Cryptocurrency Regulatory and Tax Problems when the Government Seizes Your Crypto Assets
Published: August 2, 2023
Navigating the Cryptocurrency Landscape: Global Challenges, Regulatory Frameworks, and Tax Implications in Crypto Asset Seizures
In May 2021, Tesla Inc., the electric car manufacturer, made a significant announcement declaring that it would no longer accept Bitcoin as a form of payment. This decision, as reported by CBC, had a profound impact on the cryptocurrency market, leading to a decline in cryptocurrency prices. Subsequently, in June 2021, China took a decisive step by announcing a complete ban on all financial institutions and payment companies from engaging in any cryptocurrency-related transactions. This move, as highlighted by CBC, intensified the downward trend in cryptocurrency prices, with China's commitment to "crack down on cryptocurrencies" adding to the market uncertainty. Furthermore, as per CBC's reports, the Bank of Canada suggested the possibility of initiating a challenge, "declaring that crypto works against the public good". Additionally, the same source mentioned that while numerous investors are concerned about the prospect of losing their digital investments, some have already "lost more than half their investments" due to the continuous decline in the Canadian cryptocurrency market.
As reported by CBC, Tesla Inc.'s announcement had a profound impact on the crypto sector, resulting in a “nearly $1 billion US wipe-off of the market capitalization in the crypto sector”. The news played a significant role in the cryptocurrency market's decline of 54% “from a record high of $64,895 on April 14”. This marked the first monthly drop since November 2018. Furthermore, as per CBC's reports, China's announcement further aggravated the decline in Bitcoin, which was initially triggered by Tesla's decision to cease accepting it as payment. By mid-May, Bitcoin experienced a significant drop of over 50%, reaching “a three-and-a-half month low of $30,066”, the lowest point since January 2021. According to CNBC, towards the end of June, Bitcoin hit a monthly low of $28,908. Moreover, CBC highlights that Bitcoin's downward trajectory had a negative impact on other crypto assets, including ether (a coin limited to the Ethereum blockchain network) which recently experienced a decline, reaching its weakest level since late January 2021.
As per CBC's findings, Bitcoin, already facing pressure due to Tesla and China's announcements, suffered a significant loss, exceeding 50% at its peak. Other cryptocurrencies, like Dogecoin, experienced an even greater loss “in percentage terms”. However, CBC clarifies that the impact was more substantial for investors who “bought at margin”. Buying at margin entails investors borrowing from their broker to invest, but lenders require them to repay part of the owed amount if the stake's value falls below a certain level. Consequently, some investors who bought at margin “are forced to sell into a falling market” unless they had surplus funds to cover their loan upon demand for repayment. CBC referenced CNBC's business news service, which highlighted that margin calls have intensified “volatility in the unregulated global crypto market”. In this market, some investors borrow from their brokers “at ratios as of 100 to 1”, meaning they borrow $100 for every $1 of their own money to make investments. While this leverage investment strategy can potentially yield substantial profits when markets are rising, margin traders run the risk of losing all of their investments in a declining market. CBC underlined that Canadian brokerages do not offer these types of margins; however, “in a global market everyone suffers the consequences”.
In June 2021, as reported by CBC, El Salvador, a country that utilizes the US dollar as its official currency, made history by becoming the first nation to officially recognize cryptocurrency as "legal tender." The President of El Salvador, Nayib Bukele, announced that the government would ensure the convertibility of cryptocurrency to its exact value in dollars at the time of the transaction. In this context, CBC further explains that some Salvadorians who recently opted to negotiate their salaries in Bitcoin may now be regretting their decision due to the recent decline in Bitcoin's value.
Additionally, in June 2021, the Bank for International Settlements (BIS) released its report titled "Central Bank Digital Currencies: An Opportunity for the Monetary System" (referred to as the "BIS Report"). This report shed light on the persistent challenges faced by the cryptocurrency market. As per CBC, the BIS Report emphasizes that central banks “will begin to issue their own digital coins” and may even take measures to discourage the use of cryptocurrencies. The conclusion of the BIS Report, highlighted by CBC, asserts that “innovations like cryptocurrencies, stablecoins, and the walled garden ecosystems of big techs all tend to work against the public good elements that underpins the payment system”.
