Planning for the Tax Implications of Emigrating from Canada While Holding Cryptocurrency Assets

Introduction: Canadians Eye a Move Abroad for Favorable Tax Treatment on Cryptocurrency

This last decade has seen a rapid growth in popularity of cryptocurrencies as short-term investments or speculative assets, and long-term stores of value. That rise in popularity has posed and continues to pose new challenges for the international tax system, and how to regulate the global cryptocurrency market. This continued legislative gray area concerning taxation of cryptocurrencies has given birth to so-called “crypto nomads”, or wealthy cryptocurrency investors taking advantage of the intangible nature of cryptocurrency to move to and between favourable tax jurisdictions for their trading activities. The rise of crypto nomads has driven unprecedented tax competition between global states. Countries like Portugal, Switzerland, or the United Arab Emirates have quickly become cryptocurrency tax havens for crypto nomads, by either refusing to regulate and tax cryptocurrency trading activities, or by offering favourable tax treatment for cryptocurrency investments.

The Canadian tax system has continued to lag behind many other countries with respect to regulating and legislating taxation of cryptocurrencies. As a result, many Canadian cryptocurrency investors have either begun to consider or already have moved abroad to take advantage of this unprecedented tax competition between states. And while the opportunity may seem lucrative to Canadian cryptocurrency investors, there are very good reasons to be cautious about such an abrupt move. The Canadian cryptocurrency tax system is no slouch when it comes ensuring that emigrating Canadian taxpayers pay taxes before leaving the country.

Under subsection 128.1(4) of the Canadian Income Tax Act, a Canadian taxpayer emigrating to another state is subject to a deemed disposition on that taxpayer’s qualifying property. This is generally referred to as Canada’s “departure tax”. The departure tax is the mechanism by which the Canadian tax system asserts its jurisdiction to tax the accrued value of a Canadian taxpayer’s property during that taxpayer’s period of residence in Canada. Where a deemed disposition is triggered, that taxpayer is deemed to have sold and re-purchased that taxpayer’s qualifying property at fair-market-value. The accrued gains on that property is then recognized before emigrating from Canada and has to be reported for tax purposes, even though the taxpayer has not actually disposed of the property. This is particularly relevant to Canadian cryptocurrency holders, because cryptocurrencies like Bitcoin or Ethereum, NFTs, and other digital assets may be qualifying property subject to departure tax.

Canada’s departure tax may create a hefty tax bill for the unprepared Canadian cryptocurrency investor seeking to move abroad. However, there are always exceptions to the rule. The most relevant exception for cryptocurrency investors is subparagraph 128.1(4)(b)(ii), which provides that the departure tax will not apply to property of a taxpayer which qualified as inventory of a business carried on in Canada through a permanent establishment at the time of emigration. Whether a Canadian cryptocurrency trader can benefit from this exception depends on a number of intertwined factors, which touch on both the principles of tax residence and exactly how that trader engages with cryptocurrency. This article will first survey the rules concerning tax residence in Canada, and the conditions under which somebody can emigrate for tax purposes from Canada. This article will then discuss the circumstances in which a Canadian cryptocurrency trader’s holdings may qualify as inventory of a business, and the additional complications with how digital business models interact with both Canada’s domestic laws and the international tax regime concerning active businesses. Finally, we will provide some pro tax tips and some frequently asked questions concerning Canadian departure tax and taxation of cryptocurrencies.

A Summary of Residence Rules for Canadian Domestic Tax Law Purposes

In order to understand the Canadian departure tax, it is first necessary to understand how Canada establishes its jurisdiction to tax individuals. The Canadian tax system adopts the concept of residence as the primary basis of income taxation. Under subsection 2(1) of the Canadian Income Tax Act, the worldwide income of an individual resident in Canada is subject to tax. In contrast, a non-resident individual of Canada is only subject to tax on Canadian-source income under subsection 2(3) and Part XIII of the Income Tax Act. Thus, if an individual is a Canadian tax resident, then Canada will assert its jurisdiction to tax any income that individual earns from cryptocurrency trades whether they are conducted in Canada or in another country. Section 126 of the Income Tax Act would then permit that individual to take a credit against any Canadian tax liability for foreign taxes paid on that foreign crypto income. The credit would only be available to the extent that the individual had pre-credit Canadian taxes owing to ensure the tax system remains equitable.

