Proposed GST/HST Amendments for Cryptocurrency Mining: What's Included and What's Not - Canadian Tax Lawyer Analysis

Introduction: Changes to GST/HST Rules for Mining Cryptocurrencies

The draft GST/HST regulations requiring cryptocurrency mining were published by the Canadian Department of Finance in February 2022. The proposed regulations will effectively treat cryptocurrency mining as an exempt supply: the miner will not be required to collect and remit GST/HST on the money they earn from mining, but they will also be prohibited from claiming input tax credits (or ITCs) for the costs associated with their mining operation.

There has been no implementation of these proposals as of yet. However, in anticipation of that eventuality, Canadians who trade in cryptocurrencies, non-fungible tokens(NFTs), and other blockchain-based assets ought to familiarize themselves with these new prospective GST and HST regulations.

An introduction to Canada's GST/HST system is provided in this article. After looking at the proposed GST/HST regulations for cryptocurrency mining, it offers pro tax crypto tips from our team of knowledgeable Canadian tax lawyers that specialize in cryptocurrency.

The GST/HST System in Canada: A Quick Overview

"Every recipient of a taxable supply made in Canada," as defined by subsections 165(1) and (2) of the Excise Tax Act of Canada, is subject to GST/HST. A sale, transfer, barter, exchange, rent, or donation of a service or product that took place within the course of doing business is considered to be a "taxable supply," which includes the majority of business transactions.

However, even though the buyer (the recipient of the good or service) is responsible for paying the GST/HST, the supplier (vendor) is responsible for actually collecting and remitting the tax. To do this, eligible commercial vendors must apply for a GST/HST number with the Canada Revenue Agency, collect the GST/HST they are required to pay on their goods and services, and then send the funds to the CRA.

However, a number of businesses are excluded from the requirement to collect GST/HST under the Excise Tax Act. For instance, if a taxpayer's cumulative global revenues over the previous four fiscal quarters did not reach $30,000, neither registration nor collection of GST/HST is required. (The amount rises to $50,000 if the taxpayer is a public service body, such as a non-profit organization, a charity, a municipality, a school authority, a hospital authority, a public college, or a university.)

A company providing financial services is another example of a company that is exempt from the requirement to charge or collect GST/HST. The Excise Tax Act defines "financial service" as any transaction involving money or a "financial instrument," which includes the following transactions:

• Keeping or supervising a loan account, a chequing account, or a savings account;
• Transactional exchanges of currencies;
• Acquiring or disposing of a financial instrument;
• The practice of paying using a financial instrument;
• Either borrowing or lending a financial instrument;
• A financial instrument's issuance, acceptance, or transfer of ownership, 
• The availability of a financial instrument;
• A financial instrument's payment or receipt of money in the form of dividends, interest, principal, benefits, or any other kind of related payment or receipt.

Generally speaking, securities, insurance contracts, precious metals, and other like items are referred to as "financial instruments". The definition of financial instruments in the Excise Tax Act was amended by the Canadian Parliament in June 2021 to include "virtual payment instruments." In the definition of a virtual payment instrument, "property that is a digital representation of value, that serves as a medium of exchange, and that only resides at a digital address of a publicly distributed ledger" is used. Ethereum, Bitcoin, and Chainlink are examples of fungible cryptocurrencies that fit the concept of a virtual payment instrument. As a result, since both crypto trading and using it as a form of payment fall within the definition of "financial service" under the Excise Tax Act, they are both free from GST and HST.

However, a virtual payment instrument expressly disallows the following:

• "property that confers a right, whether immediate or future, absolute or contingent, to be exchanged or redeemed for money or specific assets or services, or to be converted into money or specific property or services"; and 
• "property that is primarily intended for use within or as part of a gaming platform, an affinity or rewards program, or a similar platform or program."

As a result, specialty tokens issued by cryptocurrency platforms to investors under DeFi agreements may be excluded from the definition of a virtual payment instrument. In crypto liquidity mining, for example, an investor provides cash to a cryptocurrency platform in need of liquidity in return for the platform issuing the investor a specialized token entitling the investor to redeem that token for a specific amount of cryptocurrency units. Specialized liquidity tokens having these characteristics are not included in the definition of a virtual payment instrument.

Moreover, the concept of a virtual payment instrument does not explicitly include non-fungible tokens (also known as NFTs). A "digital representation of value" is not typically found in NFT artwork, which instead frequently consists of a digital reproduction of a work of art or piece of music.  As a result, It might be argued that it doesn't "serve as a medium of trade". Therefore, despite the fact that a cryptocurrency trading business is a taxable supply of financial services free from GST/HST, commercial NFT sales are nonetheless subject to the Excise Tax Act of Canada.

