CRA’s update on taxation of cryptocurrency, NFTs and Form T1135: Guidance from a Canadian tax lawyer

Introduction: Who needs to file form T1135

Under S.233.3 of the Income Tax Act, Canadian tax residents (individuals, corporations or certain partnerships and trusts), who at any time of year, own any specified foreign property (SPF) with a total cost that exceeds $100,000 Canadian at any time of the year, is required to the T1135 form for the taxation year. The due date for the T1135 form is the same as a taxpayer’s income tax return. For individuals, the deadline is generally April 30 of the following year, while corporations and certain trusts may have an off-calendar year-end as the deadline. The term specified foreign property encompasses funds or intangible property, or for civil law incorporeal property, situated, deposited or held outside Canada. In November 2023, the Canada Revenue Agency (CRA) published its guidance on whether cryptocurrency and NFTs in Canada should be reported on the T1135 return as intangible property.

Whether cryptocurrency or an NFT qualifies for intangible property depends on its location

As per Technical Interpretation 2014-0561061E5, the CRA considers cryptocurrency (then referred to as "digital currency") and NFTs to be funds or intangible property, potentially requiring reporting on Form T1135 based on its location of being "situated, deposited or held." Determining whether a taxpayer's cryptocurrency or an NFT is situated, deposited, or held outside Canada is complex and depends on various factors, including its holding through an intermediary. For instance, the CRA's webpage on Form T1135 clarifies that shares of a Canadian resident corporation held by a non-resident agent for a Canadian reporting entity are considered intangible property located outside Canada.

When cryptocurrency or a NFT is held through an intermediary, understanding the relationship between that intermediary and the taxpayer is crucial. In Canada, intermediaries offering crypto asset services to Canadian clients must comply with guidelines from the Canadian Securities Administrators (CSA), known as "crypto trading platforms" or "CTPs." If CTPs are residents in Canada and comply with Canadian regulations, cryptocurrency held through them for Canadian clients is typically not considered as located outside Canada. However, the determination of where cryptocurrency is "situated, deposited or held" is a factual question that requires a review of all relevant documents and circumstances specific to each situation.

Cryptocurrency or NFTs held in an adventure in the nature of trade may be excluded from T1135

Paragraph s.233.3(1)(j) of the Income Tax Act states that only property used or held exclusively in carrying on an active business is excluded from specified foreign property. According to the CRA, subsection 248(1) of the Income Tax Act defines "active business" as "in relation to any business carried on by a taxpayer resident in Canada, means any business carried on by the taxpayer other than a specified investment business or a personal services business." Therefore, if a resident of Canada is conducting a business that is not a specified investment business or a personal services business, that business will be considered an active business. If it is determined that property such as cryptocurrency or NFTs is held or used in an adventure in the nature of trade, the CRA will consider that such property is not held or used "in the course of carrying on an active business" for the purpose of applying paragraph (j) of the definition of "specified foreign property" in subsection 233.3(1) of the Income Tax Act. Therefore, the exclusion provided in that paragraph would not apply to the property.

The CRA has previously stated in interpretation bulletin IT-459 that although an adventure or concern in the nature of trade is included in the definition of the term "business" under the Income Tax Act, it does not necessarily mean that a taxpayer engaged in such an activity is "carrying on" a business or has "carried on" a business. The determination of whether these phrases apply in the Income Tax Act depends on the level of activity, and each situation must be assessed based on its own specific facts.

The legal test to determine whether a taxpayer engaged in an adventure in the nature of trade is set out in Happy Valley Farms Ltd. v the MNR, and it’s based on the review of the following factors:

• The nature of the property sold.
• The length of period of ownership.
• The frequency or number of other similar transactions by the taxpayer.
• Work expended on or in connection with the property realized.
• The circumstances that were responsible for the sale of the property.
• The intention at the time of acquiring an asset as inferred from surrounding circumstances and direct evidence (This is the most important factor).

Penalties due to failure to file T1135

Failure to submit the T1135 form may lead to a penalty of at least $100 or $25 per day for each day the form is late, up to a maximum of $2,500. If the CRA requests the return and the individual knowingly or due to gross negligence fails to submit the T1135 form, the penalty is $1,000 per month for each month the form is late, with a maximum of $24,000. Additional penalties may be imposed for forms that are late by more than 24 months.

Voluntary disclosure application

Taxpayers who fail to file their T1135 forms on time don't need to panic as the Voluntary Disclosure Program (VDP) is designed as a second chance for taxpayers to correct their previous errors on their tax returns or disclose unreported income in exchange for penalty or interest relief. However, for the CRA to accept a VDP application, it must be

1. Voluntary;
2. Complete;
3. Involve the application or potential application of a penalty;
4. Include information that is at least one year past due; and
5. Include payment of the estimated tax owing.

The CRA has made it clear that it is not obligated to accept all VDP applications and each VDP application will be reviewed based on its own merit. Regarding whether to accept an application, it is subject to the CRA's own discretion. Therefore, it is highly recommended that a taxpayer consults with an experienced Canadian tax lawyer to maximize the chance to be accepted.

FAQ:

What is specified foreign property?

Specified foreign property which generally includes (but is not limited to):

• Funds deposited or held outside Canada (including Canadian dollar funds deposited outside of Canada),
• Intangible (such as cryptocurrency and NFTs) and tangible property located outside of Canada (e.g., land and buildings outside Canada),
• Shares of foreign corporations, even if held in an investment account in Canada,
• An interest in a non-resident trust acquired for consideration (e.g., foreign mutual funds and exchange-traded funds listed on a U.S. exchange),
• Shares of a Canadian corporation held outside Canada (e.g., holding RBC shares in an investment account in Jersey),
• An interest in a partnership holding specified foreign property unless the partnership is required to file Form T1135,
• An interest in, or right with respect to, a non-resident entity (e.g., an option to purchase shares of a foreign corporation),
• A property convertible into, exchangeable for, or conferring a right to acquire specified foreign property,
• A debt owed by a non-resident, including government and corporate bonds, debentures, mortgages, and notes receivable,
• An interest in a foreign insurance policy, and
• Precious metals, gold certificates, and futures contracts held outside Canada

Specified foreign property does not include:

• Foreign property held in registered accounts such as RPPs, RRSPs, RRIFs, RESPs, RDSPs, locked-in registered plans, and TFSAs,
• Units of Canadian mutual fund trusts or mutual fund corporations investing in foreign securities (e.g., RBC U.S. Equity Fund) or held in a foreign currency,
• Personal-use property (e.g., vacation homes, vehicles, jewelry, artwork, etc.) and
• Property used or held exclusively in carrying on an active business (e.g., foreign real estate where you operate your active business)

What is the legal test to determine whether a taxpayer engaged in the adventure in the nature of trade thereby excluding what would otherwise be specified foreign property from the T 1135 reporting requirements?

The legal test is set out in Happy Valley Farms Ltd. v the MNR, and the court will consider all of the following factors:

• The nature of the property sold.
• The length of period of ownership.
• The frequency or number of other similar transactions by the taxpayer.
• Work expended on or in connection with the property realized.
• The circumstances that were responsible for the sale of the property.
• The intention at the time of acquiring an asset as inferred from surrounding circumstances and direct evidence (This is the most important factor).

Disclaimer: This article just provides broad information. It is only up to date as of the posting date. It has not been updated and may be out of date. It does not give legal advice and should not be relied on. Every tax scenario is unique to its circumstances and will differ from the instances described in the article. If you have specific legal questions, you should seek the advice of a Canadian cryptocurrency tax lawyer.