The concept of residence can be distinguished from citizenship or nationality, in that it consists of an individual’s various ties to Canada as opposed to that individual’s Canadian administrative (i.e. immigration) status. The various rules under the Income Tax Act that work to determine whether an individual is a Canadian tax resident consider that individual’s personal and economic connections to Canada. For purposes of Canada’s domestic tax laws, an individual can be found resident in Canada under two different circumstances:

1. Where that taxpayer is “ordinarily resident” within the meaning of subsection 250(3) of the Income Tax Act; or
2. Where that taxpayer is not otherwise ordinarily resident in Canada at any point in a given taxation year, that taxpayer is a “deemed resident” under paragraph 250(1)(a) of the Income Tax Act.

These two rules will be briefly discussed in turn.

The “Ordinary Residence”, or “Factual Residence” Rule

Subsection 250(3) provides that an individual is a resident of Canada where that individual is “ordinarily resident” in Canada. However, the Income Tax Act does not otherwise define what it means to be resident, or “ordinarily resident”, and so Canada’s courts have been tasked with articulating the conditions to be a Canadian resident. The test of whether somebody is an “ordinary resident” is often referred to as the “factual residence” test. The Supreme Court of Canada in Thomson v. M.N.R., [1946] C.T.C. 51, posited that a taxpayer’s residency is “the place where in the settled routine of his life he regularly, normally or customarily lives.” While Canadian courts have re-affirmed consistently that an individual’s factual residence is a purely fact-specific analysis, the courts have developed a consistent list of residence ties that are considered as fundamental to evaluating where an individual is a factual resident. The Federal Court of Canada in The Queen v. Reeder, 75 DTC 5160, provided a succinct list of relevant factors, including the individual’s:

1. past and present habits of life;
2. regularity and length of visits in the jurisdiction asserting residence;
3. ties within that jurisdiction;
4. ties elsewhere;
5. permanence or otherwise of purposes of stay abroad.

The Canada Revenue Agency (“CRA”) has also published its own views in Income Tax Folio S5-F1-C1 on what factors will militate in favour of an individual being a Canadian factual resident. While the CRA’s published views on Canadian tax law do not have force of law in Canada, they have been recognized by Canadian courts as fundamental tools for the interpretation and application of Canada’s tax laws to other taxpayers. Those views should not be ignored when they correctly interpret the law, and in particular, CRA’s Income Tax Folio S5-F1-C1 has been cited with approval by the Tax Court of Canada and reasonably tracks applicable case law concerning Canadian tax residency.

Broadly speaking, after considering both the common law and CRA’s published views, the most significant factors for establishing whether an individual is a Canadian factual resident will include:

• whether that individual has a “dwelling place” (i.e. a home or apartment) available for their long-term use in Canada;
• whether that individual has a spouse or common-law partner in Canada; and
• whether that individual has any dependants in Canada.

Other important secondary ties that can influence a finding that an individual is a Canadian factual resident or not include that individual’s personal property (i.e. furniture and vehicles), economic ties (i.e. bank accounts, investments, registered plans, credit cards and other debt), immigration status, government documents (i.e. health insurance, driver’s licence, passport), and social ties (i.e. memberships to professional organizations or unions, or recreational clubs or religious organizations) in Canada.

It bears repeating that an individual’s factual residence remains a purely fact-specific determination. Canadian courts have in certain circumstances found a taxpayer to be a non-resident of Canada, or to have ceased to be a factual resident in Canada, despite maintaining significant ties (i.e. a dwelling, spouse, or dependants) in Canada.

