Questions? Call 
Crypto Tax Lawyer Logo

Canadian tax liability for unreported NFT-sourced income: Israel’s prosecution of Holy Rock NFT creators

picture of YOM HAZIKARON
By: Crypto Tax Lawyer

Published: April 10, 2023

Last updated: October 10, 2023

Introduction: The Israeli Tax Authority Makes Two Arrests in a Substantial Tax Evasion Scheme Involving NFTs

In March of 2023, the Israeli Tax Authority announced that it had arrested two Israeli citizens for suspected tax evasion concerning unreported income of over USD $2 million from non-fungible token (or “NFT”) dispositions. An NFT is in essence an indivisible digital token used to represent ownership of a unique digital asset. The token for a particular NFT is recorded on a digital ledger, typically the Ethereum (“ETH”) blockchain, using a smart contract to associate that token’s ownership to a particular instance of data which may include an art piece or any other sort of collectible. That data will typically be hosted through an off-chain service such as a cloud-based service to allow the NFT holder to access the data in question. An NFT content creator will produce a public key that certifies the authenticity of the NFT token’s history, as a means of providing the NFT as a proof of provenance.  

According to a report by the Jerusalem Post and the Israeli Tax Authority, the two accused were the creators of the Holy Rock NFT project, aimed at producing an NFT of each unique stone embedded in Jerusalem’s Western Wall to sell to digital collectors. The two accused sold the NFTs created through the project for units of ETH cryptocurrency, and then moved those units of ETH between various cryptocurrency wallets to increase the complexity of any public ledger audit trail. The two accused reportedly failed to declare any gains on the disposition of their NFTs for ETH.

The rising popularity of blockchain technology like cryptocurrencies and NFTs has fuelled fear among global law enforcement agencies and tax authorities that digital assets could be to facilitate tax evasion by disguising the character of taxable transactions. This is because of the inherent anonymity that blockchain technology offers to digital asset traders. While each transaction on a blockchain is public by nature, the unique wallet address associated with an entry on a digital ledger does not identify who the actual wallet holder is. In response, regulatory bodies like the Israeli Tax Authority and the Canada Revenue Agency (“CRA”) taken aggressive measures to clamp down on use of digital cryptocurrency assets as a means of disguising unreported income.

While the CRA has not published any compliance or enforcement notices concerning the global NFT marketplace, it has done so concerning the virtual currency and cryptocurrency marketplace. And while the subject matter of the Holy Rock NFT project is undoubtedly Israeli, it provides an interesting case study for exploring the various powers that the CRA has to investigate tax evasion, and the means that exist to punish tax evaders both civilly and criminally. This article will first explore the general principles concerning taxation of NFTs under the Canadian cryptocurrency tax system. This article will then discuss the means by which the CRA can investigate taxpayers using NFTs to facilitate suspected tax evasion, and the range of punishments a taxpayer may face should they willingly or unwittingly engage in tax evasion. Finally, we will provide some pro crypto tax tips and some frequently asked questions concerning taxation of NFTs and tax audit investigations.

Why are NFT Dispositions Taxable for Canadian Tax Purposes?

Under section 3 of the Canadian Income Tax Act, a Canadian taxpayer’s income will include all income from a productive source inside or outside of Canada. Enumerated sources of income under the Canadian Income Tax Act includes income from a business or property, which would necessarily include the sale of an NFT. Under the Canadian tax system, whenever a disposition of an asset takes place, the gain or loss on that disposition must be computed, reported and taxed in the year of disposal. A disposition will be taxable regardless of whether a particular asset is sold for fiat currency or cryptocurrency, or exchanged for another asset. Thus, whenever an NFT is sold for fiat currency or traded for another asset like cryptocurrencies or other NFTs, the Canadian tax system recognizes that sale or trade as a taxable event, and the gains or losses on that disposition are computed for tax purposes have to be reported in the year of disposition.

It is clear that the disposition of an NFT will trigger tax consequences for a Canadian taxpayer. The important and technically difficult consideration is whether that disposition should be regarded as a capital gain, or revenue from a business (which can include a one-time disposition). This is an important question for crypto tax planning purposes because, unlike revenue from a business, only half of a taxpayer’s capital gains will form taxable income in the year of disposal (or, where that disposition results in a capital loss, only half of that loss will be deductible, and that loss will only be deductible against capital gains). Given the proven volatility of the NFT global marketplace, the distinction between capital gains and business income can be significant for a Canadian taxpayer in determining how much tax is owing or saved.

