Canadian Crypto-Tax Updates: CRA’s Crypto-Mining Tax Tips Provide Insufficient Clarity

“Cryptic on Cryptocurrency” says David Rotfleisch, a Canadian Crypto-Tax Lawyer

Introduction – The CRA Releases Tax Tips on Mining Cryptocurrency

On March 13, 2023, the Canada Revenue Agency’s Media Room released crypto tax tips about cryptocurrency mining. The CRA’s very brief media release was notably light on details and included few genuinely helpful tax tips for Canadians who engaged in cryptocurrency mining.

This article first discusses the difference between cryptocurrency mining, cryptocurrency staking, and cryptocurrency liquidity mining. It then elaborates on a number of the Canadian tax implications relating to cryptocurrency mining that the CRA’s media release neglected to mention. It concludes by offering pro tax tips from our expert Canadian crypto-tax lawyers.

Cryptocurrency Mining, Cryptocurrency Staking & Liquidity Mining

It is generally helpful to distinguish between cryptocurrency mining, cryptocurrency staking, and cryptocurrency liquidity mining. Cryptocurrency mining and cryptocurrency staking each describe various transaction-verification processes. Liquidity mining is conceptually unrelated to cryptocurrency mining or cryptocurrency staking. But liquidity mining is often confused with cryptocurrency mining because of its similar name, and it’s often confused with cryptocurrency staking because of its apparently similar arrangement.

Cryptocurrency mining is the verification process in blockchain protocols that use the proof-of-work system. To remain decentralized, all blockchain networks rely on consensus mechanisms to validate new cryptocurrency transactions. The two most commonly used consensus mechanisms are (i) the proof-of-work system and (ii) the proof-of-stake system. The Bitcoin blockchain, for instance, currently uses the proof-of-work system. The cryptocurrency miner verifies transactions in the proof-of-work system by devoting 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. The mathematical problems in proof-of-work systems intend to make falsification prohibitively expensive. To falsify the blockchain, a malicious user must wield over half the total computational power deployed by all miners. So, from an economic standpoint, it’s unprofitable to attempt falsify a blockchain in a proof-of-work system. 

Cryptocurrency mining transpires on a competitive basis. The first miner to validate the transaction receives a mining reward. The mining reward usually consists of new tokens in the native cryptocurrency or transaction fees (or both). (Another disincentive for malicious users is that miners lose their mining rewards if they repeatedly attempt to validate blocks that the remaining network considers invalid.)

Cryptocurrency staking is the verification process in blockchain protocols that use the proof-of-stake system. The Ethereum blockchain, for example, uses the proof-of-stake system. To participate in the validation process, the validators—called cryptocurrency stakers—must hold a certain minimum stake in the blockchain. The various proof-of-stake systems adopt varying criteria for measuring a validator’s stake in the blockchain. In some systems, for example, a validator’s stake is measured by the quantity of native cryptocurrency that the validator owns. Other systems require the validator to put up sufficient collateral in the form of the network’s native cryptocurrency, which is held in escrow for a set period. In contrast to the proof-of-work system, which requires every crypto miner to wield significant computing power and bear heavy electricity costs, the proof-of-stake system selects validators who will likely act in good faith. Cryptocurrency stakers typically either own a large quantity of the native cryptocurrency or put up the requisite collateral. In either case, the crypto staker has an incentive to validate transactions honestly. The system aims to prevent malicious users from controlling the validation process by forcing them to invest heavily in the blockchain before gaining any ability to mount an effective attack.

Like cryptocurrency miners in the proof-of-work system, cryptocurrency stakers receive a reward in exchange for verifying transactions on the blockchain. The staking reward typically consists of new tokens in the blockchain’s native cryptocurrency or transaction fees, or both. Yet unlike a crypto miner, who can receive a mining reward without having previously owned any of the blockchain’s native tokens, a cryptocurrency staker receives a staking reward only if the crypto staker has an interest in the blockchain’s native tokens.  

Unlike cryptocurrency mining (i.e., the verification process in the proof-of-work system) and unlike cryptocurrency staking (i.e., the verification process in the proof-of-stake system), cryptocurrency liquidity mining has nothing to do with verifying transactions on the blockchain network. Rather, it generally constitutes a decentralized finance (DeFi) loan or investment.  With crypto 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).

Oversimplifying the Canadian Income-Tax Implications of Cryptocurrency Mining

The Canada Revenue Agency’s media release on Canadian crypto tax on crypto mining vastly oversimplifies the Canadian income-tax implications—almost to the point of saying nothing:

Mining may have tax implications. The income tax treatment for cryptocurrency miners is different depending on whether your mining activities are a personal activity (a hobby) or a business activity. This is decided on a case-by-case basis.

