Canadian Tax Lawyer Analysis of the Bored Ape Yacht Club’s Non-Fungible Tokens
Published: January 17, 2023
Introduction –Non-fungible Tokens (Nfts) – What Are They?
NFTs are a relatively recent phenomenon that has begun to make roaring gains, in contrast to cryptocurrencies like Bitcoin and Ether, which have been widely popular for a while. An NFT is a data unit that is kept as part of a blockchain, which is a type of digital ledger. Since NFTs are non-fungible, they are distinct and cannot be substituted with other NFTs (as opposed to a particular bitcoin which is essentially identical to any other bitcoin). Although there are no strict restrictions on the kind of data that may be recorded, NFTs are now utilized as a document that certifies the owner of a certain piece of property. Since good artwork is generally valued because each piece is distinctive and one-of-a-kind and because reproductions are significantly less expensive than originals, this function is being used to give digital artwork more value since digital artwork can be easily copied and there is no way to tell the difference between an "original" and a "copy." This is where NFTs come in; they are currently utilized as proof of ownership for a specific work of digital art and may afterward be purchased or sold. You can read more about NFTs and how they are taxed here.
Bored Ape Yacht Club NFT
In early September 2021, 107 NFTs from the Bored Ape Yacht Club collection broke previous records when they were auctioned online at the Sotheby’s auction house for US$24.4 million. The Bored Apes comprise a group of 10,000 cartoon apes, each of which has a unique blend of characteristics and aesthetics, including attire, accessories, and facial expressions. The Bored Ape Yacht Club collection was introduced in April of that year, with an average secondary market price of about $1,500 at the time of their introduction. By September of 2021, the average price had remarkably increased to over $100,000 per piece. At the time of its debut, the pieces' secondary market average was around $1,500. The highest single ape was also sold for 740 Ether, which at the time of the sale was equivalent to almost $2.9 million. These digital apes even have pets of their own. The Bored Ape Kennel Club is a group of NFTs that features digital artworks of different dogs that are sold to the apes as pets. A collection of 101 Bored Ape Kennel Club NFTs sold for $1,835,000 at the same Sotheby's auction, despite not being quite as expensive as the apes themselves.
Capital Gains vs. Business Income: Taxation on the Sale of Bored Apes and Other NFTs
Gains and losses on property are computed, taxed, and required to be reported in the year of disposal for Canadian tax purposes whenever a disposition takes place. That implies that whenever an NFT is sold or traded, whether it is for another NFT, a cryptocurrency, or fiat currency, a taxable event happens and gains and losses are computed for taxation. While that tax requirement is clear, the question of whether the sale of the NFT should be regarded as capital or revenue from a business is more complicated. This is significant because, unlike business income, which is recorded for tax purposes at 100%, capital gains are treated differently, with just 50% of a capital gain being taxable (or deductible). Given the skyrocketing NFT prices, the difference in Canadian crypto taxes due depending on whether a transaction is classified as a capital gain or commercial income can be in the hundreds of thousands or even millions of dollars.
Unfortunately, there is no clear precedent that enables one to establish whether a given transaction should be taken into account on account of business or capital, and the distinction between capital gains and income is usually complicated. In order to determine whether a disposition was made on account of business or capital, there are six factors that should be taken into account collectively, according to the leading decision, Happy Valley Farms Ltd v. HMQ. The following are the contributing elements:
- Transaction frequency: For instance, a history of intensive buying and selling of non-fungible tokens or of a rapid turnover of NFTs may signal a business;
- Duration of ownership: For instance, unusually short holding periods of non-fungible tokens suggest commercial activities rather than capital investments;
- Knowledge of NFT marketplace: Such as the fact that a business categorization is favored by improved knowledge or experience of NFT markets;
- Connection to the taxpayer's other work: Such as if NFT transactions (or similar dealings) are associated with the taxpayer's employment or other business, which indicates toward a business;
- Time invested: For instance if a significant portion of the taxpayer's time is spent researching non-fungible-token markets and potential acquisitions or actively maintaining a portfolio of non-fungible tokens, there is a higher possibility that the taxpayer will be characterized as operating a business;
- Finance: For instance, leveraged NFT transactions signify a business; and
- Advertising: For instance, enhanced chance of business classification if the taxpayer has marketed or otherwise made it known that he deals in non-fungible tokens
The main objective of these considerations is to ascertain the taxpayer's intention about the sale of the property as demonstrated by the taxpayer's actions and the external environment. Even though the primary goal was an investment, it should be noted that the sale may be taxed as business income if there was a secondary intention at the time of acquisition of resale for profit. Despite this, NFTs are potentially better positioned than cryptocurrencies to be classified as capital assets since they may be seen as more equivalent to art collecting (which is typically regarded as capital) than cryptocurrencies, which are seen as being similar to commodities like gold. As an example, art dealers are still regarded as earning business income, therefore keep in mind that the above considerations still apply. Make sure your NFT sales are properly described by speaking to one of our knowledgeable and experienced Canadian crypto tax lawyers who specialize in the taxation of cryptocurrencies.