The determination of whether the profit or loss from a disposition of property should be on account of capital or income has been subject to extensive litigation in Canadian tax courts. Although the Tax Court of Canada has yet to hear a case on disposal of NFTs, it is reasonable to assume these principles will nevertheless apply when characterizing the proceeds of an NFT disposition. It is important to acknowledge that no single factor will determine the proper characterization of the proceeds from disposing of a property, and that every case should and must be evaluated on its own facts. However, Canadian courts have consistently articulated specific objective factors that should be considered in determining whether a disposition of property was made on account of capital or income. If considering NFTs, that would include:

  • Transaction frequency – for instance, a trend of frequently buying and selling NFTs, or a high rate of NFT turnover by a taxpayer, may point to a business;
  • Duration of ownership – for instance, a taxpayer keeping NFTs for short periods of time indicates commercial activities rather than capital investments;
  • Understanding of NFT marketplaces – a taxpayer’s knowledge or expertise with NFT markets favours a business categorization;
  • Relationship to the taxpayer’s other employment - for instance, if NFT trades (or similar activities) are a component of the taxpayer’s employment or other business, that favours a business characterization;
  • Time invested – for instance, there is a higher change that the taxpayer will be classified as operating a business if a significant portion of that taxpayer’s time is spent researching potential NFT acquisitions, analyzing NFT markets, or actively managing an NFT portfolio;
  • Financial support – for instance, leveraged NFT purchases and transactions signify a business; and
  • Advertising – for instance, there is a greater chance that the taxpayer’s NFT company would be characterized as a business if the taxpayer had advertised it as a business, or if a taxpayer markets or makes it known that the taxpayer deals in NFTs.

Broadly speaking, a taxpayer’s purpose at the time of purchasing a property is the most significant factor to consider when determining whether a disposition of that property resulted in a capital gain or business income. The Tax Court of Canada and the Canada Revenue Agency will ultimately consider the objective circumstances surrounding the acquisition and sale of the property, including the factors enumerated above, to determine a taxpayer’s purpose for acquiring the property. It is worth nothing that the definition of “business” under subsection 248(1) of the Canadian Income Tax Act includes “an adventure or concern in the nature of trade”, which has been interpreted to include even a single acquisition and sale of property, and so even a single transaction can result in business income where the objective circumstances support that characterization.

The Potential Penalties for Failing to Properly Report Tax on Disposition of NFTs

A taxpayer can face significant civil or potentially criminal penalties for tax evasion, depending on the taxpayer’s level of culpability. Subsection 239(1) of the Canadian Income Tax Act sets out a number of conditions whereby a Canadian taxpayer may face significant fines and possible imprisonment for intentionally making, participating in, assenting to or acquiescing to making a false statement on a tax return or willfully manipulating or destroying financial records to disguise a tax obligation. A conviction under subsection 239(1) carries a possible penalty of between 50% to 200% of the tax evaded, or imprisonment of up to two years. The crucial element that defines possible criminal liability for tax evasion is the mindset of the taxpayer when committing the act in question that gives rise to liability. Subsection 163(2) provides an alternative civil scheme for punishing taxpayers who knowingly or under circumstances amounting to gross negligence make a false statement or omission on a tax return (these penalties are often referred to as “gross negligence penalties”). Under subsection 163(2), for a false statement or omission, a taxpayer may be liable for the greater of: (1) $100; and (2) 50% of the total amount of tax that would otherwise be payable by the taxpayer.

The anonymity offered by digital ledgers for NFT traders has presented some challenges to the CRA seeking to initiate crypto tax audits of Canadian NFT traders for suspected tax evasion. The existing powers granted to the CRA to collect information on Canadian taxpayers as part of a tax audit do not have much utility for investigating taxpayers who engage in purely wallet-to-wallet transactions. However, the growing importance of digital asset exchanges as a means of facilitating NFT trading presents one important vector facilitating tax audits by the CRA concerning Canadian NFT traders. Section 231.2 of the Canadian Income Tax Act empowers CRA tax auditors and investigators to compel persons to provide documents or information that are required as part of a tax investigation. This power is exceptionally broad and his historically allowed the CRA to compel banks and other third-party financial institutions to produce statements and records. The CRA has not been shy about extending this power to compel digital asset marketplaces to surrender information on Canadian cryptocurrency and NFT traders. In 2020, the CRA successfully obtained an order from the Federal Court to compel Coinsquare Ltd., a Toronto-based cryptocurrency platform, to produce confidential tax information on Canadian users’ trading activity and cryptocurrency holdings. So, while digital ledgers may afford NFT traders a sense of anonymity, the CRA still has mechanisms to audit NFT traders who use trading platforms and marketplaces to facilitate their trading activity.

If the CRA obtains evidence over the course of a tax audit that may justify bringing criminal charges against a taxpayer, that taxpayer’s case is then referred to the Department of Justice for prosecution under the Canadian Criminal Code. And while there is no restriction on the ability of the CRA to share information gathered as part of a civil tax audit with the Department of Justice, the CRA’s investigative powers to conduct a civil tax audit cannot be used to facilitate a criminal investigation. Where the predominant purpose of a CRA tax audit becomes investigating criminal or quasi-criminal activity, then a taxpayer’s constitutionally entrenched right to protection against self-incrimination under section 7 of the Canadian Charter of Rights and Freedoms is triggered. Further, a taxpayer’s rights under section 8 of the Canadian Charter of Rights and Freedoms will protect that taxpayer from unreasonable search and seizure by the state, which nullifies the CRA’s powers under section 231.2 to compel production of documents for that investigation. And while the CRA and the Department of Justice have the onus of informing a taxpayer when a tax audit becomes a criminal or quasi-criminal investigation, in cases where the CRA or the Department of Justice fail to meet this obligation, it becomes the taxpayer’s onus to challenge any inappropriate use of the CRA’s powers to gather evidence for a criminal case. This will require that the taxpayer demonstrate the CRA’s predominant purpose for gathering information as part of a tax audit was for its use in a criminal investigation as opposed to the civil tax audit, which is an unforgiving hurdle for any taxpayer to have to overcome.

