CASE STUDY: Canadian Crypto-Tax Lawyer Saves Cryptocurrency Investor from Criminal Prosecution for Tax Evasion by CRA

Brief Situation Overview

A Canadian individual who worked as a computer analyst developed an interest in Bitcoin (BTC) and other cryptocurrencies very early in their development. This individual initially purchased over 200 BTC in 2011, when BTC was trading at around $4.00 per coin. In 2016, 2017, and 2018, this individual branched out and bought other cryptocurrencies, including Ethereum (ETH) and Ethereum Classic (ETC).

By the time this taxpayer approached our knowledgeable Canadian crypto-tax lawyers for crypto-tax advice, the taxpayer had amassed a cryptocurrency portfolio worth hundreds of thousands of dollars—all of which was entirely unreported to the Canada Revenue Agency (CRA).

The taxpayer's failure to report hundreds of thousands of dollars in crypto income and crypto assets to the Canada Revenue Agency exposed the taxpayer to both civil tax liability, in the form of gross-negligence penalties, and criminal prosecution for tax evasion.

The Approach & Solution

This taxpayer retained the expert Canadian crypto-tax lawyers at Rotfleisch & Samulovitch PC to remedy the taxpayer's non-compliance and mitigate or eliminate the taxpayer's exposure to civil tax liability and criminal tax prosecution.

To remedy our client's tax-compliance problems, our experienced Canadian crypto-tax lawyers sought to file a voluntary disclosure application under the Canada Revenue Agency's Voluntary Disclosures Program (VDP). The VDP permits qualifying taxpayers to avoid criminal tax charges and sidestep civil tax penalties.

Problems & Challenges

The first challenge was that our client's VDP application needed to satisfy the VDP's "completeness" condition.

The CRA's Voluntary Disclosures Program requires a taxpayer's VDP application to be "complete," which means that the application must disclose all previous instances of taxpayer non-compliance and include "all CRA returns, forms, and schedules needed to correct the non-compliance."

This requirement meant that, before we could even start preparing our client's VDP application, our Canadian crypto-tax lawyers needed to thoroughly analyze our client's cryptocurrency transactions, identify their Canadian tax-law implications, and determine the appropriate scope and filing position of our client's VDP application.

The second challenge was that our client's VDP application was time-sensitive. The CRA will reject a VDP application unless the taxpayer's VDP application is "voluntary," which means that the CRA received the taxpayer's VDP application before the Canada Revenue Agency's tax auditors or criminal investigators discovered the non-compliance that the taxpayer sought to disclose.

As a result, our veteran Canadian crypto-tax lawyers had to analyze years of our client's crypto transactions and tax filings for past years, prepare our client's VDP application, and file it with the CRA's Voluntary Disclosures Program as quickly as possible.

Moreover, our client's circumstances gave rise to several complex Canadian crypto-tax issues.

For example, we needed to determine whether our client's cryptocurrency should be characterized as (i) trading inventory, which gives rise to business income (or business losses) when sold, or as (ii) capital property, which gives rise to a capital gain (or capital loss) when sold.

The income/capital distinction determines the extent to which the resulting gain is included in taxable income. Business income is fully taxable, while only a portion of a capital gain is taxable. In particular, for the first $250,000, only one-half of the capital gain is taxable, and for any amount over $250,000, two-thirds of the capital gain is taxable.

Our client's immense crypto portfolio also required our Certified Specialist in Taxation Canadian crypto-tax lawyer to determine whether the crypto portfolio met the Canadian Income Tax Act's definition of "specified foreign property." If so, then our client had an obligation to file T1135 forms, meaning that our client's VDP application would need to include T1135 forms. If our client's VDP application mistakenly omitted these forms, we risked invalidating our client's entire voluntary disclosure application and exposing our client to civil tax penalties and criminal tax prosecution.

For more information about the income/capital distinction and about T1135 forms for cryptocurrency holdings, read our article "The T1135 Foreign-Reporting Exemption & Canadian Cryptocurrency-Trading Businesses & Canadian NFT-Trading Business: Are Canadian Cryptocurrency and NFT Traders Required to File a T1135 Form?"

Results

In spite of facing several complicated crypto-tax issues, our top Canadian crypto-tax lawyers expertly and swiftly analyzed our client's cryptocurrency transactions, provided a tax-law opinion about the Canadian tax implications, and promptly prepared and filed a VDP application on our client's behalf.

Moreover, the Canada Revenue Agency's Voluntary Disclosures Program accepted our client's VDP application under the VDP's General Program, which meant that our client had received the maximum relief available under the VDP. Our prudent Canadian crypto-tax lawyers had therefore saved our client from massive civil tax penalties and looming criminal tax prosecution.  

Lessons Learned

Our client's tax problems partly stemmed from the Canada Revenue Agency's failure to give the general public clear information about cryptocurrency transactions and the resulting Canadian tax implications.

Even as of the date of this article, the CRA's publications on cryptocurrency transactions provide superficial guidance and don't alert Canadian taxpayers to the various, complex tax issues that their cryptocurrency portfolios may invoke.

That said, Canadian taxpayers also need to understand that they cannot depend upon the CRA for advice or information about reporting their cryptocurrency transactions. The Canada Revenue Agency's sole task is to enforce Canada's tax laws.

The CRA cannot give Canadian taxpayers a legal opinion or provide them with legal advice. This is especially true when it comes to the Canadian tax consequences of emerging technology, such as blockchain-based assets, or novel commercial transactions, such as smart contracts and other DeFi arrangements.

And even when the CRA does release a publication explaining the CRA's view of certain cryptocurrency transactions, the Canada Revenue Agency is not in any way bound by that publication.

The doctrine of estoppel does not preclude the CRA from issuing a tax assessment or tax reassessment that is inconsistent with a previously released CRA publication (e.g., see: Stickel v MNR, [1973] CTC 202, 73 DTC 5178 (FCA); aff'd. [1974] CTC 416, 74 DTC 6268 (SCC)).

In other words, if the CRA decides to audit the cryptocurrency transactions that you reported in your income tax return, the tax auditor can ignore the CRA's own previously released guidelines and reassess you contrary to those guidelines—even if you relied on that CRA publication when preparing your tax return.

As a result, Canadian taxpayers who trade, invest in, mine, or stake cryptocurrency, non-fungible tokens (NFTs), or other DeFi and blockchain-based assets should seek tax law advice from an expert Canadian crypto-tax lawyer.

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.