Cryptocurrency in The Know: The Regulations and Tax Effects of Crypto Assets Seizure

Global Challenges, Regulations, and the Tax Implications Associated with the Seizure of Crypto Assets: An Introduction to Cryptocurrency

A maker of electric vehicles Tesla Inc. said in May 2021 that it would no longer accept Bitcoin as payment. Tesla's statement reportedly caused cryptocurrency values to drop, according to CBC. China made its intention to prohibit all financial institutions and payment providers from offering services linked to cryptocurrency transactions to the public in June 2021. According to CBC, the price decrease in cryptocurrencies was made worse by China's announcement to "crack down on cryptocurrencies." Additionally, the Bank of Canada hinted at the possibility of launching a challenge "declaring that crypto works against the public good," according to CBC. Furthermore, the continued downturn in the cryptocurrency market has caused some investors to "lose more than half their investments," based on CBC reports, while many investors are concerned about perhaps losing all of their digital investments.

A "nearly $1 billion US wipe off of the market capitalization in the crypto sector" followed Tesla Inc.'s announcement, according to CBC. Furthermore, the Tesla Inc. statement significantly contributed to the cryptocurrency market's 54% collapse "from a record high of $64,895 on April 14"—the first monthly decline since November 2018—and as of October 2022  plunged into a 70% decline. Additionally, as per CBC, Tesla's decision to cease taking Bitcoin as payment was what first caused the decrease in Bitcoin, which was worsened by China's pronouncement. According to CBC, Bitcoin had dropped more than 50% by mid-May 2021, and  "it hit a three-and-a-half month low of $30,066," the lowest since January 2021. Since then there have been more significant market declines paralleling the drop in the stock market and the increase in interest rates as a result of the global recession.

According to CBC, Bitcoin suffered a peak loss of more than 50% in May 2021 while already being put under pressure by Tesla and China's pronouncements. Dogecoin and other cryptocurrencies had even greater losses "in percentage terms," but according to CBC, the loss was greater for investors who "bought at margin." Buying on margin is a "process where investors borrow from their broker to invest but are required by lenders to pay back a part of what they owe if the value of their stake falls below a certain level," as defined by CBC. Some investors who purchased on margin "are forced to sell into a falling market," according to CBC, unless they have extra money to repay their loan amount when it is demanded. According to CNBC Business News, margin calls have increased "volatility in the unregulated global crypto market," where some investors are borrowing from their broker "at ratios of 100 to 1," according to CBC. To buy their investments, investors can borrow $100 for every $1 they have on hand. Margin traders run the danger of losing all of their money even though this type of leveraged trading can be profitable while markets are rising. While Canadian brokerages can not provide these kinds of margins, according to CBC, "in a global market everyone suffers the consequences,"

According to CBC, El Salvador, which uses the US dollar as its unit of exchange, became the first nation to formally recognize cryptocurrencies as "legal tender" in June 2021. Nayib Bukele, the president of El Salvador, stated that the "government will guarantee the convertibility to the exact value in dollars at the moment of the transaction," as explained by CBC. According to CBC, some Salvadorians who just negotiated their pay in Bitcoin may now regret their choice given the cryptocurrency's ongoing drop.

In addition, the Bank for International Settlements (BIS) published a report in June 2021 titled "Central Bank Digital Currencies: An Opportunity for Monetary System" (the "BIS Report") that clarified the cryptocurrency market's ongoing difficulties. The BIS Report indicates that central banks "will begin to issue their own digital coins," and they might even take steps to prevent the usage of cryptocurrencies, according to CBC. The conclusion of the BIS Report argues that "innovations such as cryptocurrencies, stablecoins, and the walled garden ecosystems of big techs all tend to work against the public good elements that underpin the payment system," which is what CBC cited.

In commemoration of Israel's new President Isaac Herzog's inauguration, The Jerusalem Post reported that the Knesset, the country's legislature, joined the global trend of "creating NFT - a non-fungible token." NFTs are simply digital assets that represent things (such as music, art, and films) that can be purchased and sold online. They are frequently encoded using the same software as cryptocurrencies, according to Forbes Media. According to The Jerusalem Post, some NFTs are growing in popularity across the globe, with an "NFT of the original World Wide Web code recently sold for $5.4 million". The Jerusalem Post states that although the Knesset is the "first parliament in the world to create an NFT," the NFT's continued success on a global scale may encourage other governments to join the trend. For example, the "artist Mike Winkelmann recently sold an NFT for a record price of $69.3 million", according to The Jerusalem Post. Government officials' growing interest in NFTs and cryptocurrencies is reflected in the Knesset.

