Foreign Reporting Requirements for Cryptocurrency (Form T1135)

Posted on January 17, 2024April 2, 2024 by [email protected]

Foreign Reporting Requirements for Cryptocurrency (Form T1135)

The CRA requires that individuals, corporations and certain partnerships and trusts that hold “specified foreign property” (SFP) with an aggregate cost basis of over $100,000 CAD at any time during the tax year report using form T1135 – Foreign Income Verification Statement.

Late filing of the form attracts a hefty penalty of $25 per day up to a maximum of $2,500. There CRA can also choose to assess ‘gross negligence’ penalties of $500 per month up to a maximum of $12,000 for failure to file the form.

If you hold cryptocurrency that has a cost basis of $100,000 or more, you will have to file this form with your personal tax return (T1) or corporate tax return (T2), depending on whether you own it personally or through a corporation, unless certain exceptions are met. Trusts and partnerships must also file this form, if applicable.

Is cryptocurrency considered “specified foreign property”(SFP)?

A common question from taxpayers and advisors has been – when is cryptocurrency considered to meet the definition of “specified foreign property”?

The CRA has been slow to comment on cryptocurrency taxation issues, but has provided updated guidelines for tax considerations, and has recently commented on form T1135 in response to clarifying questions posed by CPA Canada, which will be discussed further here.

Most often, taxpayers would be familiar with this form when SFP is held such as shares of foreign companies (i.e shares of publicly traded US corporations).

Included in SFP is “intangible property situated, deposited, or held outside Canada”. The CRA has commented:

“As stated in Technical Interpretation 2014-0561061E5, it is the CRA’s view that cryptocurrency (referred to at the time as “digital currency”) is funds or intangible property. As such, cryptocurrency may need to be reported on Form T1135 depending on where it is “situated, deposited or held”.”

So yes, cryptocurrency may be considered to be SFP by the CRA, and may need to be reported on form T1135.

Where is cryptocurrency situated, deposited, or held?

This has been the tricky part. Where does cryptocurrency exist? If you hold cryptocurrency in cold storage, is it situated where your hardware wallet is stored? If it is held by an intermediary such as an exchange, does the location of the exchange dictate this? What if the exchange is Canadian, but they store cryptocurrency in cold storage in another country? If that is the case, how would we know?

The fact that cryptocurrency is for lack of a better word “stored” on a blockchain argues that it can exist simultaneously in many geographical locations. So, can it arguably be ‘situated’ anywhere?

With all of this uncertainty and without going down rabbit holes of exchanges, intermediaries, nodes, and hot vs. cold storage, we have generally taken the stance as advisors that cryptocurrency is always considered to be situated, deposited, or held outside of Canada, and recommend including the cost basis of all crypto assets in determining foreign reporting requirements.

Like many complex questions regarding cryptocurrency, looking at traditional finance examples is often helpful where no guidance or legislation provides answers, which is what the CRA has done here, referring to where the shares of a corporation are ‘held’:

“…shares of a Canadian resident corporation held by a non-resident agent for the benefit of a Canadian reporting entity are considered to be intangible property situated, deposited or held outside Canada.”

So, the CRA is extrapolating that intangible property, even if it is shares of a Canadian company, if managed/held by a third party (such as an exchange), and if that third party is situated outside of Canada, the property would be SFP for the purposes of the T1135.

What about when the third party that is custodian of your crypto is a Canadian crypto exchange? The CRA commented:

“Where cryptocurrency is held through an intermediary, characterizing the relationship between that intermediary and the taxpayer may be relevant in determining whether the cryptocurrency is situated, deposited or held outside Canada. In Canada, intermediaries that wish to offer crypto assets services to Canadian clients must comply with guidelines issued by the Canadian Securities Administrators (“CSA”) – referred to by the CSA as “crypto trading platforms” or “CTPs”. While the determination of where cryptocurrency is “situated, deposited or held” is a question of fact that can only be determined after a review of all the documents and the circumstances applicable to a particular situation, it is our view that, where CTPs are resident in Canada and comply with Canadian regulations, cryptocurrency held through such CTPs for the benefit of Canadian clients will typically not be considered as “situated, deposited or held” outside Canada.”

