Can You Claim Income Tax Deductions for Crypto Losses, Crypto Scams? It Depends, Says CRA

Introduction: Income-Tax Deductions for Losses from Cryptocurrency Fraud and Crypto-Exchange Bankruptcy

Canadian cryptocurrency investors and traders have lost millions of dollars’ worth of crypto investments and crypto inventory as a result of fraud by both large and small crypto exchanges and platforms. After embezzling or “misplacing” their clients’ funds, the fraudulent crypto exchanges often go bankrupt, leaving bankruptcy trustees and bankruptcy courts to sift through the few remaining assets and distribute them among the exchange’s former clients, who, if lucky, generally receive only pennies on the dollar. The Canadian crypto exchange QuadrigaCX, which lost almost $200 million in investor assets, and the disgraced US crypto exchange FTX, which lost over $1 billion, are two notable examples.

But FTX and QuadrigaCX represent only the headline-making cases of cryptocurrency-based investor fraud. On an almost daily basis, Canadian and international anti-fraud groups and consumer watchdogs identify crypto scams aiming to defraud investors, and our law firm’s Canadian crypto-tax lawyers regularly advise clients who have been victims of crypto fraud.

Although their money might unfortunately never be recovered, Canadian cryptocurrency investors who fall victim to crypto fraud may be able to deduct the loss for income-tax purposes. For further details, read our article about income-tax deductions for losses from crypto-based investments.

In November 2023, the Canada Revenue Agency participated in a roundtable with the Association de planification fiscale et financière (APFF), during which the CRA responded to a series of questions about cryptocurrency held through centralized crypto-exchange platforms. The Canada Revenue Agency’s answers bear upon the entitlement to claim income-tax deductions for crypto losses stemming from fraud by or bankruptcy of a centralized crypto-exchange platform. The CRA’s answers also demonstrate the necessity of seeking tax advice from a knowledgeable Canadian crypto tax lawyer before you make tax claims relating to cryptocurrency transactions.

This article discusses the CRA’s recent commentary about claiming tax deductions relating to crypto losses stemming from a crypto exchange’s fraud or bankruptcy. This article also offers pro crypto tax tips for Canadian cryptocurrency traders and investors from our top Certified Specialist in Taxation Canadian crypto-tax lawyer.

New CRA Commentary: The Crypto Exchange’s Terms of Service Determine Whether the Taxpayer Beneficially Owns the Cryptocurrency

During the November 2023 APFF roundtable, when answering questions about cryptocurrency held through centralized cryptocurrency-exchange platforms, the Canada Revenue Agency distinguished between the following two arrangements:

1. An arrangement whereby the cryptocurrency exchange holds the cryptocurrency (in the taxpayer’s exchange account) as a custodian for the benefit of the taxpayer; and
2. An arrangement whereby the cryptocurrency exchange owns the cryptocurrency and gives the taxpayer a right to withdraw a specified amount of cryptocurrency (i.e., the balance of the taxpayer’s exchange account)

Under the first arrangement, the taxpayer—not the exchange—owns the cryptocurrency within the taxpayer’s account with the exchange. The crypto exchange merely acts as a custodian with respect to the cryptocurrency that it holds within client-designated wallets. Under the second arrangement, however, the exchange—not the taxpayer—owns the cryptocurrency.

The cryptocurrency exchange’s terms of service will typically contain the provisions allowing an experienced Canadian crypto-tax lawyer to distinguish whether a taxpayer owns the underlying cryptocurrency or holds merely a contractual right against the crypto exchange. For example, in cases where the exchange itself owns the cryptocurrency within its client-designated wallets, the exchange’s terms of service will give the exchange all the rights associated with ownership—e.g., the rights to pledge, sell, stake, or lend the cryptocurrency, and the right to all profit therefrom. The terms of service will give the account holder the right to withdraw the balance—that is, the right to receive a specific amount of cryptocurrency from the exchange.   

According to the Canada Revenue Agency, each arrangement brings about specific Canadian crypto tax consequences, not only when a taxpayer transfers cryptocurrency to or from such an exchange, but also if a taxpayer loses access to the cryptocurrency held by the exchange.