As per reports by The Jerusalem Post, the Knesset, which serves as Israel's legislature, has embraced the worldwide trend of "creating NFT - a non-fungible token" in celebration of the inauguration of Israel's President, Isaac Herzog. Simply put, as described by Forbes Media, NFTs are digital assets representing various objects, such as music, art, and videos, which can be bought and sold online. These assets are often encoded using the same blockchain software as cryptocurrency. The Jerusalem Post further elaborates that certain NFTs have gained significant popularity on a global scale, with an “NFT of the original World Wide Web code recently being sold for $5.4 million”. By becoming the "first parliament in the world to create an NFT," the Knesset's initiative might inspire others to follow suit and participate in the trend of "creating NFTs." For instance, the report cites “artist Mike Winkelmann recently sold an NFT for a record price of $69.3 million”. This move by the Knesset underscores how government officials are increasingly engaging with NFTs and cryptocurrency.
In May, Bloomberg reported that the "Bank of Israel is testing Ethereum tech" as part of an internal digital trial recently launched. The country's central bank stated that its digital payment system has the potential to positively impact the national economy by "simplifying payment processes while providing security to both parties in a transaction," as revealed by Bloomberg. According to Coindesk, some experts believe that central bank digital currencies could establish an "efficient and inexpensive infrastructure for cross-border payments." In addition to Israel's efforts, Coindesk's reports indicate that other banks, such as Sweden's Riksbank and the European Central Bank, are “actively researching and developing their own digital currencies in preparation for expected launches” in the next five years. On the other hand, Coindesk highlights that the US Federal Reserve is taking a "more cautious approach" when it comes to launching its own digital currencies.
Despite the persistent challenges faced by the cryptocurrency market, CBC sheds light on the advantages associated with digital money issued by central banks. CBC explains that unlike cryptocurrencies, which may experience unpredictable fluctuations, the value of digital money issued by central banks is stable and known. Additionally, CBC points out that unlike stablecoins, which are tied to an underlying asset, digital money from central banks holds legal tender status and can be used for transactions anywhere. Both CBC and the BIS Report suggest that digital coins issued by central banks might offer numerous benefits akin to cryptocurrency "without the disadvantages." For instance, according to CBC, central bank digital currencies eliminate the need for intermediaries in money transfers while simultaneously safeguarding privacy and upholding the integrity of the payment system and law enforcement. However, CBC also notes that long-time cryptocurrency holders may hold differing opinions on the benefits associated with central banks issuing digital money. According to CBC, unlike cryptocurrencies, transactions and payments made with digital money from central banks could potentially be traceable by government authorities for various reasons, including law enforcement and taxation.
A number of central banks have indicated their interest in a central bank digital currency (CBDC).
In 2023 the Bank of Canada announced that it was exploring the possibility of issuing a digital version of the Canadian dollar. The Bank of Canada clarified that it was not intending to issue a crypto Canadian dollar in the near future what was exploring the options in case it decided to do so down the road.
According to Block Crypto Inc., on July 7, 2021, Israel's Minister of Defense issued a seizure order for crypto wallets believed to be linked to Hamas operatives. The crypto wallets consist of a list of "84 addresses for Bitcoin, Tether, Ether, and Dogecoin, among others." As per Block Crypto Inc., the National Bureau for Counter Terror Financing, “attributes most of these wallets to seven Palestinian nationals it associates with Hamas”, although some “remain anonymous”. Block Crypto Inc. explains that Hamas is a terrorist Islamic group controlling the Gaza Strip and has been designated as a terrorist organization by the European Union, United States, and Israel. The Minister of Defense of Israel stated that “any individual who claims ownership of any or all of the Property [specifically, the 84 crypto addresses] may present their claims and submit them in writing to the Head of the National Bureau for Counter Terror Financing”. Moreover, Block Crypto Inc. highlights that “this is not the first time that Hamas has been identified as using crypto to gather donations”. In 2019, as reported by Block Crypto Inc., an Israeli not-for-profit organization attempted to cease Hamas' use of Coinbase, and in 2020, the US Department of Defense and Department of Justice revealed a "massive seizure operation that hit cryptocurrency wallets owned by Hamas, Al-Qaeda, and ISIS."
In early June 2021, CBC reported that US government officials successfully recovered the "majority of a multimillion-dollar ransom payment" related to the Colonial Pipeline hack. This significant ransom recovery was achieved through the efforts of a "specialized ransomware task force created by the Biden administration's Justice Department," as per CBC's findings. This development highlights the increasingly assertive approaches being adopted by government authorities to address the escalating and highly damaging ransomware attacks affecting various industries worldwide, including the crypto market, as reported by CNN.