188.2 of the Excise Tax Act: Proposed GST/HST Tax Rules for Cryptocurrency Mining, Nodding, and Pool Mining

Section 188.2 was planned to be added to the Excise Tax Act by Canada's Department of Finance in February 2022. Section 188.2 would deal with how cryptocurrency mining would be treated if it were made into law. There has been no implementation of these plans yet. These tax rules will retrospectively go into force on February 5, 2022, if the law is enacted, according to the Department of Finance.

According to Section 188.2, "mining activity" is not considered a supply for GST/HST purposes. Three activities are considered to be part of mining under the proposed legislation:

• Cryptocurrency mining: The process by which new cryptocurrencies are validated and added as a new block to the blockchain of the cryptocurrency network is known as mining.
• Cryptocurrency nodes: Nodes for cryptocurrencies: the process of looking after a cryptocurrency network's blockchain and granting users access to the blockchain ledger.
• Pool mining: Cryptocurrency miners combine their computing power to maximize their chances of being the first to validate a transaction. This practice is known as "pool mining." (Cryptocurrency mining takes place in a competitive environment. The miner who validates the transaction first receives a mining reward.)

Therefore, under the proposed tax rules, Canadians who engage in cryptocurrency mining, cryptocurrency nodding, or cryptocurrency pool mining are not required to return GST/HST on the mining rewards or other compensation they get for such activities.

The consequence is that if a cryptocurrency miner, cryptocurrency node, or cryptocurrency pool miner purchases, consumes, or uses any service or product in connection with the activity of mining cryptocurrencies, section 188.2 will be interpreted to mean that the taxpayer did not use the service or product in the course of a business. The ability to claim input tax credits (ITCs) for cryptocurrency mining activities is thus denied to cryptocurrency miners, cryptocurrency nodes, and cryptocurrency pool miners. For instance, the proposed section 188.2 will prevent a Canadian cryptocurrency miner from claiming ITCs for the GST/HST due to the electrical expenses associated with mining cryptocurrencies.

Consequently, section 188.2 essentially classifies cryptocurrency mining as an exempt supply: On the one hand, the cryptocurrency miner does not have to collect and submit GST/HST on their mining remuneration. The crypto miner cannot, however, claim input tax credits for the GST/HST that was incurred while operating the mining activity. This is consistent with the way the GST/HST is applied to exempt supplies, such as financial, healthcare, medical, and dental services. Although an exempt supplier does not charge GST or HST, it is not permitted to use ITCs to recoup the GST or HST it paid on its business expenditures. Contrarily, a supply that has been zero-rated is still taxable, but the GST/HST rate is 0%. Therefore, even though a zero-rated supplier is not required to charge GST or HST, the zero-rated supplier can nevertheless make an ITC claim to recoup the GST or HST it was required to pay on its business expenditures.

The proposed regulations for the cryptocurrency mining tax in Canada contain an exception: They don't apply when someone mines cryptocurrency on behalf of someone else whose identity is known to the first person and who isn't a "mining group operator," which is essentially a coordinator of a mining pool. Section 188.2 does not apply in these specific situations—when someone mines cryptocurrency for a known individual who does not coordinate a mining pool—and the miner of the cryptocurrency may be required to charge GST/HST on that supply of mining services.

Commentary: What Does Section 188.2 of the Excise Tax Act Define as a "Mining Activity"?

A "mining activity" is defined as the key term in the proposed section 188.2. According to the proposed tax rule, a "mining activity" is regarded as not being a supply for the purposes of the GST/HST.

The definition of "mining activity" appears to explicitly take into account the common understanding of what cryptocurrency mining entails, namely the verification process in blockchain protocols that depend on the proof-of-work validation mechanism. In a proof-of-work system, the validator, or crypto miner, uses computational power to solve mathematical problems. By doing this, the miner validates new cryptocurrency transactions and disseminates the findings to other network users by adding the validated transaction as a new block to the blockchain.

However, it is possible to wonder if "mining activity" also means including the verification process in blockchain protocols that rely on the proof-of-stake validation mechanism. Staking or "forging" refers to this technique of verification. In line with their stake in the blockchain, users are given validation privileges under the proof-of-stake method. Neither "staking" nor "forging" are mentioned in the proposed statute. Additionally, it does not differentiate between proof-of-stake and proof-of-work validation procedures.

No matter the verification method the blockchain protocol uses, the proposed legislation probably sought to ensnare cryptocurrency-related blockchain transaction verification activity. Cryptocurrency staking, on the other hand, resembles an investment more so than cryptocurrency mining does. The cryptocurrency staker is unable to obtain rewards for staking without first making a required investment in the native tokens of the cryptocurrency platform, in contrast to a cryptocurrency miner, who may collect a mining reward without ever owning any of the native tokens of the blockchain. Maybe the difference between GST/HST treatment and this distinction justifies it. In any case, there is still no clarification from the Department of Finance. It is therefore yet unclear whether the proposed provision 188.2 covers crypto staking.

