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Over 50 criminal leads are being pursued by tax fraud investigators in the UK, Australia, the Netherlands, Canada, and the US after they discover a potential $1 billion cryptocurrency-based Ponzi scheme - Advice From A Canadian Tax Lawyer Regarding Cryptocurrencies

Bitcoins plotted in soil to signify planting and growth of cryptocurrency
By: Crypto Tax Lawyer

Published: November 14, 2022

Introduction: The International Tax Coalition's Cryptocurrency Campaign

The Canada Revenue Agency (CRA) was one of a group of international tax authorities that committed in the summer of 2018 to work together to identify cryptocurrency users who were evading their tax obligations. Since then, the CRA, the IRS, and other tax authorities have only refined the methods they use to track down cryptocurrency users for crypto tax audits or to bring charges of tax evasion against them. 

International tax authorities have found over 50 leads on cryptocurrency-related tax offenses, including one case that seems to be a $1 billion Ponzi scheme, as of May 2022, when cryptocurrency markets were already on edge due to the collapse of the ostensible stablecoin TerraUSD (UST). The use of non-fungible tokens (NFTs) in tax fraud and money laundering is another issue that tax administrators warn about.

The Joint Chiefs of Global Tax Enforcement, a coalition of worldwide tax authorities, is initially discussed in this article (J5). The article then talks about J5's disclosures regarding newly started tax fraud investigations involving over 50 particular targets in the Netherlands, the US, the UK, Australia, and Canada. The J5's cautions regarding red flags pointing to potential fraud in NFT transactions are then reviewed in this article. This article next addresses the Canadian taxation of cryptocurrency losses or NFT losses brought on by fraud, and it closes with professional tax advice from our leading crypto tax lawyers for Canadians who trade and invest in cryptocurrencies or non-fungible tokens.

The Joint Chiefs of Global Tax Enforcement: International Collaboration Enables CRA to Identify Canadian Cryptocurrency Investors & Traders (J5)

The CRA joined the Joint Chiefs of Global Tax Enforcement (J5) on July 3, 2018, which is a collaborative multinational effort to look into crypto tax evasion and money laundering including cryptocurrencies and NFTs. 

Along with the Canada Revenue Agency, tax officials from the Netherlands, Australia, the United States, and the United Kingdom are also included in the J5. The J5's mission is to solve the issues that cryptocurrencies and non-fungible tokens bring for tax administrators in its member nations through information exchange and cooperative investigations. The initiative specifically aims to identify hidden income and assets from taxpayers' possessions of non-fungible tokens and cryptocurrencies including Binance USD (BUSD), Tether (USDT), BNB (BNB), USD Coin (USDC), Cardano (ADA), Solona (SOL), Dogecoin (DOGE), and Polkadot (DOT). 

The establishment of the organization denoted a deliberate attempt by tax authorities to gather knowledge of cryptocurrency transactions and non-fungible token transactions involving taxpayers in Australia, Canada, the Netherlands, the United States of America, the United Kingdom, and the Netherlands.

A $1 billion crypto Ponzi scheme and more than 50 specific leads on tax fraud related to cryptocurrencies

The J5 informed news organizations in May 2022 that it had discovered more than 50 leads on tax offenses involving cryptocurrencies. The leads originate from each of the J5 nations: Australia, Canada, the United States, the United Kingdom, and the Netherlands. Jim Lee, the Chief of Criminal Investigations for the US Internal Revenue Service, stated that some of these leads "concern individuals with significant NFT transactions involving potential tax or other financial crimes throughout our jurisdictions." One of these leads appears to be a $1 billion Ponzi scheme. 

Every J5 country is impacted by this lead, which is billion with a "B," according to Lee. Inquiries into tax crimes have already started in each nation, and news organizations anticipate an official statement from the J5 and its participants, such as the Canada Revenue Agency, shortly.

Identification of NFT Red Flags by The J5 to Alert the Public to Risks

Banks, law enforcement officers, and private citizens should be aware of risks while working with non-fungible tokens, according to an intelligence alert issued by the Joint Chiefs of Global Tax Enforcement (J5) on April 28, 2022. 

