Canadian Tax Advice From A Canadian Tax Lawyer: Canadian Cryptocurrency Tax Pitfall-Derivative Tax Liability Under Section 160 For Non-Arm's-Length Cryptocurrency Transactions
Published: August 24, 2022
Last updated: September 7, 2022
Introduction: As per Section 160 of Canada's Income Tax Act: Related-Party Cryptocurrency Transactions and Derivative Tax Liability
The Income Tax Act of Canada's Section 160 is the most effective weapon for tax collection. It prevents taxpayers from trying to transfer assets to friends, family, or related companies in order to hide property from the Canada Revenue Agency.
Section 160 captures a broad range of transactions, including transactions involving non-fungible tokens (NFTs) and transactions involving cryptocurrencies such as Bitcoin (BTC), Tether (USDT), USD Coin (USDC), Binance Coin (BNB), Cardano (ADA), Solana (SOL), Polkadot (DOT), and Dogecoin (DOGE). As a result, section 160 permits the CRA's tax collectors to pursue you for the transferor's tax debt if you receive cryptocurrency, non-fungible tokens (NFTs), or any other assets including blockchain-based assets from a related party who has outstanding tax debts such as a spouse, child, business partner, or trust or corporation in which you have an interest. (Your derivative crypto-tax liability is capped at the fair market value of the transferred asset at the time of transfer and is subtracted from that amount by the value of what you paid in consideration for the asset. In the section below, we go into further depth on section 160's operations.)
This post covers the derivative crypto-tax liability under section 160 of Canada’s Income Tax Act. Additionally, it provides expert tax advice from our top Canadian crypto tax lawyers on avoiding and contesting section 160 assessments.
The Functions of Section 160 of the Income Tax Act of Canada
Section 160 is a notoriously strict rule: it provides no due-diligence defence, it applies even if the transaction was not motivated by tax avoidance, and it captures transferees who are unaware that they are acquiring property from a tax debtor (e.g., see: Canada v Heavyside, 1996 CanLII 3932 (FCA), at para 3). Additionally, there is no limitation period under Section 160. As a result, years after the alleged transfer, the Canada Revenue Agency may assess you in accordance with the regulation.
If each of the following four requirements is met, Section 160 is applicable:
- A property was transferred. The definition of "transferred property" under section 160 encompasses a wide variety of transactions, including those in which a tax debtor “transferred property, either directly or indirectly, by means of a trust or by any other means whatever.”
- The transferor had a tax liability with the Canada Revenue Agency at the transfer time.
- At the time of the transfer, the receiver was one of the following: (a) the transferor’s spouse or common-law partner (or a person who has since become the transferor’s spouse or common-law partner didn’t provide full consideration—e.g., a gift of cryptocurrency or NFTs.
- For the transferred property, the recipient paid the transferor a lower payment than its fair market value.
To put it another way, section 160 will apply to transactions in which you received blockchain-based assets including cryptocurrency, non-fungible tokens (NFTs), or any other property from a related party who has outstanding tax debts.
In cases where section 160 is in engaged, the transferor and the recipient are "jointly and severally" responsible for the transferor's tax debt. In particular, at the moment of the transfer, the recipient assumes independent liability for the transferor's tax debt. In particular, at the moment of the transfer, the recipient assumes independent liability for the transferor’s tax debt. The Canadian Revenue Agency will now be able to pursue both the original taxpayer and their derivative for the tax debt. In fact, the derivative tax debtor is indeed accountable to the CRA until the tax debt is fully refunded, even if the original tax debtor is later released from bankruptcy and no longer has to pay the underlying tax debt. (e.g.: Canada v Heavyside, ibid.)
Note that, the transferee's derivative tax liability under Section 160 is limited to the transferred asset's fair market value. In addition, the amount of any consideration that the receiver gave for the property is deducted from the recipient's liabilities. For example, a tax debtor who owes the CRA $2 million in tax debt and holds bitcoin and NFTs worth $1,000,000 in total. If the tax debtor gifts the bitcoin and NFTs to his son, the son will be liable for $1,000,000 under section 160, or the amount that the digital assets are worth. (If he gifted the cryptocurrency and NFTs subsequently increase in value to $3 million, the derivative tax liability is still limited to the $1,000,000 value at the time of transfer.) In contrast, if the son paid the tax debtor $500,000 for the digital assets, his responsibility under section 160 equals $500,000, or the worth of the digital assets less the cost of the acquisition.
Payments must comply with Section 160(3) in order to discharge the joint liability. A payment made by a taxpayer who has inherited accountability under section 160 will lower both debts, meaning that it will lower both the tax debt of the original tax debtor and the tax debt of the jointly liable third-party taxpayer. However, a payment made by the original tax debtor is controlled by an ordering rule. All tax debts that are more than the joint liability must first be paid by the original tax debtor. Therefor the original tax debtor must settle all outstanding tax debts that belong exclusively to the original debtor initially.
The original tax debtor owes $1 million in taxes, and the joint debtor becomes jointly liable for $500,000 under section 160, continuing from our prior scenario.
- The section 160 liability of the joint debtor is discharged and the original tax debtor's liability is lessened by $1,000,000 if the joint debtor pays up the entire $1,000,000 joint debt.
- If the original tax debtor pays $1,000,000, that amount will only be enough to pay the original debtor's portion of the original debtor's $1,000,000 tax debt. As a result, the payment decreases the original tax debtor's balance by $1,000,000 while leaving the joint debtor's burden at $1,000,000 unaltered.
- However, if the original tax debtor had paid $1,150,000, such payment would have been sufficient to discharge $150,000 of the joint debtor's burden and lower the original tax debtor's balance by $1,150,000.