During the November 2023 APFF roundtable, the CRA was presented with a fact pattern where a taxpayer had transferred bitcoins to a centralized cryptocurrency-exchange platform. The platform’s terms of service gave the platform the rights to pledge, sell, and lend the bitcoins, and to keep all profits therefrom. The terms of service gave the taxpayer the right to withdraw the taxpayer’s bitcoin balance at any time, and they stated that the withdrawals would be paid from a wallet in which bitcoins from various clients were deposited.  

The Canada Revenue Agency was then asked whether the taxpayer’s transfer of bitcoins to such a cryptocurrency-exchange platform constituted a “disposition” for tax purposes. The CRA answered affirmatively. The taxpayer’s crypto deposit with the platform would likely constitute a disposition for tax purposes, since, in the CRA’s opinion, the crypto exchange’s terms of services likely meant that taxpayer had transferred ownership of the bitcoins to the crypto-exchange platform. This is because, under the platform’s terms of service, the taxpayer’s bitcoin deposit had given the cryptocurrency exchange the right to use those crypto assets, to derive profits from them, and to dispose of them at its discretion.

The CRA was also quizzed about situations in which a taxpayer lost access to the cryptocurrency held by the crypto exchange—e.g., because of the crypto exchange’s fraud, financial mismanagement, or bankruptcy.  In the CRA’s view, if, by means of the crypto exchange’s terms of service, the exchange thereby owns the deposited crypto assets and the taxpayer holds only a contractual claim to demand payment from the crypto exchange, the cryptocurrency loss—whether by fraud, financial mismanagement, or bankruptcy—is suffered by the exchange itself, not the taxpayer. The taxpayer, according to the Canada Revenue Agency, continues to hold the contractual claim against the crypto exchange.  

Granted, the value of the taxpayer’s claim may be diminished if the crypto exchange doesn’t possess sufficient net assets to fully satisfy the claim. But the value of the claim is a separate issue. The taxpayer still possesses that contractual claim—even if the crypto exchange has managed to lose the cryptocurrency that gave rise to the claim. As a result, in these circumstances, the taxpayer may not yet be entitled to claim the crypto loss as a tax deduction.

This means that, according to CRA, there are two separate transactions and events. The first is a disposition giving rise to a gain or loss when the crypto is transferred to the exchange. The second is a write off of the contractual right to the return of the crypto from the exchange.  Note that these events may well occur several taxation years apart, giving rise to income in one year and a deduction in a subsequent year.

On the other hand, the crypto exchange’s terms of service may provide that the exchange holds the deposited cryptocurrency as a custodian for the taxpayer’s benefit. A loss of such cryptocurrency, the CRA acknowledged, is the taxpayer’s loss. It follows, then, that the taxpayer would be entitled to claim the crypto loss as a tax deduction for the taxation year in which the crypto exchange lost the taxpayer’s cryptocurrency.

Finally, the CRA was also queried about the types of evidence that a taxpayer could adduce to prove the taxpayer’s entitlement to claim a crypto-scam loss when the taxpayer has lost access to more appropriate records. The Canada Revenue Agency stated that the taxpayer could produce the following: public information about the crypto platform's fraud or bankruptcy; documents confirming account activation; any signed contracts between the taxpayer and the crypto platform; a copy of any claim filed with the crypto platform's bankruptcy trustee; pleadings from any crypto-recovery proceedings initiated by the taxpayer; proof of the taxpayer’s previously declared crypto-related income or losses; proof that the taxpayer’s cryptocurrency had not been disposed of prior to the crypto platform’s bankruptcy; precise calculations of the claimed loss; any documentation regarding recovery or compensation; and proof that the taxpayer did not sell the taxpayer’s claim to the crypto platform's bankruptcy trustee.