Moreover, as reported by IFC, Kazakhstan has recently enacted a new taxation law to levy taxes on cryptocurrency mining starting from January 1, 2022. IFC clarifies that while the new law is projected to yield significant revenue in the national currency, numerous businesses are expressing their dissent against taxing cryptocurrency mining. According to IFC, these businesses are apprehensive about the potential repercussions of the taxation law on the future of the mining industry in Kazakhstan. It is worth noting that cryptocurrency mining activities in Canada are also subject to taxation under the regular tax law rules. However, the determination of whether these mining activities qualify as a business or a hobby for Canadian income tax purposes, along with the appropriate method for reporting profits, entails navigating complex tax law considerations. Our team of top Canadian crypto tax lawyers is equipped to assist in identifying your Canadian obligations and exploring tax planning opportunities concerning cryptocurrency mining.
The IFC report sheds light on how governmental authorities worldwide are currently focusing on "the regulation of the cryptocurrency market." For example, China has taken a strict stance by banning the cryptocurrency market and ordering banks to cease facilitating cryptocurrency transactions. On the other hand, South Korea has adopted a comprehensive set of rules specifically tailored to exchanges within the crypto market. In Canada, several exchanges, including Poloniex and KuCoin, have received notices for failing to comply with regulations within the stipulated time. However, the tightening of regulations in Canada, driven by concerns over bitcoin's energy impact, has prompted some cryptocurrency miners to consider relocating to other power sources, as reported by Coindesk. Consequently, cryptocurrency exchanges such as Bitmex and Binance are opting to leave Canada due to the country's new securities regulations. It is essential to be mindful of potential tax implications arising from the departure of cryptocurrency exchanges, especially if conversions of coins into other cryptocurrencies or fiat currencies are necessary for transfers to other exchanges. Such dispositions of cryptocurrency can trigger taxable events, requiring reporting in accordance with Canada's Income Tax Act, potentially leading to capital gains or business income. While the effectiveness of stricter restrictions and regulations on the cryptocurrency market and mining industry remains uncertain, IFC highlights that governmental authorities are increasingly determined to maintain control over their currencies.
Cryptocurrency Concerns: Global Challenges, Regulations, and Tax Implications of Seizing Crypto Assets
There are significant concerns and challenges associated with the cryptocurrency market, particularly related to specific cryptocurrency tax implications. As mentioned previously, notable events such as Tesla's reversal of accepting Bitcoin payments and China's ban on financial institutions and payment companies providing cryptocurrency services have raised apprehensions. Additionally, central banks, like the Bank of Canada and The Bank of Israel, are considering issuing their own digital coins while discouraging the use of cryptocurrencies. Investors and traders in the crypto market are experiencing worries about potential losses, with some already facing significant declines in their digital investments. The impact of margin calls is forcing certain cryptocurrency traders to sell their investments amidst the market downturn. Moreover, as previously mentioned, the Bank of Canada and other central banks are hinting at possible actions to discourage cryptocurrency usage. However, the efficiency and effectiveness of such measures remain uncertain. Even if central banks and the US Federal Reserve take action to discourage cryptocurrency use, the true extent of their impact is yet to be determined. Additionally, the volatile nature of the cryptocurrency market raises questions about whether digital money issued by central banks could exacerbate volatility in other markets or within its own domain. It is crucial to acknowledge that any changes in crypto holdings, including coin-to-coin conversions driven by market changes, have tax implications. Regardless of the motive, these transactions may incur tax obligations that must be addressed.
Several governments worldwide are directing their focus towards regulating different aspects of cryptocurrency. For instance, Kazakhstan is preparing to impose taxes on cryptocurrency mining, Israel has issued orders for the seizure of specific crypto wallets, and China is implementing a complete ban on all cryptocurrency-related activities. Nevertheless, the impact of stricter restrictions and regulations on the cryptocurrency market and the taxation of cryptocurrency mining remains uncertain in terms of providing governmental authorities with control over their currencies.
Furthermore, as mentioned earlier, Israel's Minister of Defense signed a seizure order for crypto wallets believed to be linked to Hamas operatives. Similarly, USA Today recently reported that US government officials managed to recover the "majority of a $4.4 million cryptocurrency ransom payment in the Colonial Pipeline hack." These instances highlight the domestic powers wielded by governmental authorities in dealing with cryptocurrency transactions and the crypto market. As the landscape evolves, certain governmental authorities are intensifying their efforts to retain control over their currencies, while others have demonstrated the capability and willingness to seize cryptocurrency when they consider it essential or fitting.
