Knowing the Tax Implications Of Creating and Selling Blockchain Non-Fungible Tokens (NFTS) in Canada: A Tax Guide From A Canadian Tax Lawyer Relating to Canadian NFT Artists & The Tax Man
Published: November 8, 2022
The New Medium for Digital Artists and Content Creators: Blockchain Non-Fungible Tokens (NFTs) - A Brief Summary
Non-fungible tokens (NFTs) have quickly emerged as a brand-new medium for monetizing the work of artists, musicians, and content producers. Musician and artist Grimes earned roughly $6 million through the sale of a collection of non-fungible tokens representing digital artwork in March 2021. A 107-piece set from the Bored Ape Yacht Club collection, which was auctioned off by Sotheby's in September 2021 for a staggering $24 million, was made up of thousands of NFTs, each of which represented a cartoon ape with its own shades, emotions, and outfits. In February of 2022 Julian Assange and Pak’s Clock NFT sold for $52.7 million (16953 ETH), the second-most expensive single NFT ever sold. It depicts a timer showing the number of days Assange has spent in prison. In March 2021 the most famous and the most expensive NFT sale to date took place. It was Beeple’s Everydays: The First 5000 Days and sold for the princely sum of $69.3 million.
NFTs, or non-fungible tokens, are essentially one-of-a-kind digital assets that use blockchain technology to track ownership. Any digital content, such as a digitized image, song, poetry, or even this article, can be turned into an NFT. The public can use blockchain technology to verify ownership transfers and confirm who is the current owner of a particular non-fungible token. As a result, an NFT enables the ownership, purchase, and sale of distinctive digital goods. An NFT is similar to a cryptocurrency, like Ethereum (ETH), Bitcoin (BTC), or Dogecoin (DOGE), that uses blockchain technology to track ownership . But each NFT possesses distinct qualities, unlike cryptocurrencies. In contrast to bitcoin, which is fungible (you can exchange one Bitcoin for another and get the same item), each NFT is unique, which is why they are termed "non-fungible" tokens. Rembrandts are not the same as authentic Picassos when traded for them. For NFTs, the same remains true. As a result, it is not surprising that non-fungible tokens have attracted the most interest and enthusiasm due to their potential for monetizing digital art and music.
NFTs also give artists and musicians the option to program a resale royalty directly into the NFT, which results in commissions after the initial point of sale. In theory, this royalty may last forever, thanks to blockchain technology. This permits the artist or musician to generate ongoing income from the sale of creative works or songs in the future, increasing their income as their work or popularity rises.
There are several Canadian tax difficulties raised by the creation and sale of blockchain NFTs by Canadian taxpayers. Additionally, Canadian NFT artists and content creators will be unsure of how to properly declare their income to the Canada Revenue Agency without the proper NFT-tax assistance of an expert NFT and crypto tax lawyer. The purpose of the article is to inform Canadian NFT artists and Canadian NFT content creators about their tax responsibilities in Canada. It describes how self-employed NFT artists and NFT content creators in Canada are required to pay income taxes as well as GST/HST. The article ends with expert tax advice for Canadian taxpayers who create non-fungible tokens for sale from our top Canadian NFT-tax lawyers.
What Canadian Tax Implications Await Self-Employed NFT Artists and NFT Content Creators?
NFT Art Sales: A Taxable Business Income Source
The Income Tax Act of Canada makes distinctions between several types of income, including capital gains, business income, income from property (or investment income), and income from an office or employment. Different sources of income are subject to different income tax laws. For instance, business and investment income are both wholly taxable in Canada. However, only 50% of a capital gain is counted toward taxable income.
For self-employed NFT artists and NFT content creators in Canada, the revenue from creating and selling non-fungible tokens will often qualify as business income. The same is true for royalties on NFTs protected by copyright. A copyright NFT is a blockchain arrangement in which a creator of a work of art, literature, or music releases non-fungible tokens and so sells a portion of the rights to it. As a result, a percentage of any royalties paid on the underlying work is distributed to the owner of the non-fungible tokens. In contrast to other situations where a royalty payment may be passive investment income, it generates active business income for the artist, author, or musician who developed the royalty-paying copyright NFT and made it available to the general public.