The newsletter, titled "J5 NFT Marketplace Red Flag Indicators," highlights things that you should be aware of if you're working with non-fungible tokens or intend to buy one. The newsletter attempts to provide banks, law enforcement personnel, and members of the business sector with some information about potential red flags in the NFT market. The newsletter, as the J5 emphasizes, is not intended to be an exhaustive list of the dangers posed by NFTs; rather, it is a compilation of the best practices that the J5 members have developed as a result of extensive research on NFTs.

Will Day, the Deputy Commissioner of the Australian Taxation Office, stated that this bulletin "is intended to be the first of many that can be used by financial institutions to assist in the fight against tax crime and money laundering involving virtual assets."

Account/transaction indicators that could indicate cases of tax fraud or money laundering are identified in the J5 NFT Marketplace Red Flag alert. The following account or transaction characteristics were labeled as "strong indicators" of fraud in the bulletin:

  • Transactions over $100,000 in new issues or on the secondary market that are not visible to the general public.
  • A close-knit set of digital accounts that transact with one another is referred to as a network of sending and receiving parties to the same transaction or series of transactions.
  • Non-fungible tokens that have just been created and are being sold right away for high values that don't match those of the other tokens in the collection.
  • NFTs that are initially purchased for a high price before being sold to the same party again for a much lower price (or from a third party).
  • Frequent turnover of NFTs with poor value. In the newsletter, the NBA's Top Shots NFTs were used as an illustration. "On Top Shots with the NBA you see a lot of low value (i.e. sub 10K) NFTs being bought in the same day with owners only holding their position for minutes," the advisory stated. This can be a means of laundering money.
  • A visibly overpriced or underpriced NFT that is regularly traded in a condensed period of time.
  • Wash trading, often known as deliberately inflating the sale value with each sale between related accounts.
  • Improper mint address: The contract address does not correspond to the address stated on the NFT project's website. 
  • Before a transaction can be completed, you must submit your MetaMask wallet address and your Ethereum wallet seed phrase (recovery phrase).
  • False NFT offers are provided via email as part of phishing scams.
  • Airdrops or giveaways of fictitious tokens.
  • Impersonating someone on social media by using unverified profiles without any followers who are actually online.
  • The use of counterfeit NFT collections as a fraud exploit.
  • Price: There is cause to believe that the site is a rip-off if there is a significant price difference between it and a reliable marketplace.

These characteristics of the account or transaction are classified as "moderate indicators" of fraud:

  • Smaller amounts split out among multiple transactions with no observable community, such as five transactions with a total value of under $10,000 spread out over a few days. Because it might be the product of software testing, the advisory advises caution "when looking at this indicator in isolation."
  • Within the NFT, reused code. It's also crucial to remember that sharing code within the software development community is common, thus this indicator by itself is not conclusive.
  • Creating an NFT, paying a high price for it, and then losing a lot of money on the sale. As an example, a buyer might buy an NFT for $2M and sell it for $1500K in a very short period of time. Before reaching a decision, more thought would need to be given to the possibility that this is also a result of the market's overall volatility.
  • On the marketplace profile, there is no thumbnail. (Note that this indicator alone is not conclusive, just as the other ones mentioned above.)
  • On the market profile, there is no checkbox for verification. (Note that this signal alone is not conclusive, just like the other ones mentioned above.) Accounts that have been verified and have a blue checkmark (OpenSea). However, unauthorized individuals have the ability to hack legal accounts and utilize them for money laundering or fraud.
  • Traceability on the project has no traceable contract address in Ethereum (Note: some legitimate projects have also exhibited this).
  • The exact date and location of the NFT's minting are unclear.
  • NFT fields for properties and project descriptions are blank or unclear (Note: some legitimate projects have also exhibited this).
  • A large proportion of sales in a collection were made from similar or grouped wallets.

It is made very apparent in the J5 NFT Marketplace Red Flag notice that no single indicator can prove that something is fraudulent. Individuals and organizations should employ a thorough screening process when looking for potential fraud, including putting Know-Your-Client precautions in place in addition to keeping an eye out for the warning signs indicated above.