Notably, Canadian tax implications arise when governmental authorities confiscate cryptocurrencies, and our experienced Canadian crypto tax lawyers can provide valuable guidance on this matter. Governments may seize cryptocurrency wallets and transaction information to uncover tax evasion, promote compliance with Canada's tax system, and collect taxes on unreported income. Additionally, confiscated cryptocurrencies can be used by government officials to track and investigate other crypto wallets and their holders. It is vital to recognize that the seizure of cryptocurrency assets also carries tax implications. For instance, such seizures may inform governmental authorities in enacting and implementing stricter regulations regarding cryptocurrency taxation. Furthermore, the confiscation of cryptocurrency might lead holders and traders to consider avoiding countries with restrictive regulations to evade tax obligations. From a Canadian tax perspective, the seizure of cryptocurrency assets is considered a disposition, and as per Canada's Income Tax Act, the resulting taxable event must be reported on the crypto holder's income tax returns. This reporting could potentially result in a capital or income gain, or more likely, a loss.
Cryptocurrency Taxation in Canada
Under Canada's Income Tax Act, income generated from cryptocurrency transactions can be categorized as either business income or capital gain. Similarly, losses incurred in cryptocurrency transactions are classified as either business losses or capital losses. Taxpayers are required to determine whether a cryptocurrency transaction falls under income or capital for income tax purposes. When cryptocurrency is utilized to purchase goods and services, the Canada Revenue Agency considers the transaction as a "barter transaction" for income tax purposes. A "barter transaction" occurs when goods or services are exchanged without the use of legal currency. However, using cryptocurrency to acquire goods or services is treated as a disposition for income tax purposes, resulting in a gain or loss.
Additionally, in cases where a taxable property or service is traded for cryptocurrency, the GST/HST that applies to the property or services is determined based on the fair market value of the cryptocurrency at the time of the exchange.
Tax Pro Tips - Cryptocurrency Tax Implications
As of now, Canada has not introduced any specific legislation, whether tax-related or otherwise, explicitly addressing cryptocurrency or cryptocurrency transactions. Similarly, Canadian courts have not yet made any rulings on tax matters concerning cryptocurrency or cryptocurrency transactions.
If you have inquiries about the tax treatment of cryptocurrency or cryptocurrency transactions, or if you need assistance regarding potential tax implications arising from governmental authorities confiscating cryptocurrency, don't hesitate to contact one of our top Canadian crypto tax lawyers for expert tax guidance. Our Certified Specialist in Taxation Canadian tax lawyer possesses vast experience in dealing with cryptocurrency taxation matters.
If you or your business have unreported income, or if income earned through cryptocurrency transactions was incorrectly reported as capital gains instead of business income, you might be eligible for relief through CRA's voluntary-disclosures program (VDP). Voluntary disclosures, often referred to as tax amnesty, involve intricate legal aspects that require meticulous analysis and advice from an experienced Canadian tax lawyer. For proper tax guidance concerning a potential voluntary disclosure application, consider reaching out to our certified specialist in taxation, a knowledgeable Canadian tax lawyer.
The Voluntary Disclosures Program serves the purpose of combatting "tax evasion and aggressive tax avoidance," aiming to maintain a responsive and equitable tax system for all Canadians. Through Canada's Voluntary Disclosures Program, taxpayers, including corporations, are given the opportunity to voluntarily (1) correct inaccurate or incomplete information and/or (2) disclose previously unreported information to the CRA. Canadian taxpayers with unreported income may qualify for penalty relief and partial interest relief under the Voluntary Disclosures Program. To be considered a valid application, the following criteria must be met:
- The application must be "voluntary";
- The application must be "complete";
- Estimated taxes owing must be paid. If a taxpayer is unable to make the payment at the time of application, they can request a "payment arrangement";
- The application should include information regarding income tax that is at least one year past due;
- The application should include information regarding GST/HST for at least one reporting period that is past due.
To be eligible for relief under the Voluntary Disclosures Program, the taxpayer must submit a comprehensive application that adheres to the program's stated requirements as mentioned above. If you have unreported income or seek suitable crypto tax planning to alleviate your tax burden, do not hesitate to reach out to our tax law office. Our team of top Canadian tax lawyers is ready to provide expert tax guidance tailored to your needs.
"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."