In an announced internal digital trial, the "Bank of Israel is testing Ethereum tech," according to a May 2021 Bloomberg story. Based on a statement from Israel's central bank, the country's digital payment system has the ability to boost economic growth by "simplifying payment processes while providing security to both parties in a transaction," according to Bloomberg. Some think, according to Coindesk, that digital currencies issued by the central bank will build "efficient and inexpensive infrastructure for cross-border payments." Coindesk further reports that the European Central Bank and Sweden's Riksbank are two of the financial institutions that are "actively researching and developing their own digital currencies in preparation for expected launches" over the course of the following five years. The US Federal Reserve, on the other hand, is taking a "more cautious approach" to the introduction of its own digital currencies, according to Coindesk.

CBC highlights some of the advantages of digital currency produced by central banks despite the continued difficulties facing the cryptocurrency industry. According to CBC, the value of digital currency issued by central banks "are known," as opposed to cryptocurrencies, which may "rise and fall unpredictably." Furthermore, according to CBC, central bank-issued digital money "can be spent anywhere as a legal tender," unlike stablecoins. Stablecoins are characterized by CNBC as "cryptocurrencies pegged to an underlying asset." Moreover, the BIS Report and the CBC seem to imply that digital coins issued by central banks may offer many of the benefits of cryptocurrencies "without the disadvantages." For instance, according to CBC, central banks' digital currency not only "eliminates the role of an intermediary" in the transfer of money between investors but it also "protect privacy while maintaining the integrity of the payment system and law enforcement." As explained further by CBC, long-time cryptocurrency owners are likely to disagree with the advantages of central banks producing digital currency. CBC claims that, in contrast to cryptocurrencies, payments conducted with digital currency issued by central banks may be able to be tracked by governmental authorities for a variety of purposes, including but not limited to taxation and law enforcement.

In connection with that, according to Block Crypto Inc., on July 7, 2021, Israel's Minister of Defense approved an order authorizing the seizure of cryptocurrency wallets thought to be linked to Hamas agents. The cryptocurrency wallets include a list of "84 addresses for Bitcoin, Tether, Ether, and Dogecoin, among others," according to Block Crypto Inc. The National Bureau for Counter Terror Financing "attributes most of these wallets to seven Palestinian nationals it associates with Hamas," according to Block Crypto Inc., although some of the crypto wallets "remain anonymous." Explaining further, Hamas is an Islamic terrorist organization that rules over the Gaza Strip. The "European Union, the United States, and Israel have all designated Hamas or its affiliates as terrorist organizations", as claimed by Block Crypto Inc. Israel's Minister of Defense allegedly stated in a press release that "any individual who claims ownership of any or all of The Property [the 84 crypto addresses] may make their claims and submit them in writing to the Head of the National Bureau for Counter Terror Financing." Furthermore, Block Crypto Inc. adds that "this is not the first time that Hamas has been identified as using crypto to gather donations".  For instance, according to Block Crypto Inc., an Israeli non-profit organization tried to stop Hamas from using Coinbase in 2019, and the US Departments of Defense and Justice revealed a "massive seizure operation that hit cryptocurrency wallets owned by Hamas, Al-Qaeda, and ISIS" in 2020.

Early in June 2021, CBC shared an incident where the US government officials were able to retrieve the "majority of a multimillion-dollar ransom payment" in the Colonial Pipeline hack. This ransom recovery was the first seizure carried out by a "specialized ransomware task force created by the Biden administration's Justice Department," according to CBC. This reflects the more aggressive strategies being used by federal agencies to combat "the growing and increasingly destructive ransomware attacks" that are affecting a variety of global industries, including but not limited to the crypto market, according to CNN.