Business activities normally involve some regularity or a repetitive process over time. In some cases, one transaction can be considered a business activity.

If you are still setting up or preparing to go into business, such as in cryptocurrency mining, you might not be considered to have started a business. You usually have to undertake significant activity that is part of your income-earning process. However, if you are mining as a business, you have to pay tax on your business income from the mining of the cryptocurrency and any capital gains on the sale of the cryptocurrency that you validated.

In truth, cryptocurrency mining can satisfy at least three distinct characterizations, each of which comes with its own set of Canadian tax implications. Moreover, the mining itself and the disposition of the cryptocurrency acquired through mining are two separate activities, and they each invoke different Canadian tax rules.

A taxpayer might, for example, engage in cryptocurrency mining solely as a hobby or personal endeavour without commercial intent. (Granted, hobby mining is less likely nowadays because of how prohibitively expensive cryptocurrency mining has become.) As such, hobby mining is not itself a source of income. Thus, when a hobbyist miner acquires cryptocurrency through mining, the taxpayer need not report the value of those mined crypto units as income. Instead, the income inclusion (or loss realization) occurs when the taxpayer disposes of the mined crypto units. The disposition of the mined crypto units results in a capital gain or capital loss because the crypto-mining hobbyist didn’t acquire the units with the intent to trade. 

A second alternative views cryptocurrency mining as akin to acquiring inventory—namely, inventory in a cryptocurrency-trading business. On this view, the crypto mining is not itself the taxpayer’s source of income; it is an aspect of the taxpayer’s source of income. The taxpayer’s source of income consists of selling and trading the cryptocurrency units that the taxpayer acquired by mining. Thus, just as a gold miner doesn’t recognize an income inclusion upon unearthing gold deposits, a cryptocurrency trader need not recognize income when acquiring cryptocurrency through mining. Instead, the income inclusion (or loss realization) occurs when the cryptocurrency trader disposes of the mined crypto units. But unlike the crypto-mining hobbyist, who reports the resulting gain or loss on capital account, commercial cryptocurrency miner must report the resulting gain or loss on income account—that is, as business income or as a business loss.  

A third alternative treats cryptocurrency mining as akin to providing a service. In particular, through cryptocurrency mining, the taxpayer expends computing power to validate blockchain transactions and thereby provides a service to users collectively. In exchange, the cryptocurrency miner receives compensation in the form of the mining reward. In this case, the cryptocurrency mining is itself a source of income. As a result, when the cryptocurrency miner receives mining rewards, those receipts are fully taxable as the miner’s business income under subsection 9(1) of Canada’s Income Tax Act. Thus, when calculating taxable income, the Canadian cryptocurrency miner must include the fair-market value of the cryptocurrency that the miner received as a mining reward—specifically, the value, expressed in Canadian dollars, as of the time that the miner received the cryptocurrency. In addition, because the crypto miner has reported the value of the mining-reward cryptocurrency as taxable income, subsection 52(1) of the Income Tax Act allows the crypto miner to increase the tax cost of that cryptocurrency accordingly. The increased tax cost prevents double tax when the crypto miner ultimately disposes of the cryptocurrency that the crypto miner received as a mining reward.

At the end of the day, despite the gross oversimplification in the Canada Revenue Agency’s media release on crypto mining, Canadian taxpayers must understand that no single tax-law analysis will cover every case involving cryptocurrency mining. The income-tax implications depend on each taxpayer’s specific set of facts. This means that Canadian taxpayers who mine cryptocurrency should educate themselves about their income-tax obligations by seeking tax guidance from an expert cryptocurrency tax lawyer in Canada.

Omitting GST/HST Developments Concerning Cryptocurrency Mining

The Canada Revenue Agency’s media release on crypto mining neglects to mention any of the GST/HST rules concerning cryptocurrency transactions generally or any of the recent developments concerning cryptocurrency mining specifically.  

Generally speaking, a cryptocurrency-trading business constitutes a supply of financial services, which is exempt from GST/HST.  Under Canada’s Excise Tax Act, a financial-service business need not charge or collect GST/HST. 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,” which 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.” This definition captures essentially every type of fungible cryptocurrency. Cryptocurrency trading is therefore GST/HST exempt. 

Moreover, 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/HST rules. For more details about the proposed GST/HST rules for cryptocurrency mining, read our article “Proposed GST/HST Amendments for Cryptocurrency Mining: What's Included and What's Not.” 