We find this a bit too ambiguous to comfortably determine what portions of a taxpayer’s cryptocurrency holdings would fit into these parameters. It could be argued based on this CRA comment that if all of your crypto holdings are in a compliant, Canadian CTP, and you hold no other SFP, then you would not need to file form T1135.

Barring unique situations, we still recommend that all cryptocurrency holdings be included in the consideration for the total cost basis of SFP.

Capital vs. Inventory

There is a common ‘carve-out’ rule that excludes cryptocurrency and other property from being considered SFP. If the property is used or held exclusively in an ‘active business’, then it is not included in specified foreign property.

The distinction of capital property vs. inventory is important for those trading cryptocurrency, either as an individual or a corporation. There are several determining factors to consider whether trading activity is capital in nature, or constitutes an active business (again, this is out of scope for this discussion).

In short – assuming that ‘day-traders’ of cryptocurrency are carrying on an active business (this is complicated and requires analysis to determine), the cryptocurrency held is considered inventory of the active business, and is not required to be reported for the purposes of form T1135. Note: there may be situations where some property held is inventory in active business and some is capital property.

This would likely not apply to holders that have purchased cryptocurrency over time, with the intention of holding for appreciation in value over the long-term and/or receiving staking rewards. This situation better reflects that of a traditional stock investor, and would likely be considered capital property for taxation purposes and included as SFP for form T1135.

The CRA also commented on whether crypto held in an “adventure in the nature of trade” would be considered inventory held in an active business. This would be applicable in a case where someone who has never dabbled in cryptocurrency decides there is an opportunity for a quick flip for profit and, say, purchases a bunch of BTC, and sells the next day for a substantial profit.

This is likely not a capital transaction, but also per the CRA comments, does not constitute carrying on an active business. This would be an adventure in the nature of trade. Therefore, if at one point in the year, the person in this example held BTC with a cost basis of $150,000, and sold it the next day, they would be required to file form T1135 in that year:

“…although an adventure or concern in the nature of trade is included in the definition of the term “business” in section 248, it does not necessarily mean that a taxpayer who is engaged in an adventure or concern in the nature of trade is “carrying on” a business or has “carried on” a business. Where it is established that property such as cryptocurrency or NFTs are held or used in an adventure in the nature of trade, CRA will consider that such property is not held or used “in the course of carrying on an active business” for purposes of applying paragraph (j) of the definition of “specified foreign property” in subsection 233.3(1) of the Act. As such the exclusion provided in that paragraph would not be applicable with respect to the property.”

T1135 Filing Due Date

The due date for filing form T1135 is the same date as income tax returns for individuals, corporations and trusts and the same date as the partnership information return for partnerships. See HERE for dates.

If you need help navigating cryptocurrency taxation and reporting, you can CLICK HERE to book a consultation with our team.

Disclaimer: Any tax information published on this blog is based on the facts provided to us and on current tax law (including judicial and administrative interpretation) during the time of publication. This does not constitute legal advice. Tax law can change (at times on a retroactive basis) and these changes may result in additional taxes, interest, or penalties. Practice due diligence and if in doubt, speak with a member of our team.

USA Adopts Fair Value Accounting for Bitcoin

Posted on January 10, 2024January 10, 2024 by [email protected]

USA Adopts Fair Value Accounting for Bitcoin

The U.S. Financial Accounting Standards Board (FASB) has officially adopted Fair Value Accounting for Bitcoin for fiscal years beginning after December 15, 2024. The shift will trigger major swings in value and will benefit companies with crypto on their balance sheets. As Canadians on the forefront of digital asset accounting and taxation, we urge CPA Canada to follow suit. New standards are required to allow stakeholders of all backgrounds to be able to better understand and use financial statements. Let’s look at the details.

The Details:

On December 13, 2023, the Financial Accounting Standards Board (FASB) issued ASU 2023-08 which addresses the accounting and disclosure requirements for certain crypto assets. The new guidance requires entities to measure certain crypto assets at fair value, with changes in fair value recorded in net income in each reporting period.

ASU 2020-08 requires entities with crypto asset holdings to:

Present on the balance sheet the aggregate amount of “crypto assets measured at fair value separately from other intangible assets” that are not measured at fair value.
Include in net income changes in the fair value of crypto assets separately from changes in the carrying amount (e.g., impairments and amortization) of other intangible assets, including other digital assets that are not measured at fair value.
Classify as cash flows from operating activities those cash receipts from the nearly immediate sale of crypto assets that were “received as noncash consideration in the ordinary course of business (for example, in exchange for goods and services transferred to a customer).”