Because of this, self-employed NFT artists and NFT content creators are required by subsection 9(1) of the Income Tax Act to disclose their earnings as business income. Their non-fungible tokens are considered inventory, and any earnings from the sale of non-fungible tokens are completely taxable. Any royalties received from copyright NFTs must be declared as fully taxable business income by the recipients.
In addition, the Canadian Income Tax Act's subsection 9(1) allows for the deduction of costs incurred to generate business income. For instance, in order to create the non-fungible token, an NFT artist is often required to pay a "gas fee," which is a processing price for the computing energy required to create and validate the special NFT on the blockchain. The gas price qualifies as a deductible expense for self-employed NFT artists and content creators who produce non-fungible tokens to generate revenue for their businesses.
How to Calculate and Claim Inventory Costs of NFTs as Inventory?
The Income Tax Act does not precisely define how a taxpayer should compute inventory expenses, however subsection 9(1) of the Income Tax Act of Canada codifies the deductibility of inventory costs by defining a taxpayer's business income as the taxpayer's "profit from that business." Generally accepted accounting principles (GAAP) and commercial practice are largely taken into consideration by Canadian income-tax law.
For instance, accrual accounting is recommended by commercial practice for the majority of businesses, particularly those with high inventory turnover. The cost of a non-fungible token cannot be deducted as an expense for the fiscal period in which it was purchased, hence an NFT art dealer who keeps a sizable inventory of NFT artwork may record inventory costs on an accrual basis. Instead, during the fiscal period in which the non-fungible token was sold, the NFT art dealer records the inventory cost as an expense (i.e., cost of goods sold). The inventory cost is shown as an asset on the balance sheet for the fiscal period for any NFT inventory that is still on hand at that time.
Read the article "Tax Guide for Crypto & Bitcoin Businesses: Computing Inventory Costs" for further information on how to calculate and deduct the cost of blockchain-based inventory.
The Filing of Canadian Income-Tax Returns for Incorporated NFT Artists, NFT Art Dealers and NFT Content Creators
A T2 Corporation Income-Tax Return must be filed by the corporation within four or six months (depending on the type of corporation) of the end of the taxation year if the NFT artist, NFT content creator, or NFT art dealer runs the business through a corporation. (A corporation's fiscal year and off-calendar tax year may coincide, unlike an individual including a sole proprietor who must use a calendar year end.)
Two months following the conclusion of the corporation's tax year, all unpaid taxes must be paid. The tax is due within three months of the end of the corporation's tax year, but if it is eligible for the small business deduction, the corporation may postpone payment by one month.
The Filing of Canadian Income-Tax Returns for Unincorporated NFT Artists, NFT Art Dealers and NFT Content Creators Under Sole Proprietorship
By June 15th of the following year, if the NFT artist, NFT content creator, or NFT art dealer runs the business as a sole proprietor (unincorporated), he or she must submit their Canadian T1 General Income-Tax Return for the previous year. However, the tax is due by April 30. In other words, the tax is payable approximately a month and a half before the tax return is due (otherwise, interest begins to accrue).
Self-Employed NFT Artists and NFT Content Creators' GST/HST Obligations: Non-Fungible Token Sales as a Taxable Supply
GST/HST obligations may also arise from creating and selling NFT artwork. "Every recipient of a taxable supply made in Canada," as defined in Section 165 of the Excise Tax Act, is subject to GST/HST. A "taxable supply" is essentially the commercial sale of products or services, and it includes the sale of artwork by an artist and the sale of music by a musician.
Commercial NFT sales remain a taxable supply even though a bitcoin trading business is a supply of financial services that is exempt from GST/HST. The purchase or sale of a "virtual payment instrument," which is defined as a "property that is a digital representation of value, that functions as a medium of exchange, and that only exists at a digital address of a publicly distributed ledger," is considered to be a "financial service" under the Excise Tax Act of Canada and is exempt from GST/HST obligations. As a result, fungible cryptocurrencies like Bitcoin, Tether, or Ethereum meet the criteria for "virtual payment instruments," but NFT artwork doesn't. A non-fungible token does not "function as a medium of exchange" when it represents a work of art or piece of music since it is not a "digital representation of value."