The “Deemed Residence” Rule

Paragraph 250(1)(a) of the Income Tax Act deems an individual to be a resident of Canada throughout a particular tax year if that person “sojourned” in Canada for 183 days or more in that year. This is often referred to as the “deemed residence” rule. The meaning of “sojourning” has been broadly interpreted to mean that the individual was “temporarily resident” in Canada. A commuter can be distinguished from a sojourner, in that a commuter is only present in Canada for purposes of travelling between destinations like to and from work. A sojourner may stay in Canada, even casually or intermittently, but with some sense of permanence. Whether an individual is a sojourner is a fact-specific analysis similar to the factual residence test.

It is worth acknowledging that an individual can only be deemed resident in Canada where that individual was not otherwise a factual resident of Canada, and so the factual residence test must be considered before the deemed residence rule when determining an individual’s status as a Canadian tax resident.

When Does a Taxpayer Cease to be a Canadian Tax Resident?

In much the same way that an individual can be viewed as a Canadian tax resident under Canada’s domestic laws, an individual can also be viewed as a non-resident for tax purposes. An individual may be viewed as a factual non-resident where that individual’s ties to Canada are minimal and demonstrate that Canada is not that individual’s settled, normal or customary place of living. For a Canadian factual resident to become a non-resident, that taxpayer will have to break enough enough significant residence ties to Canada such that there is no longer a basis for Canada to assert its tax jurisdiction over that individual. As well, where a taxpayer sojourns in Canada for fewer than 183 days, the deemed residence rule will simply not apply. Breaking Canadian tax residence under the domestic Canadian tax regime can prove quite difficult without appropriate planning. A Canadian tax resident must sever enough significant ties to Canada in a given tax year, and must also to avoid returning to Canada to avoid being caught by the deemed residence rule. 

There is an additional rule that may apply to deem an individual to be a non-resident of Canada, where there is a conflict of international laws. In principle, an individual may simultaneously be a Canadian tax resident and a tax resident of another country under that country’s own laws. Without an additional system of relief, an individual could be subject to double taxation on worldwide income under both jurisdiction’s domestic tax laws. To prevent this, Canada has formed a number of bilateral tax treaties with countries worldwide which contain provisions to help settle what countries’ domestic tax laws will have claim to tax that individual. While each of Canada’s bilateral tax treaties are unique, most Canadian treaties follow the OECD Model Tax Convention. Article 4(2) of the OECD Model provides a number of tie-breaker rules to be applied in sequence to deem which country’s tax system lays ultimate claim to tax an individual. Under the OECD Model, an individual is deemed to be a resident in the jurisdiction:

1. in which that the individual has a permanent home available;
2. in the jurisdiction of that individual’s “centre of vital interest”;
3. in the jurisdiction of that individual’s “habitual abode”;
4. in the jurisdiction that individual is a citizen or national; or
5. where the above-tests remain inconclusive, whatever mutual conclusion that the competent authorities of each jurisdiction arrive at (that is, the Canada Revenue Agency and the other country’s tax authority will come to an agreement on the issue.)

To give effect to an international treaty determination, subsection 250(5) of the Income Tax Act provides what is referred to the “deemed non-residence” rule. Under subsection 250(5), where a Canadian tax resident is resident in both Canada and another country, and under an applicable bilateral tax treaty that individual is deemed a resident of the other country and not Canada, then that individual is deemed to be a non-resident of Canada as of that day the treaty applied. In other words, the deemed non-residence rule will only apply where an individual is resident in both Canada and another country, and is not deemed a Canadian tax resident under that treaty. Thus, where a Canadian tax resident is otherwise deemed to be a Canadian tax resident under a bilateral tax treaty, that individual’s status as a Canadian tax resident will remain untouched.

Avoiding the Deemed Disposition Rule on Emigration from Canada

As discussed above, when an individual becomes a non-resident of Canada, that taxpayer is subject to departure tax on qualifying property under subsection 128.1(4) of the Income Tax Act. While subsection 128.1(4) applies broadly to a taxpayer’s property, which may include cryptocurrency holdings and NFTs, the Canadian tax system provides specific exceptions for property that would be inappropriate to tax on emigration. The most relevant exception for cryptocurrency investors is subparagraph 128.1(4)(b)(ii), which provides that the deemed disposition will not apply to property which qualified as inventory of a business carried on in Canada through a permanent establishment. Whether subparagraph 128.1(4)(b)(ii) applies to a taxpayer’s property relies on two legal determinations:

1. the cryptocurrency assets in question must form inventory of a business of the taxpayer, and must not be capital property; and
2. the cryptocurrency inventory must belong to a business that is carried on in Canada through a permanent establishment at the time the taxpayer ceases to be a Canadian resident.

