The Foreign Property Tax Implications Associated With Cryptocurrency Ownership

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Jamie Golombek: Where, exactly, is your cryptocurrency located? It is complicated

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If you hold foreign property the total cost of which exceeds $ 100,000 at any time in a tax year, you have to file Form T1135. The form covers the obvious items, such as your Swiss bank account or Cayman offshore investment portfolio, but it is also required for foreign stocks, such as Apple Inc., Microsoft Corp. unregistered brokerage account.

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Foreign securities held in pooled products, such as Canadian mutual funds and registered retirement savings plans or other registered funds, are excluded. Personal-use property, such as a Florida vacation home that is not usually rented, is also excluded.

The late filing penalty is $ 25 per day up to a maximum of $ 2,500, plus late interest. There have been at least 20 reported cases in which taxpayers have been assessed a late filing penalty since the introduction in 1998 of Form T1135. Many of these cases involved a purely innocent failure to produce penalty that was imposed by the Canada Revenue Agency, even though all of the income from the foreign property and / or the capital gain / loss on its disposition was been fully declared in the Canadian return.

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But is the cryptocurrency considered foreign property, and if so, should it be declared on the T1135?

These questions were discussed in a recent article by William Musani and Ashvin Singh of Felesky Flynn LLP, a tax law firm with offices in Alberta and Saskatchewan. They analyzed whether cryptocurrency fell within the technical definition of “specified foreign property” in the Income Tax Act, which includes “intangibles located, deposited or held outside Canada that are not not used or held exclusively in connection with the operation of an active business. of the taxpayer.

In 2015, the CRA stated that “digital currency would be funds or intangibles and would be specified foreign property of a person or partnership to the extent that it is located, deposited or held in the country. ‘outside of Canada’.

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But where, exactly, is your cryptocurrency located?

This is where it can get a little tricky, due to the very nature – and attractiveness – of cryptocurrency in general. Many cryptocurrency investors think they are holding it in a digital wallet on a server, but that’s not really the case because the cryptocurrency, which is intangible property, is not actually physically located, deposited or held anywhere.

In practice, a right to your cryptocurrency exists in the form of a digital ledger on the associated blockchain. But because it’s stored on a blockchain, it can exist in multiple geographic locations simultaneously.

These digital registers are considered to be both “distributed” and “decentralized” databases. The database that records the rights of a cryptocurrency holder is stored and updated in several places at once, i.e. distributed, which makes it difficult, if not impossible, to manipulate its records. The ledgers are also decentralized, as no distributed database is the only source of true ownership of a particular cryptocurrency.

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Essentially, your digital wallet doesn’t store the cryptocurrency itself, but rather one (or a combination) of your public or private keys. Think of the public key as your account number and the private key as your personal identification number needed to access account information.

The authors of the article argue that when it comes to the location of your cryptocurrency holdings, the geographic location of your private key is “arguably the most relevant factor in determining where that cryptocurrency is located. , filed or held for the purposes of the deed “.

But the answer to this question may depend on whether you are using a “hot” or “cold” digital wallet. Hot wallets are digital wallets connected to the internet, which is how almost all cryptocurrency exchanges or online providers store your cryptocurrency. Cold wallets aren’t connected to the internet and are typically found on a physical storage drive (think Gerald Cotten and the QuadrigaCX collapse after $ 190 million in cryptocurrency went missing).

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It seems clear that the geographic location of a cold wallet is where the physical drive, computer, or USB stick containing the private key is located. If the cold wallet is in Canada, the associated crypto holdings associated with it are unlikely to be subject to T1135 foreign asset reporting requirements, the authors say.

On the other hand, when a hot wallet is used, “the location of the back-end server used by the wallet provider should be a strong determinant of the situs. If the server is located outside of Canada, the associated assets are more likely to be subject to foreign asset reporting requirements.

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But things can get even more complicated if you store your private key in multiple places at once. Let’s say you keep a document containing your private key on a computer in Canada. In this case, it may be exempt from the T1135 overseas reporting requirements. But what if you save this document in the cloud. Where are the cloud servers located geographically? There is a good chance that they are not in Canada and, if so, your cryptocurrency could be considered by the CRA to be intangible property located outside of Canada and, therefore, require a declaration of foreign property.

In the end, the best advice is probably to disclose your cryptocurrency on the T1135 or risk severe penalties from the CRA for non-disclosure. As Musani and Singh conclude: “This very complex and unique form of intangible property flouts traditional concepts and methods historically used to determine the situs of other types of intangible property. Given the administrative position of the CRA and the hefty penalties associated with failing to file Form T1135… the conservative approach is to report cryptocurrency holdings if the holdings situation is ambiguous.

Jamie Golombek, CPA, CA, CFP, CLU, TEP is Managing Director, Tax and Estate Planning at CIBC Private Wealth in Toronto. [email protected] .

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