Pro Tax Tips: Legal Opinion on Proper Cryptocurrency Tax Reporting & Entitlement to Tax Deductions for Crypto-Scam Losses

The Canada Revenue Agency’s recent commentary bears upon a taxpayer’s entitlement to claim income-tax deductions for crypto losses stemming from fraud by or bankruptcy of a centralized crypto-exchange platform. The CRA’s answers also demonstrate the necessity of seeking tax advice from a knowledgeable Canadian crypto-tax lawyer before you make tax claims relating to cryptocurrency transactions.

In particular, the CRA’s position entails that Canadian cryptocurrency investors and traders should ask an experienced Canadian crypto-tax lawyer to scrutinize the terms of service of any crypto-exchange platform with which they hold crypto assets and the terms of any other agreements with crypto-exchange platforms or third-party crypto-wallet providers. Two superficially similar arrangements may actually impose markedly different legal obligations and rights on various parties, thereby subjecting them to radically different tax outcomes, including the timing of a taxpayer’s entitlement to claim tax deductions for crypto-scam losses.

You should also maintain a copy of any formal legal opinions that you received from your top Canadian crypto-tax lawyer. For instance, our expert Canadian crypto-tax lawyers can prepare a tax memorandum examining your entitlement to claim tax deductions for crypto-scam losses and whether your cryptocurrency losses may be reported as capital losses, as business losses, or as a blend of both. This confidential and privileged document can prove invaluable by ensuring that the CRA doesn’t fault you for misrepresenting the information on your tax returns.

During the November 2023 APFF roundtable, the Canada Revenue Agency indicated that it may accept the following types of evidence for the taxpayer’s entitlement to claim a crypto-scam loss when the taxpayer has lost access to more appropriate records: 

• public information about the crypto platform's fraud or bankruptcy;
• documents confirming account activation;
• any signed contracts between the taxpayer and the crypto platform;
• a copy of any claim filed with the crypto platform's bankruptcy trustee;
• pleadings from any crypto-recovery proceedings initiated by the taxpayer;
• proof of the taxpayer’s previously declared crypto-related income or losses;
• proof that the taxpayer’s cryptocurrency had not been disposed of prior to the crypto platform’s bankruptcy;
• precise calculations of the claimed loss;
• any documentation regarding recovery or compensation; and
• proof that the taxpayer did not sell the taxpayer’s claim to the crypto platform's bankruptcy trustee.

Still, if you use a cryptocurrency exchange, you should periodically export your transaction information to avoid losing it. Ideally, you should also use offsite or cloud storage to back up your documents and computer files.

In addition, if you discover that you’ve been defrauded by what you initially believed to be a legitimate cryptocurrency investment, you should gather as much information as possible to show that the enterprise purported itself to be a legitimate investment and to prove the amount that you lost. Acceptable evidence might include bank-account statements or cryptocurrency-exchange statements showing the amounts that you transferred to the illegitimate enterprise, wire-transfer records, screenshots of your account with the fraudulent crypto platform, emails or screenshots of communications with the individuals behind the fraudulent crypto platform, and police reports.

You should also consider hiring a private investigator to prepare a forensic blockchain-tracing analysis showing that the crypto scammers transferred your crypto assets to unauthorized wallets.

Proper supporting documents and recordkeeping should convince a CRA tax auditor to allow your crypto-loss claim. If you run into a particularly unreasonable tax auditor, however, consult one of our top Canadian crypto-tax lawyers, who can represent you during your crypto tax audit.  

Frequently Asked Questions

I’m a Canadian cryptocurrency investor, and I held all my crypto assets with a crypto-exchange platform that has now gone bankrupt. As a result, I can no longer access my cryptocurrency.  Can I deduct the resulting loss for income-tax purposes?

You might be able to claim a tax deduction, but your entitlement depends on the cryptocurrency exchange’s terms of service. During the November 2023 APFF roundtable, when answering questions about cryptocurrency held through centralized cryptocurrency-exchange platforms, the Canada Revenue Agency distinguished between the following two arrangements:

1. An arrangement whereby the cryptocurrency exchange holds the cryptocurrency (in the taxpayer’s exchange account) as a custodian for the benefit of the taxpayer; and
2. An arrangement whereby the cryptocurrency exchange owns the cryptocurrency and gives the taxpayer a right to withdraw a specified amount of cryptocurrency (i.e., the balance of the taxpayer’s exchange account)

Under the first arrangement, the taxpayer—not the exchange—owns the cryptocurrency within the taxpayer’s account with the exchange. The crypto exchange merely acts as a custodian with respect to the cryptocurrency that it holds within client-designated wallets. Under the second arrangement, however, the exchange—not the taxpayer—owns the cryptocurrency.