This article will discuss these two conditions in turn.

The Conditions for Property to Constitute Inventory of a Business

Only two major categories of property are recognized by the Income Tax Act for income tax purposes:

1. capital property, the disposal of which results in a capital gain or loss; and
2. inventory, this disposal of which results in a  business income or loss.

It is the type of income produced when a property is sold that determines whether that property is a capital property or inventory. Determining whether the profit or loss from a disposition of property should be on account of capital or income has been subject to extensive litigation in Canadian tax courts, and to answer this question, courts have considered a variety of factors, including:

• Transaction frequency – for instance, a trend of selling frequent cryptocurrency buying and selling or a high rate of cryptocurrency unit turnover may point to a business;
• Duration of ownership – for instance, keeping cryptocurrencies for short periods of time indicates commercial activities rather than capital investments;
• Understanding of cryptocurrency marketplaces – more knowledge or expertise with cryptocurrency markets favours a business categorization;
• Relationship to the taxpayer’s other employment; for instance, if cryptocurrency trades (or similar activities) are a component of the taxpayer’s employment or other business, It indicates toward business;
• Time invested – for instance, there is a higher change that the taxpayer will be classified as operating a business if a significant portion of that taxpayer’s time is spent researching potential acquisitions, analyzing cryptocurrency markets, or actively managing a cryptocurrency portfolio;
• Financial support – for instance, leveraged cryptocurrency transactions signify a business; and
• Advertising – for instance, there is a greater chance that the taxpayer’s cryptocurrency company would be characterized as a business if the taxpayer had advertised it as a business.

In the end, the taxpayer’s purpose at the time of purchasing the property is the most crucial factor that courts consider when deciding whether a disposition of property resulted in a capital gain or business income. The Tax Court of Canada and the Canada Revenue Agency will pay attention to the objective circumstances surrounding both the acquisition and sale of the property in order to determine a taxpayer’s purpose for acquiring the property. This will be the case even if only a single property is purchased.

Broadly speaking, characterizing proceeds from a transaction as capital gains is better for a taxpayer than receiving business income because only half of a taxpayer’s capital gains are treated as taxable income. For the purposes of departure tax, however, the opposite holds true because of the exemption under subparagraph 128.1(4)(b)(ii). A taxpayer cannot arbitrarily elect for one characterization over the other though. The appropriate characterization of a Canadian taxpayer’s cryptocurrency activities as a business or as investing is a very fact-specific analysis, depending heavily on the taxpayer’s intentions at the time of purchasing that cryptocurrency and whether that cryptocurrency was purchased with the intention of trading.  

When a Cryptocurrency Business is “Carried on in Canada” at the Time of Emigration

The second condition required for the exemption under subparagraph 128.1(4)(b)(ii) to apply is that the emigrant in question be carrying on a business through a permanent establishment in Canada at the time the emigrant ceases to be a Canadian tax resident. Whether an individual is carrying on a business in Canada is generally not a controversial question and requires determining whether the individual undertook an activity in pursuit of profit. Subsection 248(1) of the Canadian Income Tax Act provides a very broad definition of a business, which includes “a profession, calling, trade, manufacture or undertaking of any kind whatever and … an adventure or concern in the nature of trade”. Thus, even the income from a single purchase and sale of a property can qualify as on account of income, and thus qualify as a business, where the surrounding factors show an intent to re-sell property for a profit.