To put it differently, the original tax debtor must pay off all of his personal tax debts before his tax payments may discharge the joint liability.
The Excise Tax Act's Section 325 offers a similar set of guidelines for GST/HST debts. In other words, whereas transfers made by individuals with income tax liabilities are covered by section 160 of the Income Tax Act, transactions made by individuals with GST/HST debts are covered by section 325 of the Excise Tax Act.
Pro Tax Advice: How to Avoid and Respond to Derivative Crypto-Tax Assessments under Section 160
When you transfer cryptocurrencies, non-fungible tokens, or other blockchain-based assets to friends and family in an effort to hide property from the Canada Revenue Agency (CRA), you put those people at risk of CRA tax collection action. Additionally, even if you aren't trying to elude the CRA crypto tax auditors and collectors, section 160 could arise and bite you. Similarly, if you get bitcoin, ETH or NFTs, or other blockchain-based assets from a connected person who has unpaid taxes, you can be liable for derivative crypto-tax obligation. Consult one of our knowledgeable Canadian crypto-tax lawyers for guidance on lowering your exposure to a derivative crypto-tax assessment under section 160 if you intend to engage in a blockchain transaction with a related party, including a transaction involving a trust, and either you or that party has tax debts (or may later be reassessed for a prior tax year).
You may contest both the validity of the assessment itself and the underlying tax liability if you receive a notice of assessment under section 160 of the Income Tax Act or section 325 of the Excise Tax Act by submitting a notice of objection within the required time frame. Furthermore, even if the main tax debtor didn't, you can contest the underlying tax liability. You may still fight the underlying tax debt—and you may make individual arguments—even if the original tax debtor did contest the obligation but failed to reduce the amount.
The Appeals Division of the Canada Revenue Agency will designate an appeals officer to examine the merits of your objection after receiving a notice of objection, which initiates the CRA's administrative dispute-resolution procedure. You can carry on the case by submitting a notice of appeal to the Tax Court of Canada if the CRA's appeals officer makes an unfavorable ruling. (Alternatively, if the Appeals Division has not made a decision within 90 days of the date that you submitted your objection, you may essentially sidestep the CRA's Appeals Division and appeal straight to the Tax Court of Canada.)
However, you only have a short period of time to contest the section 160 assessment. In general, you have 90 days from the date on the derivative-tax assessment to file a notice of objection, and you have 90 days from the date on the notice of confirmation from the Appeals Division of the CRA to appeal to the Tax Court of Canada. You may be considered for an extension if you miss the 90-day cutoff point, but you must submit your application between one year and 90 days of the date on the assessment or confirmation in order to be evaluated. You can also ask for a delay in the deadline for submitting a notice of appeal to the Tax Court of Canada, but those delays are far more challenging to get. Even if the original tax debtor declares bankruptcy, you will still be personally liable for the derivative crypto-tax debt if you fail to use your appeal rights within the specified time frames.
Fortunately, by consulting a knowledgeable Canadian lawyer experienced in crypto tax laws in Canada as soon as possible, Canadian cryptocurrency users may typically avoid these issues. Contact our Canadian tax lawyer who is a Certified Specialist in Taxation right now. Our knowledgeable Canadian tax lawyers have in-depth knowledge of this area of the law, and we can make sure that you submit a powerful, detailed, and convincing objection to the Canada Revenue Agency or appeal to the Tax Court of Canada.
Frequently Asked Questions
Question: I Owe The Canada Revenue Agency A Sizable Amount In Income Taxes. However, the majority of my assets are in cryptocurrency, and as a measure of defense from CRA tax collectors, I want to transfer my cryptocurrency to my child. This shouldn't be a problem at all, right?
Answer: According to section 160 of the Income Tax Act of Canada, you'll subject your son to derivative tax responsibility. As a tactic for tax collection, Section 160 tries to prevent taxpayers from attempting to transfer cryptocurrency assets to friends or family in order to evade the Canada Revenue Agency's tax collectors. If you permit your child exposure to your cryptocurrencies, section 160 allows the CRA's tax collectors to go after your child for outstanding income taxes. The amount that your child owes in derivative taxes under section 160 is limited to the fair market value of the cryptocurrency that was transferred, and any money that your child paid you for the cryptocurrency will be deducted from that amount, if any.
Question: In accordance with Section 160 of the Income Tax Act, I just received a Notice of Assessment for Derivative Tax Liability. The Appraisal Relates Cryptocurrency, Non-Fungible Tokens, And Other Blockchain-Based Assets that I Received From My Spouse. I want to appeal this assessment in the Canadian Tax Court. What Should I Do Now?
Answer: You must first submit a notice of objection to the Appeals Division of the Canada Revenue Agency even if you intend to take the case to Tax Court. The actual objection must be submitted within 90 days of the assessment's date under Section 160. Following the submission of your objection, you must wait at least 90 days before submitting a notice of appeal with the Tax Court of Canada. Similar to other types of litigation, tax litigation is subject to a number of procedural regulations that impact practically every aspect of the case, including deadlines, admissible evidence, settlement discussions, and the nature of pleadings. Consult one of our knowledgeable Canadian tax litigation lawyers who specializes in cryptocurrency issues so they can assist you to navigate the tax court system, prepare your case for the Tax Court, and represent you there. They can also help you resolve your appeal with the Crown and the CRA in advance of a hearing.
"Only general information is provided in this article. Only as of the publishing date is it current. It hasn't been updated, therefore it could no longer be relevant. It cannot or ought not to be relied upon since it does not offer legal advice. Each tax circumstance is unique to its facts and will be different from the instances described in the articles. Consult a lawyer if you have particular legal questions.”