Bitcoin ETF Taxation: A Toronto Tax Lawyer's Analysis
Published: February 8, 2023
Introduction to Bitcoin ETFs
ProShares ETF, the first-ever Bitcoin exchange-traded fund (ETF) based in the U.S. was introduced on October 19, 2021. And just within a week, another was launched on October 22, 2021 - the Valkyrie Bitcoin Strategy EFT. Both Bitcoin ETFs invest in Bitcoins by entering into agreements allowing them to purchase the cryptocurrency in the future at a certain price.
The two U.S.-based Bitcoin ETFs are not, however, the first ones to exist. In fact, there are already a number of different Bitcoin ETFs available on the Canadian securities market. The HIVE Blockchain Technologies (TSXV:HIVE), CI Galaxy Bitcoin ETF (TSX:BTCX.B), and Purpose Bitcoin ETF (TSX:BTCC.B) are among them. Purpose Bitcoin ETF and CI Galaxy Bitcoin ETF do not invest in futures contracts like their U.S. counterparts do; instead, they hold Bitcoin on behalf of their investors. While using the money it received from investors, HIVE Blockchain Technologies mines Bitcoin and Ethereum for a profit.
The possibility of investing in the Bitcoin market using EFTs while benefiting from the tax perks of a Tax-Free Savings Account (TFSA) or a Registered Retirement Savings Plan (RRSP) is what we will discuss in this crypto blog post as one of the key Canadian cryptocurrency tax implications for Bitcoin ETF investors.
How the Canadian Taxation of Bitcoin ETFs are Treated in General
The Income Tax Act treats Bitcoin ETFs as mutual funds. As a result, Canadians who are Bitcoin ETFs holders will be subject to tax on any income and capital gains they may have from holding the ETFs as well as any capital gains or losses they may have from disposing of them. Canadian taxpayers can also carry their capital losses from the disposition of their ETFs forward or backward to reduce their future or past tax obligations. Taxpayers are permitted to carry back their capital losses for a period of three years and carry forward their capital losses indefinitely under the Income Tax Act.
RRSP and TFSA: The Qualified Investments
In accordance with the Income Tax Act, only qualified investments may be vested in tax-free savings accounts (TFSAs), registered education savings plans (RESPs), registered retirement income funds (RRIFs), registered disability savings plans (RDSPs) and registered retirement savings plans (RRSPs). The only investments that qualify are those listed below.
- Deposits and money
- Securities that are listed Public corporations
- Debt obligations
- Investment funds
- Options and warrants
- Trading in different currencies
- Contracts for annuities
- Silver and gold
- Investments made by small businesses
- Receipts for payments in instalments
- Escrow agreements
The list of qualified investments mentioned above must be met in order for Canadian taxpayers to invest in cryptocurrencies through a TFSA or an RRSP.
Cryptocurrency's Tax Characterization
Any tax legislation specifically addressing Bitcoin or other cryptocurrency tokens has not yet been enacted in Canada. Likewise, a tax dispute involving cryptocurrency transactions has not yet been decided by Canadian courts.
However, CRA has stated its position on cryptocurrencies. According to the CRA, cryptocurrencies are commodities that can be traded for goods and services or purchased and sold like securities. It's crucial to keep in mind that the CRA's administrative rules do not constitute the law. Cryptocurrencies should be treated as currency for taxation purposes, according to some tax academics and tax professionals in their tax writings. However, because no legislation or court rulings have been made on this matter, Canadian taxpayers who decide to invest in bitcoin in a TFSA or RRSP account run the risk of facing a CRA cryptocurrency audit and legal action from the CRA since crypto does not fall within the definitions of qualified investments for tax-deferred plans.
TFSAs, RRSPs, and Exchange-Traded funds
Securities known as exchange-traded funds are traded on stock exchanges similarly to stocks. As qualified investments, ETFs are eligible to be held by Canadians with TFSA or RRSP accounts. Thus, TFSA and RRSP accounts should accept bitcoin ETFs as qualified investments.
To benefit from tax benefits and avoid exorbitant penalties, Canadian taxpayers investing through TFSAs or RRSPs must make sure they adhere to all applicable regulations. The main tax pitfalls for Canadian taxpayers are earning active income inside their TFSA or RRSP accounts, making excessive TFSA or RRSP contributions, funding their TFSA or RRSP accounts while not residents of Canada, and withdrawing funds from their RRSP accounts while not citizens of Canada.
Operating a Business in an RRSP or TFSA
TFSA and RRSP investments must be passive rather than active businesses. The standard rate of taxation for business incomes will apply to income earned by Canadian taxpayers who operate a crypto trading business inside of an RRSP or TFSA. By examining whether the income generated inside a TFSA or RRSP is capital gains or income, one can determine whether a taxpayer has been engaging in active business. This article link goes into great detail about the extremely complex topic of determining income vs. capital gains.
Limits on TFSA and RRSP Contributions
The maximum amount a taxpayer may contribute to an RRSP or TFSA account without incurring penalties is known as the contribution room, and it applies separately to both types of accounts. A penalty of 1% of the excess contribution amount per month may be assessed for exceeding the cap on contributions.
Non-Resident TFSA Contributions and Non-Resident RRSP Withdrawals
A non-resident who makes a TFSA account contribution while outside of Canada is subject to a penalty equal to 1% of the contribution up until the time that amount is withdrawn. A non-resident must pay a 25% withholding tax on any RRSP withdrawals made while they are outside of Canada.
It's crucial to remember that residence for tax purposes differs from residence for immigration or citizenship purposes. A body of case law on tax residence that uses a comprehensive perspective can leave individual taxpayers with a lot of unanswered questions. If you have any concerns about your tax residence, consult with one of our knowledgeable Toronto tax lawyers.
Tax Pro Tips - Know the TFSA and RRSP rules
When combined with bitcoins, TFSAs and RRSPs can be effective crypto tax planning instruments. When purchasing Bitcoin ETFs for a TFSA or RRSP account, it's crucial for Canadian cryptocurrency investors to be aware of the restrictions on non-residents, contribution limits, and passive investments.
Please contact our tax law office for advice from one of our top crypto tax lawyers in Canada if you have any questions about tax planning related to your cryptocurrency investments or if you are under CRA audit.
Frequently asked questions
I have a cryptocurrency and NFT portfolio. Can I transfer it into my RRSP or TFSA?
No, cryptocurrency and NFTs are not eligible investments for tax-deferred savings plans. If you transfer eligible assets into a tax-deferred account you will be subject to penalties.
I would like to invest in cryptocurrency but my only investment capital is in my TFSA and RRSP. Can I acquire crypto in my tax-deferred accounts?
You cannot directly invest in crypto such as bitcoin in a tax-deferred account. However, your tax-deferred accounts can indirectly acquire crypto through an ETF or exchange-traded fund that deals in crypto. There are a number of eligible ETFs available in Canada.
"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 articles. If you have specific legal questions, you should seek the advice of a lawyer."