While it is the consumer's responsibility to pay GST/HST, it is the supplier's responsibility to actually collect the tax—that is, the person who sells the goods or services. If a supplier's yearly gross income is less than $30,000, that supplier is not required to collect GST/HST. However, in order to start collecting GST/HST on services rendered or items sold, a Canadian company must register for a GST/HST number and reach worldwide gross revenues of $30,000 or more. Inaction will result in fines, interest, and sometimes even legal action for tax evasion.
Therefore, if a self-employed Canadian NFT artist or content creator earns $30,000 or more in gross revenue, the artist or creator must register for a GST/HST number with the CRA, charge GST/HST on NFTs sold in Canada, collect the GST/HST, and then pay it to the Canada Revenue Agency. Because the NFT artist is going to be the subject of a GST/HST audit by CRA, it also follows that a bookkeeping system needs to be set up.
The net GST/HST owed to the Canada Revenue Agency might be decreased by claiming the GST/HST that the Canadian NFT artist or content creator pays to business vendors as input tax credits (ITCs). The GST/HST payable on commercial rent, the GST/HST payable on professional fees like Canadian crypto tax lawyers or accountants, the GST/HST payable on internet-service costs, and the GST/HST payable on mobile phone fees (to the extent that using the internet and a cell phone were related to work) are a few examples of amounts that can be claimed as ITCs.
Requirements for GST/HST Filing by Self-Employed NFT Artists and NFT Content Creators
Even if the NFT artist or content creator had no income during the reporting period or had no net GST/HST payable for that period, that artist or creator still has to file GST/HST returns if the GST/HST registration will be required.
When a taxpayer must submit GST/HST returns and pay the net GST/HST depends on how long the taxpayer reporting period is for GST/HST. The reporting period for GST/HST might be monthly, quarterly, or annually.
- The GST/HST return and the net GST/HST payable are both due by the end of the next month if the reporting period is monthly.
- The GST/HST return and the net GST/HST payable are both due within a month from the end of the quarter if the reporting period is quarterly.
- The GST/HST return for that reporting period and the net GST/HST payable are both due three months after the fiscal year's end if the reporting period is yearly and the business is incorporated.
- The GST/HST return for a year with an annual reporting period and a sole proprietorship operation is due on June 15 of the following year. However, the net GST/HST payable for that year must be paid by April 30 of the subsequent year. (In other words, the due dates for filing and making payments are the same as for income tax.)
Additionally, the length of a reporting period is determined by the business's annual revenue for the most recent fiscal year. A business with annual revenue of at least $1.5 million may choose between an annual, quarterly, or monthly GST/HST reporting period. If a business earned more than $1.5 million but not more than $6 million, it could choose a quarterly or monthly GST/HST reporting period. And if a company earned more than $6 million during the last fiscal year, it must utilize a monthly GST/HST reporting period.
Tax Pro Tips: Legal Analysis on the Proper Tax Reporting of Non-Fungible Tokens And Its Tax Planning, and the VDP for GST/HST and of Unreported Income Tax
A tax memorandum analyzing whether royalties on copyright non-fungible tokens should be reported as investment income, business income, or a combination of both will generally be beneficial to Canadian NFT artists and other Canadian taxpayers engaging in NFT transactions and blockchain-based arrangements. Additionally, if they've exchanged any non-fungible tokens, they'll have to decide whether to report their profits as business income, capital gains, or a combination of the two. In addition, you will probably need to submit a T1135 form together with your income-tax return if you own cryptocurrency and non-fungible tokens with a combined tax cost that exceeds $100,000.