For all entities, the ASU’s amendments are effective for fiscal years beginning after December 15, 2024, including interim periods within those years. Early adoption is permitted. If an entity adopts the amendments in an interim period, it must adopt them as of the beginning of the fiscal year that includes that interim period.

The Background:

Before ASU 2023-08, FASB standards required companies to report a loss if the crypto they hold is worth less than the purchase price, even if they haven’t sold the asset. Specifically, a crypto asset was required to be valued at its lowest observable fair value within a reporting period. No write-ups for fair value were allowed within this reporting regime.

FASB received approximately 500 letters from the digital asset community who raised concerns that, among other factors, this intangible asset model (1) did not faithfully represent the economics of crypto assets and (2) made the recognition of impairments needlessly complex by requiring entities to use a crypto asset’s lowest observable fair value within a reporting period

While the new guidance applies to assets that meet the scope criteria in ASC 350-60, not all digital assets will meet these criteria. Because Non-fungible, wrapped and created tokens are not captured in the scope of this guidance questions will remain about how entities should account for and disclose other types of digital assets.

The FASB Board anticipates that the guidance in the ASU will better reflect the economics of certain crypto assets held by entities as well as reduce the complexity and cost of complying with a historical-cost-less-impairment model under the existing requirements in ASC 350.|

The Board also acknowledged that some stakeholders were concerned about the net income volatility that could result from presenting fair value changes in net income. However, the Board believes that the benefits derived from holding a crypto asset are similar to those derived from holding equity securities that have a readily determinable fair value (i.e. holding and selling crypto assets at an appreciated value).

The Implications:

The shift will trigger major swings in value and will benefit companies with crypto on their balance sheets. Bitcoin’s price rose more than 1% after the guidance was released and it continues to rise as regulators signal to markets that BTC is to be taken seriously.

Michael Saylor, MicroStrategy’s founder and former CEO, tweeted: “FASB has officially adopted Fair Value Accounting for #Bitcoin for fiscal years beginning after Dec 15, 2024. This upgrade to accounting standards will facilitate the adoption of $BTC as a treasury reserve asset by corporations worldwide.”

Consider MicroStrategy (MSTR) as a case in point. In Q3 2023, the company possessed 158,400 bitcoins, acquired at an average historical price of $29,609 per bitcoin. With that said, under the previous FASB requirements, these holdings were reported at a impaired value of only $15,476 per bitcoin on average on their balance sheet. This depiction, however, falls short of capturing the true fair market value of $26,969 per bitcoin, a substantially higher figure that more faithfully represents the inherent value of the underlying assets being held by MSTR. With the new FASB requirements, MicroStrategy will be required to write their bitcoin up/down to fair market value, allowing for investors and the public alike to get a better representation of the companies holdings. Additionally, these changes in the valuation of digital assets on the balance sheet will occur regularly and will flow through the income statement, again, better reflecting the company’s position. These charts examine the changes in the balance sheet and retained earnings as a result of this change:FASB Chair Richard R Jones stated: “The new standard responds to feedback from stakeholders of all backgrounds who indicated that improving the accounting for and disclosure of crypto assets should be a top priority for the Board. It will provide investors and other capital allocators with more relevant information that better reflects the underlying economics of certain crypto assets and an entity’s financial position while reducing cost and complexity associated with applying current accounting.”

In our recent feedback publication to CPA Canada, we argue that a change like this is essential to inform and protect the Canadian public and to foster digital asset companies in Canada. If you are interested in this topic, we invite you to join us in writing to CPA Canada advocating for regulation in the digital asset space.

Digital Asset Markets will evolve as regulations and standards mature. If you are holding, trading or creating in the digital asset space, our industry-leading team can help. CLICK HERE to book a meeting.

Tax Loss Selling (updated for 2023)

Posted on December 15, 2021December 8, 2023 by Oliver Nelson

Tax Loss Selling (updated for 2023)

‘Tis the season for tax loss selling

To ensure you are efficiently planning for the 2023 year end, we recommend reviewing your investment positions before the end of the year. If you have realized any capital gains from the sale of securities in non-registered accounts or from the sale of cryptocurrencies on account of capital, you might want to consider the strategy of tax loss selling (or selling your ‘losing’ positions to offset some of the gains).