In addition, the IFC reports that Kazakhstan has adopted a new tax law that began taxing cryptocurrency mining on January 1, 2022. Businesses are protesting the taxation of cryptocurrency mining, despite the fact that the new law is "expected to generate billions in the national currency," according to IFC. Many businesses, as per IFC, are against the new tax law and are worried about how it would affect the development of the crypto-mining industry in Kazakhstan. Activities related to cryptocurrency mining are subject to taxation under standard Canadian tax law regulations. The process of reporting crypto profits and assessing whether your cryptocurrency mining operations qualify as a business or a hobby for Canadian income tax purposes are complex tax law issues. With regard to bitcoin mining, our leading Canadian crypto tax lawyers may assist you in identifying your Canadian obligations and tax planning opportunities. 

According to the IFC reports, governments around the world are concentrating on "the regulation of the cryptocurrency market," as seen in the case of China, which has banned the cryptocurrency market and forced its banks to stop processing cryptocurrency transactions. The IFC added that while Canada sent notices to "several exchanges [Poloniex and KuCoin] for failing to comply with regulations in a timely manner," South Korea carefully crafted a comprehensive set of guidelines for exchanges inside the cryptocurrency sector. Canadian authorities have tightened laws in response to worries about the energy impact of bitcoin, but miners are preparing to leave the country in search of alternative power sources, according to Coindesk. Additionally, due to Canada's new securities legislation, Bitmex and Binance are among the cryptocurrency exchanges that have left the country. It's critical to be aware that there can be tax repercussions if switching cryptocurrency exchanges necessitates converting any coins into fiat or other coins or other currencies. For instance, the sale of cryptocurrencies will result in a taxable event that must be reported in accordance with the Income Tax Act of Canada, which may result in a capital gain or business income. Governmental authorities are growing more eager to keep control over their currencies, even though it is unclear whether stronger limitations and the regulation of the cryptocurrency market and the cryptocurrency mining business would be effective, according to IFC.

Cryptocurrency-Related Concerns: Global Issues, Regulations, and the Tax Consequences of Seizing Crypto Assets

The market for cryptocurrencies is fraught with serious issues and difficulties, including specific crypto tax issues. In particular, it was previously mentioned that Tesla reversed its decision to accept Bitcoin payments, China announced its decision to prohibit all financial institutions and payment service providers from offering services related to cryptocurrency transactions, and central banks, like The Bank of Israel, are issuing their own digital coins while discouraging the use of cryptocurrencies. While many traders and investors are concerned about perhaps losing their digital investments, others have already lost a sizable percentage of their digital investments. Due to margin calls, some cryptocurrency traders are compelled to liquidate their holdings in a down-turning cryptocurrency market. In addition, as was previously discussed, the Federal Reserve and other central banks are expressing that they may "take action to discourage crypto's use".  Nevertheless, it is not obvious how efficient or effective central banks, like Bank of Canada, will be in restricting the usage of cryptocurrencies even if they take action. It is also unclear whether the value of digital currency issued by central banks will perhaps increase volatility in other markets or even its own market, notwithstanding the unpredictable character of the cryptocurrency market. It's crucial to understand that, regardless of whether they are made in response to market fluctuations, any adjustments to cryptocurrency holdings, including moves from coin to coin, have Canadian tax implications.

Some governments appear to be concentrating their efforts on the regulation of different aspects of cryptocurrencies. For instance, China has outlawed all cryptocurrency-related activities, Israel has ordered the seizure of a list of cryptocurrency wallets, and Kazakhstan is planning to tax cryptocurrency mining. However, it is not obvious whether tighter controls over the cryptocurrency market, including taxes on crypto mining, will give governments control over their currencies.

In addition, as was already stated, Israel's Minister of Defense authorized the seizure of cryptocurrency wallets believed to belong to Hamas agents. The "majority of the $4.4 million cryptocurrency ransom payment in the Colonial Pipeline hack" was also recently reported by USA Today as having been retrieved by US government officials. The domestic authority granted to governmental agencies in the context of cryptocurrency transactions and the cryptocurrency market is clarified by these examples. While certain political authorities are getting keener to keep control of their currency, others have the power and motivation to grab cryptocurrency when they see fit.