Pro Tax Tips: The Nature of CRA Publications & The Importance of Legal Advice on Proper Cryptocurrency Tax Reporting

While the Canada Revenue Agency’s media release on cryptocurrency mining fails to notify Canadian taxpayers about the numerous, complicated tax issues that cryptocurrency mining invokes, taxpayers must understand that they cannot rely on the CRA for advice on reporting their cryptocurrency transactions. The Canada Revenue Agency is an administrative body, and its task is to enforce Canada’s tax laws, but it has no jurisdiction to interpret or create the law. (Those jobs belong to the judiciary and the legislature, respectively.) Nor does the CRA have any jurisdiction (or competence) to give a legal opinion to Canadian taxpayers. This is especially true when it comes to the tax implications of emerging technology, like DeFi arrangements and other blockchain-based assets.  

In other words, the Canada Revenue Agency is not in any way bound by its own publications. If the CRA decides to audit your tax return, the tax auditor can ignore the CRA’s own previously released guidelines. The doctrine of estoppel does not preclude the CRA from issuing an assessment that is inconsistent with a previously released publication. See: Stickel v MNR, [1973] CTC 202, 73 DTC 5178 (FCA); aff’d. [1974] CTC 416, 74 DTC 6268 (SCC). The interpretation of tax legislation is left to the Tax Court of Canada and the appeal courts. While the courts will certainly review CRA publications, those publications do not necessarily accurately set out with tax laws.

Therefore, Canadian taxpayers who trade, invest in, mine, or stake cryptocurrency, non-fungible tokens (NFTs), or other DeFi and blockchain-based assets should seek tax-law advice from an expert Canadian crypto-tax lawyer. Because of the distinctive and novel features of various DeFi arrangements and blockchain-based assets,   Canadian taxpayers who’ve entered DeFi arrangements or dealt in blockchain-based assets should instruct their Canadian crypto-tax lawyer to prepare 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.

Moreover, solicitor-client privilege precludes the Canada Revenue Agency from learning about the confidential legal advice that you receive from our Canadian crypto-tax lawyers. As a privileged document, the tax-law memorandum will also remain beyond the reach of the Canada Revenue Agency because the CRA cannot compel the production of a document protected by solicitor-client privilege. Yet the memorandum still will be available to counter the CRA’s attempts to justify imposing gross-negligence penalties.

Frequently Asked Questions

Question: What is cryptocurrency mining?

Answer: Cryptocurrency mining is the verification process in blockchain protocols that use the proof-of-work system. To remain decentralized, all blockchain networks rely on consensus mechanisms to validate new cryptocurrency transactions. The two most commonly used consensus mechanisms are (i) the proof-of-work system and (ii) the proof-of-stake system. The Bitcoin blockchain, for instance, currently uses the proof-of-work system. The cryptocurrency miner verifies transactions in the proof-of-work system by devoting computing power toward solving mathematical problems. The first miner to validate the transaction receives a mining reward. The mining reward usually consists of new tokens in the native cryptocurrency or transaction fees (or both).

Question: In March 2023,the Canada Revenue Agency released tax tips about cryptocurrency mining. Will this publication tell me everything that I need to know about how to report my crypto-mining transactions for Canadian tax purposes? Can I rely on that publication?

Answer: No.  This CRA publication vastly oversimplifies the Canadian income-tax implications of cryptocurrency mining, and it neglects to mention any of the GST/HST rules concerning cryptocurrency transactions generally or any of the recent developments concerning cryptocurrency mining specifically. Furthermore, the CRA is not bound by its own publications. For tax-law advice on how to report your crypto-mining transactions, speak with one of our expert Canadian crypto-tax lawyers.  

Question: To assist me with preparing my Canadian tax return, I plan on using one of the Canada Revenue Agency’s publications on cryptocurrency transactions. If I rely on the CRA’s publication, does this mean that the CRA must abide by my tax return?

Answer: No. The Canada Revenue Agency is not in any way bound by its own publications. If the CRA decides to audit your tax return, the crypto tax auditor can ignore the CRA’s own previously released guidelines. The doctrine of estoppel does not preclude the CRA from issuing an assessment that is inconsistent with a previously released publication. See: Stickel v MNR, [1973] CTC 202, 73 DTC 5178 (FCA); aff’d. [1974] CTC 416, 74 DTC 6268 (SCC). The Canada Revenue Agency is an administrative body, and its task is to enforce Canada’s tax laws, but it has no jurisdiction to interpret or create the law. (Those jobs belong to the judiciary and the legislature, respectively.) Nor does the CRA have any jurisdiction (or competence) to give a legal opinion to Canadian taxpayers. You should seek tax-law advice from an expert Canadian crypto-tax lawyer, and if you’ve entered any DeFi arrangements or dealt in any unique blockchain-based assets, you should consider instructing your Canadian crypto-tax lawyer to prepare a confidential and privileged tax-law memorandum examining your GST/HST obligations under Canada’s Excise Tax Act and your income-tax obligations under Canada’s Income Tax Act.