This is not the end of the analysis, however. To meet the conditions of subparagraph 128.1(4)(b)(ii), the individual’s business must be carried on through a permanent establishment in Canada. A permanent establishment is defined by subsection 2600(2) of the Canadian Income Tax Regulations as a “fixed place of business” through which the business of an enterprise “is wholly or partly carried on.” We can draw two principal elements from this definition that are essential to finding that a permanent establishment exists:

1. there must be a distinct, discrete place of business insofar as the business is linked with a specific geographical point; and
2. the place must be “fixed” or “permanent”, in that the business has a sense of permanency to it.

As a result, places of management, branches, offices, factories, workshop, or other tangible locations are often captured by the definition of a permanent establishment. On the other hand, the definition of a permanent establishment is extraordinarily unlikely to capture isolated adventures in the nature of trade.

The Complications in Applying the Permanent Establishment Test to a Cryptocurrency Business

With respect to cryptocurrency holdings, maintaining a permanent establishment as the term is defined presents a clear and immediate issue. Many cryptocurrency investors simply do not have a dedicated space to manage their portfolios outside of their homes.

Permanent establishments are a deeply rooted concept in the international tax regime. The permanent establishment test is included as part of the OECD Model for international tax treaties, and is often employed by countries like Canada as part of its bilateral tax treaties to resolve jurisdictional disputes where an individual may be found to be operating a business in two jurisdictions at once. And while the concept is applicable to most business models, reliance on the view of a permanent establishment as a fixed place of business demonstrates not only the inflexibility of the Canadian tax system to meet the challenges of an increasingly digital world, but it also demonstrates underling issues in how the modern international tax system accounts for the growing importance of intangible asset ownership.

 In order to address the growing importance of the global digital economy, Article 5 of the current OECD Commentaries provides that a computer server may reasonably constitute a permanent establishment under certain conditions. More specifically, a server will constitute a permanent establishment if: (1) the server performs integral aspects of a cross-border transaction; (2) the server is owned or leased by a non-resident firm; and (3) the server is fixed in a location for a sufficient period of time.

The OECD Commentary supplements the OECD Model for international tax treaties, and is not a binding resource for interpreting Canada’s bilateral tax treaties. Nevertheless it does provide a rational basis for applying the permanent establishment test to a digital business for Canadian domestic tax law purposes. A cryptocurrency miner operating a mining rig physically located in Canada presumably maintains a permanent establishment in Canada. As well, a cryptocurrency trader with a server in Canada running an automated high-frequency cryptocurrency trading program would also presumably qualify as operating a permanent establishment. The permanent establishment test may be satisfied by the organized cryptocurrency businesses above because those businesses employ specialized equipment with a sense of permanence. In principle, it would be much harder for a cryptocurrency trader who simply transacts throughout the day from home or work without dedicated equipment to maintain a permanent establishment within the meaning of the term when that trader emigrates from Canada. Such a taxpayer may instead be able to take advantage of the principals of agent-principal relationships as they apply for the permanent establishment rules. Under Canadian tax law, the activity of an agent is imputed to a principal for tax purposes. Therefore, cryptocurrency business models that do not use mining rigs or high-frequency trading programs like the above may still be able to maintain a permanent establishment in Canada through use of agents trading in Canada on an emigrant’s behalf using that emigrant’s cryptocurrency holdings.

It will therefore require extensive tax planning for any individual emigrating Canada to obtain relief using the exemption under subparagraph 128.1(4)(b)(ii). There will be many timing considerations involved, including when the individual actually becomes a non-resident for tax purposes. While a taxpayer may become a non-resident at the moment the taxpayer physically departs Canada, it is also possible that taxpayer will become a non-resident only once that taxpayer has already moved to a new home country and established substantial roots. The appropriate means of establishing and maintaining a permanent establishment in Canada to benefit from subparagraph 128.1(4)(b)(ii) will necessarily be a complex and rigorous tax planning undertaking that should be supervised by an expert Canadian crypto tax lawyer to ensure that a business is being run in Canada through a permanent establishment at the time of emigration.