Tax Repercussions for Canadian Taxpayers Who Lose Cryptocurrencies or Non-Fungible Tokens as a Result of Fraud

For the Canadian taxpayer who "disposed" of the property, there is a "tax event" that results from that transaction. The term "property" is defined broadly in the Income Tax Act of Canada, and this includes intangible personal property like cryptocurrencies and non-fungible tokens (NFTs). 

The term "disposition" is defined rather broadly under the Income Tax Act as well. Generally, a "disposition" takes place each time a person gives up any aspects of property ownership (such as possession, control, etc.)—regardless of whether they do so willingly or unwillingly, and irrespective of whether they are paid for it. In light of this, each of the following transactions represents a "disposition":

  • Selling a property;
  • Contribution or a gift;
  • The repayment or termination of a loan;
  • The taking of an asset through force or expropriation;
  • A property being destroyed; and
  • A property being stolen, lost or abandoned.

Thus, if a taxpayer is a victim of a scam and loses cryptocurrency or non-fungible tokens, that taxpayer will be deemed to have "disposed" of those digital assets. By dint of the disposition, the taxpayer is now eligible to claim the ensuing loss for income tax purposes. For the digital assets that were plundered in the fraud, the taxpayer likely received no revenues. As a result, if the tax cost to the taxpayer for those digital assets is greater than zero, the taxpayer may realize that sum as a loss for the year in which the fraud  deprives the taxpayer of the digital assets.

The ensuing loss may be either a capital loss that is only partially (50%) deductible or a commercial loss that is fully deductible. The Income Tax Act of Canada has two completely distinct tax systems for business income and capital gains, respectively. In conclusion, if your digital asset transactions are given income classification, your earnings from cryptocurrency trading or NFT trading are completely taxed, while your losses from cryptocurrency trading or NFT trading are entirely deductible. Alternatively, if your digital asset transactions receive capital classification, just half of your earnings are taxable and only half of your losses are deductible. Furthermore, unlike losses on a capital account, which can only be used to offset capital gains, losses on an income account can be deducted against any source of income.

While there are many tests that go into the determination, the most important factor that the Tax Court and the Canada Revenue Agency will take into account when deciding whether the transaction resulted in a capital gain or business income is the taxpayer's motivation or purpose at the time of purchasing the cryptocurrency or non-fungible token. The Tax Court and the CRA will concentrate on the objective circumstances surrounding both the purchase and sale of the cryptocurrency in order to determine a taxpayer's intention.

Please read our "Tax Guide for Crypto & Bitcoin Businesses: Computing Inventory Costs" for more information on how to differentiate between capital gains and business income in the context of cryptocurrency transactions. You can also get in touch with one of our top Canadian crypto-tax lawyers to get a thorough Canadian crypto tax memorandum highlighting how you should deduct your cryptocurrency fraud losses.

An experienced Canadian tax lawyer provides the following advice: Voluntary Disclosures Program (VDP) for Unreported Cryptocurrency Income and Protecting Your Constitutional Rights

Over 50 leads relating to tax offenses involving cryptocurrencies have been found by the Joint Chiefs of Global Tax Enforcement in each of the J5 nations, including Canada. Investigations into tax crimes have already been undertaken by the Canada Revenue Agency.

Unaddressed gains from cryptocurrency or non-fungible token transactions need to be of serious concern to Canadian taxpayers. You run the danger of being subjected to both civil monetary penalties, such as gross-negligence penalties, as well as criminal tax evasion charges if you filed crypto tax returns that failed to disclose or underreported your cryptocurrency or NFT revenues.

Under the CRA's Voluntary Disclosures Program, you might be eligible for relief (VDP). If your VDP application is approved, the CRA will forgo criminal tax prosecution and forgive fines for gross negligence (and may reduce interest). However, a voluntary disclosure application must be submitted in a timely manner, particularly in the case of Canadian leads being investigated by the Joint Chiefs of Global Tax Enforcement. Any application that is not "voluntary" will be rejected by the CRA's Voluntary Disclosures Program, which will result in no relief being granted. This effectively means that the CRA cannot have begun a tax investigation into the non-compliance you sought to reveal before it receives your voluntary disclosure application.