The gist

Selling loss positions allows you to realize that loss in your portfolio. This is called a capital loss. These losses are tax assets as they offset capital gains in your portfolio (capital gains can only be reduced by capital losses).

If you have realized gains in the last three years (the limit on carrying back capital losses to apply against capital gains), selling losing positions before the end of 2023 will allow you to carry back the loss to one of the previous three years, resulting in a refund on the tax paid relative to the losses carried back. If you have capital gains realized in 2020, this is the last year to carry back losses and get refunded some of the tax you paid on those gains. You can carry forward capital losses from prior years indefinitely.

If you have a portfolio with gains in any of the past three years, it may be beneficial to dump some of your ‘loser’ assets to reduce your taxes owing.

Examples of tax loss selling

EXAMPLE 1: Current year gains and current year losses:

You have realized gains on the sale of some ETH of $50,000 in the current year. You also hold a position in a crypto project DOG that dropped in value during the year from $60,000 at cost down to $10,000, its current fair market value. Selling the DOG position at a $50,000 loss will fully offset the $50,000 gain realized earlier in the year from ETH.

This is a simple example that would be advisable if you felt the losing position was a lost cause and wanted to exit the position regardless. Other considerations here would be gas fees to exit the losing position. If the offsetting loss were much less and the benefit would be lost to gas fees, it would not be worth it to exit the position.

EXAMPLE 2: Prior year gains and current year losses:

You sold some shares of AAPL at a gain of $30,000 in 2021. Your investment advisor recommends “balancing” your portfolio according to your risk tolerance and long-term plan, and exiting certain positions. Any losses from the rebalancing can be carried back to 2021 to offset the gains from AAPL in that year, resulting in a refund of some of the tax paid in 2021.

Traps to avoid

Superficial loss rules

If you were to attempt to crystallize losses by selling a security or cryptocurrency, but then want to reenter the position, you must wait 30 days from the sale to the next purchase, otherwise you will be caught by the superficial loss rules. If a superficial loss is reported, the loss will be denied for tax purposes and will be added to the cost basis of the new position, effectively negating any tax benefit until you exit the new position. These rules apply to assets repurchased within 30 days be any “affiliated person” (spouses/common law partners, corporations controlled by you or a spouse, or trusts in which you or your spouse are a beneficiary).

EXAMPLE 3: Superficial losses:

On December 19th, 2023 you sold all your position in ETH which had a cost of $10,000 for $6,000 triggering a capital loss of $4,000. On Jan 2, 2024, you repurchased the same amount of ETH back for $6,000. As you repurchased the ETH back within 30 day, the superficial losses rules will deem your loss in 2023 to be NIL and the cost base of the repurchased back to $10,000 ($6,000 cost + $4,000 of superficial losses).

Identical Property

The superficial losses apply even if you buy an identical property. Generally, properties are identical if they are the same in material respects, and general buyers would not prefer one property to the other. A common example is buying shares of a corporation vs units of a mutual fund trust are viewed as identical properties.

Registered accounts

Losses from transferring securities to a registered account (RRSP, TFSA, etc) are denied under the Tax Act. If you wish to transfer an asset from a non-registered account to a registered one, it is best to sell the security and realize the loss in the non-registered account (allowing for the loss to be applied against gains), then waiting the 30 days to repurchase the asset in your registered account to avoid the superficial loss rules.

Foreign exchange

A position in a US security may be in a loss relative to the USD cost basis and the current USD fair market value, however depending on the exchange rate, the position could potentially be flipped into a gain position. Be sure to translate both the cost basis in CAD, and the expected proceeds in CAD to determine whether a US denominated security is truly in a loss position.

The Skinny

If you have losers in your portfolio and gains that have been realized, the settlement date of the sale of the losers must be before December 31, 2023 to fully realize the losses for tax purposes. If you have a portfolio with gains in any of the past three years, it may be beneficial to dump some of your ‘loser’ assets to reduce your taxes owing. It literally turns a loser into a tax asset. Something from nothing- that feels more like the holiday spirit.