of Finance has yet to clarify. So, it remains unclear whether the proposed section 188.2 applies to cryptocurrency staking.
It is, however, clear that the proposed section 188.2 doesn't apply to liquidity mining. Unlike cryptocurrency mining (i.e., the verification process in the proof-of-work system), liquidity mining has nothing to do with verifying transactions on the blockchain network. Rather, it generally constitutes a decentralized finance (DeFi) loan or investment. In cryptocurrency liquidity mining (also called “yield farming”), an investor lends or contributes capital to a cryptocurrency platform-typically, a start-up cryptocurrency platform seeking to raise capital. In exchange, the investor receives interest payments, a share of the cryptocurrency platform's transaction fees, or a specialized token giving the investor the right to redeem that token for a certain number of cryptocurrency units (or a combination of all of these benefits). Because the proposed section 188.2 doesn't apply to liquidity mining, certain liquidity-mining arrangments might draw GST/HST liability.
Finally, the proposed section 188.2 doesn't apply to the creation or sale of non-fungible tokens or NFTs.
The proposed cryptocurrency-mining GST/HST rules don't mean that Canadians who deal in cryptocurrency, non-fungible tokens, and other blockchain-based assets need not worry about GST/HST. First, these proposed GST/HST rules don't capture the creation and commercial sale of non-fungible tokens. So, a Canadian NFT artist or NFT content creator earning $30,000 or more in gross revenue must register for a GST/HST number with the CRA, charge GST/HST on NFTs sold in Canada, collect that GST/HST, and pay it to the Canada Revenue Agency. The proposed GST/HST-mining exemption also doesn't apply when a person provides cryptocurrency-mining services to a known recipient who isn't part of a mining pool. And, of course, the proposed GST/HST-mining exemption has no bearing on the income-tax consequences of cryptocurrency trading and cryptocurrency mining-both of which are fully taxable and must be reported for income-tax purposes.
Therefore, Canadian taxpayers who trade, invest in, mine, or stake cryptocurrency, NFTs, or other DeFi and blockchain-based assets will benefit from a confidential and privileged tax-law memorandum examining their GST/HST obligations under Canada's Excise Tax Act and their income-tax obligations under Canada's Income Tax Act. The distinctive and novel features of various DeFi arrangements and blockchain-based assets means that Canadian taxpayers who've entered DeFi arrangements or dealt in blockchain-based assets will require competent and expert Canadian crypto-tax guidance. Our experienced Certified Specialist in Taxation Canadian crypto-tax lawyer has assisted numerous clients with correctly reporting their cryptocurrency transactions and other blockchain-related arrangements.
Moreover, the Canada Revenue Agency cannot compel the production of a tax-law memorandum protected by solicitor-client privilege. In other words, solicitor-client privilege bars the CRA from learning about the confidential legal advice that you receive from our Canadian crypto tax lawyers in Toronto.
Yet your communications with an accountant remain unprotected because no such legal privilege exists between accountants and their clients. For that reason, if you seek tax advice but want to keep that information away from the Canada Revenue Agency, you should first approach our Canadian crypto-tax lawyers. If you also require the assistance of an accountant, we can take measures to extend our solicitor-client privilege to communications involving the accountant.
Question: What is cryptocurrency mining?
Answer: Cryptocurrency mining refers to the transaction-validation process in blockchain protocols that rely on a proof-of-work validation mechanism. The cryptocurrency miner devotes computing power toward solving mathematical problems. By doing so, the miner verifies new cryptocurrency transactions and shares the results with other network participants by recording the verified transaction as a new block on the blockchain. A reward is credited to the miner who validates the transaction first. The mining reward usually consists of new tokens in the native cryptocurrency or transaction fees (or both).
Question: Has Canada proposed new GST/HST rules for cryptocurrency mining. If so, what are the GST/HST implications of mining if the proposed GST/HST rules take effect?
Answer: Yes. Canada's Department of Finance proposed the addition of section 188.2 to Canada's Excise Tax Act. Section 188.2 addresses the GST/HST treatment of cryptocurrency mining. In particular, it deems cryptocurrency-mining activity to not be a supply for GST/HST purposes. Cryptocurrency miners therefore need not remit GST/HST on the mining rewards or other remuneration that they receive for their mining activities. In addition, if a cryptocurrency miner acquires, consumes, or uses any property or service in relation to cryptocurrency mining, section 188.2 deems the cryptocurrency miner to not have used that property or service in the course of a commercial activity. This denies cryptocurrency miners from claiming input tax credits (ITCs) for their cryptocurrency-mining operations.
In other words, section 188.2 effectively treats cryptocurrency-mining activities as exempt supplies: On the one hand, the cryptocurrency miner need not collect and remit GST/HST on the miner's compensation from mining. On the other hand, the crypto miner also cannot claim input tax credits for the GST/HST incurred by the miner when running the cryptocurrency-mining operation.
But the proposed GST/HST rules contain an exception when a person provides cryptocurrency-mining services to a known recipient who isn't part of a mining pool. In those cases, the cryptocurrency miner may need to collect GST/HST and may qualify for ITCs.
Question: Over the past few years, I made a lot of money by mining and trading various cryptocurrencies. But I don't understand how this bears upon my Canadian income-tax obligations or my Canadian GST/HST obligations. What can I do?
Answer: Canadian taxpayers who trade, invest in, mine, or stake cryptocurrency, NFTs, or other blockchain-based assets have thereby engaged in taxable transactions which trigger various tax-reporting obligations. These taxpayers will therefore benefit from a confidential and privileged tax-law memorandum examining their GST/HST obligations under Canada's Excise Tax Act and their income-tax obligations under Canada's Income Tax Act. The distinctive features of various blockchain-validation systems means that Canadian taxpayers who've mined or staked cryptocurrency will require competent and expert guidance on crypto tax in Canada. Our experienced Certified Specialist in Taxation Canadian crypto-tax lawyer has assisted numerous clients with correctly reporting their cryptocurrency transactions and other blockchain-related arrangements.
Question: I want to ensure that the Canada Revenue Agency cannot learn about the tax advice that I receive in relation to my cryptocurrency, non-fungible tokens, and other blockchain-based assets. How can I go about doing that?
Answer: Solicitor-client privilege precludes the Canada Revenue Agency from learning about the confidential legal advice that you receive from our knowledgeable Canadian tax lawyers. The Canada Revenue Agency cannot, for instance, compel the production of a tax-law memorandum prepared for you by your Canadian tax lawyer. Your communications with an accountant, however, remain unprotected because no such legal privilege exists between accountants and their clients. For that reason, if you seek tax advice but want to keep that information away from the Canada Revenue Agency, you should first approach our Canadian tax lawyers. If you also require the assistance of an accountant, we can take measures to extend our solicitor-client privilege to communications involving the accountant.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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