Pro Tax Tip – Limit Your Criminal Liability Exposure by Applying Under the Voluntary Disclosures Program

The CRA’s Voluntary Disclosures Program (“VDP”) provides an invaluable means of avoiding possible criminal prosecution for crypto tax evasion where a taxpayer failed to report tax appropriately for NFT dispositions. Under the VDP, a Canadian taxpayer can voluntarily bring forward any tax non-compliance issues to the CRA before the CRA launches its own investigation. If a taxpayer qualifies for relief under the crypto VDP, then that taxpayer may be entitled to relief from any penalties for non-compliance like gross negligence penalties, partial interest relief on taxes owing, and most importantly relief from criminal prosecution.

However, a successful voluntary disclosure application is time-sensitive. In order to qualify for relief under the VDP, a taxpayer’s disclosure must be voluntary, which means it must precede any enforcement action taken by CRA to investigate the non-compliance in question. Further, any disclosure must be complete, which means it must not only include all submissions, calculations and information concerning the tax non-compliance in question, but it must address all non-compliance issues the taxpayer is responsible for. Thus, if a taxpayer has unreported taxes owing from NFT dispositions, and other unreported income, successfully qualifying under the VDP is contingent on disclosing and remedying both instances of non-compliance. It is therefore crucial that you engage a top cryptocurrency tax lawyer to help you carefully plan and prepare any voluntary disclosure application, and to stand ready to respond to any CRA enquiries about the substance of the application to ensure that disclosure remains complete. In addition to increasing the likelihood that the CRA would grant tax amnesty, a well written disclosure application also lays the framework for a judicial review application to the Federal Court should the Canada Revenue Agency unjustly reject your voluntary disclosure application. Our expert Canadian tax lawyers have helped many Canadian taxpayers with unreported income from cryptocurrency and NFT dispositions successfully obtain relief under the VDP. If you are facing tax non-compliance concerning your digital asset sales, you should consult an expert Canadian tax lawyer right away to ensure that obtain maximum relief available under the VDP and to avoid serious criminal liability for tax evasion.


If I traded an NFT for cryptocurrency or another NFT and not fiat currency, is that trade still taxable?

Under the Canadian tax system, a disposition of property will be taxable regardless of whether that property is sold or exchanged for another asset. Thus, whenever an NFT is sold for fiat currency or traded for another asset like cryptocurrencies or NFTs, the Canadian tax system recognizes that sale or trade as a taxable event, and the gains or losses on that disposition are computed for tax purposes.

When might an NFT be viewed as inventory versus capital property for Canadian tax purposes?

Only two major categories of property are recognized by the Canadian Income Tax Act for income tax purposes: (1) capital property, the disposal of which results in a capital gain or loss; and (2) inventory, which is taken into account while calculating business income. While the taxpayer’s intent when disposing of an NFT is the most important factor in characterizing the income received, the following factors will also be considered: (1) transaction frequency involving NFTs; (2) duration of ownership; (3) the taxpayer’s understanding of NFT and digital asset marketplaces; (4) the relationship between NFTs and the taxpayer’s other employment; (5) the time invested in NFT trading by the taxpayer; (6) the taxpayer’s financial support to trade NFTs; and (7) whether the taxpayer advertises an NFT trading business in some sense.

What powers does the CRA have to compel a taxpayer to provide documents or information as part of a tax audit?

The CRA has extensive powers to compel production of documents and evidence. Under subsection 231.2, the CRA can compel any person, including third parties who are not a taxpayer under audit, to provide documents and records as part of a tax audit. This can include digital asset marketplaces like cryptocurrency and NFT exchanges where the CRA has the jurisdiction to compel that document production. 

Do the CRA’s powers to investigate and audit a taxpayer violate constitutional and common law rights?

The CRA’s extensive powers to investigate a taxpayer’s affairs do not necessarily violate a taxpayer’s constitutional and common law rights. So long as the CRA exercises its investigative powers as part of a civil audit, the CRA’s ability to compel production of documents and to interview individuals will not violate section 7 or section 8 of the Canadian Charter, or the individual’s right to remain silent. Where the predominant purpose of CRA’s investigation becomes criminal or quasi-criminal, Charter and common law rights may apply.


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 Canadian tax lawyer. 

Free Crypto Tax Advice

Need Assistance with Crypto Taxes?

Fill out the form and we'll be in touch.