Numerous clients have sought our expert Canadian Certified Specialist in Taxation's assistance with concerns relating to the accurate classification and reporting of cryptocurrency transactions, non-fungible token transactions, and other blockchain-based transactions. For tax advice if you've completed cryptocurrency transactions or transactions involving non-fungible tokens, get in touch with one of our expert Canadian lawyers who specialize in NFT and crypto taxes in Canada. Should the Canada Revenue Agency disagree with your tax-filing position, a documented tax memorandum that thoroughly analyzes your cryptocurrency transactions, non-fungible token transactions, or other blockchain-based transactions will protect you from gross-negligence fines.
On the first $500,000 of active business revenue, a Canadian-controlled private corporation (CCPC) benefits from a lower tax rate, and its individual shareholders can postpone paying shareholder-level tax to the extent that retained earnings remain within the firm. As a result, incorporating the business may be advantageous for a self-employed Canadian NFT artist or Canadian NFT content provider. See our article on the Canadian tax benefits of operating your cryptocurrency-trading business as a CCPC for more details. For guidance on crypto tax-planning in regard to running your NFT-sales business through a corporation, get in touch with one of our knowledgeable Canadian NFT-tax and crypto-tax lawyers today.
Because of technological advancements and coordinated efforts by tax authorities including the Canada Revenue Agency (CRA), Internal Revenue Service (IRS), and Her Majesty's Revenue & Customs, cryptocurrency users no longer benefit from anonymity (HMRC). This should alarm Canadian taxpayers who have undisclosed cryptocurrency profits. Taxpayers who engage in transactions with non-fungible tokens on blockchains should be similarly concerned, even if these tokens are still a relatively new concept. You run the danger of incurring not just civil monetary fines, such as gross-negligence fines, but also criminal culpability for tax evasion if you filed Canadian crypto tax returns that deleted or underreported your cryptocurrency income or your profits from non-fungible tokens. Additionally, the normal late-filing penalty can be as high as $2,500 each unfiled form and the gross-negligence penalty can be as high as $12,000 per unfiled form if you failed to file T1135 forms for your NFT holdings. Furthermore, commercial NFT sales continue to be a taxable supply even though a cryptocurrency trading business is a supply of financial services that is exempt from GST/HST. Therefore, a self-employed NFT artist or self-employed NFT content creator who makes more than $30,000 annually must register with the CRA for a GST/HST number, charge GST/HST on NFT sales made within Canada, collect the GST/HST, and then pay the GST/HST to the Canada Revenue Agency. Inaction will result in fines, interest, and sometimes even prosecution for crypto tax evasion.
Unreported taxable income, unfiled T1135 forms, and unreported GST/HST may grant relief from penalties received, interest, and prosecution under the CRA's Voluntary Disclosures Program (VDP). The Canada Revenue Agency will not commence any criminal charges against you and waive gross negligence fines if your VDP application is approved (and may cancel or waive interest). You cannot afford to wait since a VDP application is time-sensitive. This basically means that the Voluntary Disclosures Program must receive your VDP application first before Canada Revenue Agency contacts you regarding any of the non-compliance you seek to disclose. If an application is not "voluntary," the CRA's Voluntary Disclosures Program will reject it, denying any relief. See our article on the CRA Voluntary Disclosures Program for more information about meeting the requirements for relief under the VDP.
The CRA's Voluntary Disclosures Program may be able to provide you with relief. If your VDP application is approved, the CRA will renounce criminal prosecution and forgive fines for egregious negligence (and may reduce interest). Your voluntary disclosure application, however, has a deadline. Without being "voluntary," an application will be rejected by the CRA's Voluntary Disclosures Program, which effectively implies that you must submit your crypto tax voluntary-disclosure application before the Canada Revenue Agency contacts you regarding the non-compliance you wish to disclose.
Numerous Canadian taxpayers who have unreported bitcoin and blockchain transactions received assistance from our top Certified Specialist in Taxation Canadian tax lawyer. Your voluntary-disclosure application can be carefully planned and quickly prepared. 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. Make an appointment for a private, confidential consultation with one of our respected Canadian tax lawyers to find out if you are eligible for the Voluntary Disclosures Program of the Canada Revenue Agency.
"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 lawyer."