Arrange an appointment for a professional consultation with one of our knowledgeable Canadian crypto-tax lawyers to find out if you are eligible for the Voluntary Disclosures Program. Information covered by solicitor-client privilege cannot be demanded by the Canada Revenue Agency. To put it another way, the solicitor-client privilege safeguards the CRA from finding out about the legal tax advice you obtained from your Canadian tax lawyer. Your conversations with an accountant are not private, though. Therefore, you should speak with a Canadian tax lawyer first if you need tax assistance but don't want the CRA to know about it. If an accountant is required, your Canadian tax lawyer can hire the accountant and extend the privilege on your behalf. Numerous Canadian taxpayers have benefited from our skilled lawyers in the area of crypto-taxation in getting their NFT and cryptocurrency transactions in order. The likelihood that the CRA will accept your voluntary disclosure is increased by a properly drafted disclosure application, which also paves the way for a request for judicial review of the CRA's decision to reject your disclosure in the event that it was done so in an unfair manner.

The Canada Revenue Agency must need a search warrant to acquire evidence while looking into alleged criminal tax offenses, like tax evasion through cryptocurrencies. The Canada Revenue Agency (CRA) is unable to rely on its typical tax audit and information-gathering capabilities, such as those provided in sections 288 and 289 of the Canada Excise Tax Act and in sections 231.1 and 231.2 of the Canada Income Tax Act. These sections enable the tax auditors of the CRA to request and review documentation.

However, the CRA may only make use of these tax audit powers in the course of civil tax audits; it is not permitted to make use of them in the course of a criminal tax evasion investigation. This is so that the protections provided by the Canadian Charter of Rights and Freedoms (Constitution Act, 1982) can be invoked if the CRA's goal changes from a civil tax audit to a criminal inquiry. Every person in Canada is given a number of rights under the Charter while confronted with criminal charges, including tax fraud.

Consult with one of our experienced crypto-tax lawyers now to make sure the Canada Revenue Agency doesn't infringe on your constitutional rights. If the CRA has inadvertently turned your civil tax audit into a criminal tax inquiry, our Canadian tax lawyer who is a Certified Specialist in Taxation can advise you on the best course of action to take. If that's the case, we'll take action to protect your rights.

Frequently Asked Questions

Question: I've been trading several cryptocurrencies and non-fungible tokens for the past few years, and I've made a lot of money. However, I did not disclose any of it on my Canadian income tax forms. How can I get help?

Answer: According to the Voluntary Disclosures Program of the Canada Revenue Agency, you can be eligible for relief (VDP). If your VDP application is approved, the CRA will forgo criminal prosecution and forgive fines for gross negligence (and may reduce interest). See our page on the CRA Voluntary Disclosures Program for more information about meeting the requirements for relief under the VDP.

Question: I particularly chose bitcoin and non-fungible tokens to conceal my income because I live in Canada. It's likely that some of my bitcoin and NFT transactions count as money laundering. I originally thought that the Canada Revenue Agency couldn't possibly be able to track cryptocurrency and other blockchain transactions, but it turns out that I was mistaken. I am requesting relief through the Voluntary Disclosures Program of the Canada Revenue Agency in order to avoid criminal punishment. Will I be eligible for relief?

Answer: The Voluntary Disclosures Program will only provide relief if your VDP application complies with certain requirements. For instance, unless an application is "voluntary," the CRA's Voluntary Disclosures Program will reject it and thereby deny you relief; this essentially means that the CRA must first receive your voluntary-disclosure application before it has begun an investigation into the tax non-compliance you sought to disclose. The Joint Chiefs of Global Tax Enforcement, a multinational alliance of tax authorities, recently found over 50 leads regarding crypto-related tax offenses in numerous nations, including Canada. Your VDP application can therefore be particularly time-sensitive. Do not wait! Make an appointment for a professional, confidential consultation with one of our knowledgeable Canadian tax crypto lawyers right away.

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