Our expert Canadian tax crypto lawyers can provide advice on the significant Canadian tax implications of governmental authorities seizing cryptocurrencies. To find taxpayers who are evading taxes, promote tax compliance, and collect taxes on unreported income, governmental authorities may try to seize bitcoin wallets and data about cryptocurrency transactions. Additionally, authorities may be able to track down and look into other cryptocurrency wallets and their owners using the confiscated coins. It's crucial to understand that the seizure of cryptocurrency assets has tax repercussions as well. For instance, seized cryptocurrency can offer governmental authorities guidance on how to establish and put into effect tougher rules governing the taxation of cryptocurrencies. Also, the seizure of cryptocurrencies may enable traders and holders of cryptocurrencies to escape paying taxes by avoiding countries that are enforcing restrictive legislation. A seizure of cryptocurrency assets is regarded as a disposition for crypto tax purposes in Canada, and as such, under the Income Tax Act of Canada, such a taxable event must be reported on the income tax returns of the cryptocurrency holder, potentially leading to capital or income gain or, more likely in the current market, a loss.

Canada’s Taxation of Cryptocurrency

Any income from cryptocurrency transactions is classified as business income or capital gain under Canada's Income Tax Act. Furthermore, losses involving crypto transactions are classified as business or capital losses. For income tax purposes, taxpayers must determine whether a cryptocurrency transaction generates income or capital. Speak to one of our knowledgeable Canadian crypto tax lawyers for an analysis of the Canadian tax treatment of your cryptocurrency transactions. For income tax reasons, when cryptocurrency is used to acquire goods and services, the Canada Revenue Agency will classify the transaction as a "barter transaction." A "barter transaction" happens when goods or services are transferred without the use of legal currency. However, using cryptocurrency to purchase goods or services may be regarded as a disposition for income tax purposes, resulting in a gain or loss.

Furthermore, a taxable property or service when exchanged for cryptocurrency, it is the crypto fair market value at the time of exchange the computation of GST/HST applicable to such property or services shall apply.

Tax Pro Tips - Cryptocurrency Tax Implications

Tax or other legislation dealing specifically with NFT’s or cryptocurrencies or bitcoin transactions has not yet been passed in Canada. Similarly, a tax dispute involving NFT’s or cryptocurrencies or bitcoin transactions has not yet been resolved by Canadian courts.

Contact one of our top Canadian crypto tax lawyers for tax advice if you have any queries about the taxation of cryptocurrencies or cryptocurrency transactions, or about the potential tax consequences of governmental authorities seizing cryptocurrencies. Our Canadian crypto tax lawyer who is a Certified Specialist in Taxation has extensive experience in handling Canadian cryptocurrency taxation.

You may be eligible for relief under the CRA's voluntary-disclosures program (VDP) if you or your company has unreported earnings from cryptocurrency transactions, or income that was incorrectly reported as capital gains rather than business income. Voluntary disclosures, commonly referred to as tax amnesty, are a difficult area of the law that necessitates in-depth research and guidance from a competent Canadian crypto tax lawyer. For proper tax advice on a potential crypto voluntary disclosure application, think about getting in touch with our Canadian crypto tax lawyer who is a certified specialist in taxation.

To create a tax system that is responsive and equitable for all Canadians, the Voluntary Disclosures Program's goal is to prevent "tax evasion and aggressive tax avoidance." Under Canada's Voluntary Disclosures Program, taxpayers, including corporations, have the option to voluntarily (1) rectify inaccurate or incomplete information, and/or (2) disclose to the CRA information that was not previously reported. This program encourages adherence to the law. Under Canada's Voluntary Disclosures Program, taxpayers who have unreported income may qualify for reduced penalties and partial interest relief. A Voluntary Disclosures Program application that is eligible must:

• Be done on a “voluntary” basis
• Be a “complete” application
• Include the payment of the estimated taxes. A taxpayer may request consideration for a "payment arrangement" if they are unable to make such a payment at the time of application;
• Include details on income taxes that are at least one year overdue;
• Include information about GST/HST for at least one past-due reporting period.

The taxpayer must submit a complete application to the program and fulfill the VDP’s above-mentioned standards in order to be eligible for the relief under the Voluntary Disclosures Program. Please contact our tax law office to receive tax advice from one of our top Canadian crypto tax lawyers if you have unreported income or if you would like personalized crypto tax planning to lower your cryptocurrency tax burden.

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 articles. If you have specific legal questions, you should seek the advice of a Canadian tax lawyer."