In the CRA’s view, if, by means of the crypto exchange’s terms of service, the exchange thereby owns the deposited crypto assets and the taxpayer holds only a contractual claim to demand payment from the crypto exchange, the cryptocurrency loss—whether by fraud, financial mismanagement, or bankruptcy—is suffered by the exchange itself, not the taxpayer. The taxpayer, according to the Canada Revenue Agency,

still possesses that contractual claim—even if the crypto exchange has managed to lose the cryptocurrency that gave rise to the claim. As a result, in these circumstances, the taxpayer may not yet be entitled to claim the crypto loss as a tax deduction.

On the other hand, the crypto exchange’s terms of service may provide that the exchange holds the deposited cryptocurrency as a custodian for the taxpayer’s benefit. A loss of such cryptocurrency, the CRA acknowledged, is the taxpayer’s loss. It follows, then, that the taxpayer would be entitled to claim the crypto loss as a tax deduction for the taxation year in which the crypto exchange lost the taxpayer’s cryptocurrency.

The CRA’s position entails that you should ask an experienced Canadian crypto-tax lawyer to scrutinize the terms of service of the crypto-exchange platform with which you held your crypto assets.  The cryptocurrency exchange’s terms of service will typically contain the provisions allowing a knowledgeable Canadian crypto-tax lawyer to distinguish whether you owned the underlying cryptocurrency or held merely a contractual right against the crypto exchange. Contact one of our highly skilled Canadian crypto-tax lawyers today.  

I’ve been defrauded by what I initially believed was a legitimate cryptocurrency investment. What records should I retain if I intend to claim that loss?  

During the November 2023 APFF roundtable, the Canada Revenue Agency indicated that it may accept the following types of evidence for the taxpayer’s entitlement to claim a crypto-scam loss when the taxpayer has lost access to more appropriate records: 

• public information about the crypto platform's fraud or bankruptcy;
• documents confirming account activation;
• any signed contracts between the taxpayer and the crypto platform;
• a copy of any claim filed with the crypto platform's bankruptcy trustee;
• pleadings from any crypto-recovery proceedings initiated by the taxpayer;
• proof of the taxpayer’s previously declared crypto-related income or losses;
• proof that the taxpayer’s cryptocurrency had not been disposed of prior to the crypto platform’s bankruptcy;
• precise calculations of the claimed loss;
• any documentation regarding recovery or compensation; and
• proof that the taxpayer did not sell the taxpayer’s claim to the crypto platform's bankruptcy trustee.

Still, if you use a cryptocurrency exchange, you should periodically export your transaction information to avoid losing it. Ideally, you should also use offsite or cloud storage to back up your documents and computer files. In addition, if you discover that you’ve been defrauded by what you initially believed to be a legitimate cryptocurrency investment, you should gather as much information as possible to show that the enterprise purported itself to be a legitimate investment and to prove the amount that you lost. Acceptable evidence might include bank-account statements or cryptocurrency-exchange statements showing the amounts that you transferred to the illegitimate enterprise, wire-transfer records, screenshots of your account with the fraudulent crypto platform, emails or screenshots of communications with the individuals behind the fraudulent crypto platform, and police reports. You should also consider hiring a private investigator to prepare a forensic blockchain-tracing analysis showing that the crypto scammers transferred your crypto assets to unauthorized wallets.

Proper supporting documents and recordkeeping should convince a CRA tax auditor to allow your crypto-loss claim. If you run into a particularly unreasonable tax auditor, however, consult one of our elite Canadian crypto-tax lawyers, who can represent you during your crypto-tax audit.  

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 tax lawyer.