Pro Tax Tip: Implications for Planning for Departure

Planning for the tax consequences of emigrating from Canada is a fundamental part of any Canadian tax law practice. Any successful plan to take advantage of the exemption from departure tax under subparagraph 128.1(4)(b)(ii) will require considering when to trigger a taxpayer’s emigration from Canada, and also when and how to maintain a permanent establishment in Canada for that cryptocurrency business at the time of emigration. These are all considerations that should be thought through well before the date of departure, so appropriately planning to reduce taxes on emigration will require thorough tax planning and implementation well before the date of departure. This includes making arrangements to maintain a business in Canada through a permanent establishment and to ensure that your cryptocurrency assets sufficiently form part of that business, so that you can avoid being forced to liquidate a substantial part of your cryptocurrency assets to pay departure taxes.

Relief is not completely limited for those emigrants who would not qualify for the exemption. It is worth acknowledging that subsection 220(4.5) of the Income Tax Act allows a Canadian tax emigrant to elect on or before the balance due-date for the year of emigration to defer the departure tax. That Canadian emigrant must provide adequate security if the amount of departure tax the emigrant will owe is effectively greater than $16,500 CAD. The election must be made in the prescribed form by filing Form T1244 with the Canada Revenue Agency. Extending the deadline is subject to the Minister of National Revenue’s discretion and may not be granted in all cases, so a Canadian taxpayer planning to emigrate should be proactive in preparing to file for the election and by posting sufficient security to take advantage of this deferral opportunity. As discussed before, this election may only be necessary where that property is subject to the deemed disposition under subsection 128.1(4). In either case, it warrants discussing your goals and options with an expert Canadian cryptocurrency tax lawyer to determine exactly how to go about planning your departure from Canada, so you can avoid the full weight of Canada’s departure tax regime.

FAQs:

What conditions are required for a Canadian taxpayer to “emigrate” from Canada for tax purposes?

The concept of residence can be distinguished from citizenship or nationality, in that it consists of an individual’s various ties to Canada as opposed to that individual’s Canadian administrative (i.e. immigration) status. A Canadian taxpayer can become a non-resident for tax purposes where that taxpayer ceases to be a factual resident of Canada, such that Canada is no longer the individual’s settled, normal or customary place of living. As well, under subsection 250(5), where a Canadian tax resident is resident in both Canada and another country, and under an applicable bilateral tax treaty that individual is deemed a resident of the other country and not Canada, then that individual is deemed to be a non-resident of Canada as of that day the treaty applied.

When is cryptocurrency viewed as inventory versus capital property for tax purposes?

Only two major categories of property are recognize by the Canadian Income Tax Act for income tax purposes: (1) capital property, the disposal of which results in a capital gain or loss; and (2) inventory, which is taken into account while calculating business income. It is the type of income produced when cryptocurrency is sold that determines whether that cryptocurrency is a capital property or inventory. While the taxpayer’s intent when disposing of cryptocurrency is the most important factor in characterizing that income, the following factors will also be considered: (1) transaction frequency involving cryptocurrency; (2) duration of ownership; (3) the taxpayer’s understanding of cryptocurrency marketplaces; (4) the relationship between cryptocurrency and the taxpayer’s other employment; (5) the time invested in cryptocurrency trading by the taxpayer; (6) the taxpayer’s financial support to conduct cryptocurrency trades; and (7) whether the taxpayer advertises the cryptocurrency business in some sense.

What is a permanent establishment for tax purposes?

A permanent establishment is defined by subsection 2600(2) of the Canadian Income Tax Regulations as a “fixed place of business” through which the business of an enterprise “is wholly or partly carried on.” This requires that two elements be satisfied: (1) There must be a distinct, discrete place of business insofar as the business is linked with a specific geographical point; and (2) the place must be “fixed” or “permanent”, in that the business has a sense of permanency. This typically includes places of management, branches, offices, factories, workshop, or other tangible locations, and may include a computer server if certain conditions are satisfied.

Disclaimer:

"Only general information is provided in this article. Only as of the publishing date is it current. It hasn't been updated, therefore it might no longer be relevant. It cannot or ought not to be relied upon because it does not offer legal advice. Each tax circumstance is unique to its facts and will be different from the instances described in the articles. You should contact a Canadian tax lawyer if you have specific legal inquiries."