Tax Pro Tip: Use the Voluntary Disclosures Program and Professional Canadian Crypto Tax Legal Advice
As was already indicated, there may be considerable tax savings to be had by declaring the sale of an NFT as capital gains rather than business income. On the other hand, disclosing NFT income wrongly might have disastrous repercussions. The CRA may also impose a gross negligence penalty equal to 50% of the underreported taxes if a crypto audit is conducted by the CRA and it is discovered that you failed to report your NFT income accurately. In this case, you will be subject to a 17% late-filing penalty, 5-6% annual interest, and any tax that is still owed. Consequently, it is essential to make sure that all NFT sales are accurately reported.
If you have any NFT or crypto income that has been underreported or overreported, you may still be eligible for relief under the CRA's Voluntary Disclosures Program. If your application is approved, the CRA assures you that no criminal charges will be brought against you and that all fines for gross negligence will be waived. A few voluntary disclosures also get the advantage of no penalties at all and a 50% discount on any interest for tax years that are more than three years past due. Numerous Canadian taxpayers who had unreported cryptocurrency and blockchain transactions received assistance from our skilled Canadian crypto tax lawyer who is a Certified Specialist in Taxation. Your application for voluntary disclosure can be carefully planned and quickly prepared. In addition to improving your chances of receiving tax amnesty from the CRA, a properly prepared disclosure application also paves the way for a legal request for judicial review to the Federal Court in the event that the Canada Revenue Agency wrongfully rejects your voluntary disclosure application. Make an appointment for a private consultation with one of our knowledgeable Canadian crypto tax lawyers to learn whether you are eligible for the Canada Revenue Agency's Voluntary Disclosures Program.
FAQ: FREQUENTLY ASKED QUESTIONS
Question: I traded an NFT for another NFT or cryptocurrency, but I didn’t get any fiat currency in return. Is this a taxable event?
Answer: Yes, every time you exchange an NFT or cryptocurrency for something else, including another NFT or cryptocurrency, a taxable event takes place, and profits or losses are determined at that time and must be recorded on your Canadian crypto tax return.
Question: What are the Voluntary Disclosure Program requirements?
Answer: In order for a disclosure to be eligible for the Voluntary Disclosures Program, it must be:
- Voluntary, which means that the CRA must not already be aware of the unreported or incorrectly reported revenue;
- Complete, providing full disclosure of ALL unreported/misreported income;
- At least a year over the original due date - the revealed information must be at least a year old;
- Penalty owing. As a result of the information exposed, there must be a penalty due;
- Payment of anticipated tax due. In order to qualify for the relief, the taxpayer must pay what they anticipate would be due in taxes as a result of the disclosure.
Question: Is the sale of an NFT taxed as an income from capital or as an income from business?
Answer: The sale of an NFT may result in a capital gain or business income, depending on the taxpayer's objectives and the relevant details and circumstances. A capital gain categorization has the advantage that only 50% of the gain is subject to tax. However, misrepresenting your income may result in hefty fines and interest. As a result, in this circumstance, it is essential to get professional counsel from a renowned Canadian crypto tax lawyer.