However, it is evident that the proposed section 188.2 does not apply to liquidity mining. Liquidity mining has nothing to do with confirming transactions on the blockchain network, unlike cryptocurrency mining (i.e., the verification procedure in the proof-of-work system). Instead, it typically takes the form of a loan or investment in decentralized finance (DeFi). In crypto liquidity mining, also known as "yield farming," a financier loans money to or makes a contribution to a cryptocurrency platform, usually a startup platform that needs to generate money. In return, the investor receives interest payments, a portion of the transaction fees collected by the cryptocurrency platform, or a unique token that entitles the holder to a predetermined amount of cryptocurrency units (or a combination of all of these benefits). Since liquidity mining is not covered by the proposed section 188.2, some liquidity mining arrangements can result in GST/HST obligations.

Last but not least, the development or sale of non-fungible tokens, or NFTs, is not covered by the proposed section 188.2.

Pro Tax Tips: Tax-Law Analysis of Appropriate Cryptocurrency Tax Reporting

The proposed GST/HST regulations for cryptocurrency mining do not relieve Canadians who deal in cryptocurrencies, non-fungible tokens, and other blockchain-based assets of their GST/HST obligations. First, the production and commercial sale of non-fungible tokens are not covered by these proposed GST/HST guidelines. As a result, every Canadian NFT artist or NFT content producer who generates a gross income of $30,000 or more must register with the CRA for a GST/HST number, charge GST/HST on NFTs sold in Canada, collect the GST/HST, and then pay the GST/HST to the Canada Revenue Agency. Additionally, when a person provides cryptocurrency mining services to a known recipient who isn't a member of a mining pool, the proposed GST/HST mining exemption does not apply.

So, a confidential and privileged tax law memorandum examining their GST/HST obligations under the Canada Excise Tax Act and their income tax obligations under the Canada Income Tax Act will be beneficial to Canadian taxpayers who trade, invest in, mine, or stake cryptocurrency, NFTs, or other DeFi and blockchain-based assets. Due to the unique and cutting-edge characteristics of different DeFi arrangements and blockchain-based assets, Canadian taxpayers who have engaged in DeFi arrangements or transacted in blockchain-based assets will need professional and specialized Canadian crypto-tax guidance. Our knowledgeable Certified Taxation Specialist Canadian crypto tax lawyer who specializes in cryptocurrencies has helped a large number of customers disclose their crypto transactions and other blockchain-related agreements.

The production of a tax law document that is covered by the solicitor-client privilege cannot also be enforced by the Canada Revenue Agency. Solicitor-client confidentiality prevents the CRA from knowing about the confidential legal counsel you obtain from our Toronto-based Canadian crypto tax lawyers.

Yet due to the lack of a similar legal privilege between accountants and their customers, any conversations you have with an accountant are still not protected. Because of this, you should first contact our Canadian crypto-tax lawyers if you want tax assistance but don't want the Canada Revenue Agency to know about it. If you also need an accountant's help, we can take steps to extend the solicitor-client privilege to interactions with the accountant.

Frequently Asked Questions

Question: What exactly is cryptocurrency mining?

Answer: The process of validating transactions in blockchain protocols that use a proof-of-work validation mechanism is referred to as cryptocurrency mining. The crypto miner uses his or her processing power to solve mathematical issues. By doing so, the miner validates new cryptocurrency transactions and communicates the results with other network members by adding the validated transaction to the blockchain as a new block. The miner who validates the transaction first receives a reward. Mining rewards are often in the form of new tokens in the native cryptocurrency or transaction fees (or both).

Question:  Does Canada have new GST/HST regulations for mining cryptocurrencies? If such is the case, how would mining be impacted by the proposed GST/HST rules if they are implemented?

Answer: Yes. The addition of section 188.2 to the Canada Excise Tax Act was proposed by the Department of Finance of Canada. The treatment of mining for cryptocurrencies under GST/HST is covered in Section 188.2. For the purposes of the GST/HST, it specifically considers cryptocurrency mining to be an activity that is not a supply. Consequently, cryptocurrency miners are not required to file GST/HST returns on the mining rewards or any compensation they receive as compensation for their mining efforts. Furthermore, according to section 188.2, a cryptocurrency miner is not considered to have utilized a specific product or service during the course of a business operation if they buy it, use it, or use it in connection with cryptocurrency mining. Because of this, cryptocurrency miners are not allowed to collect input tax credits (ITCs) for their work.

Or, to put it another way, section 188.2 essentially classifies cryptocurrency mining as an exempt supply: On the one hand, the miner of cryptocurrencies is exempt from collecting and remitting GST/HST on their mining rewards. However, the cryptocurrency miner is also prohibited from claiming input tax credits for GST/HST paid while operating the mining activity.

However, there is an exemption to the proposed GST/HST laws when someone provides cryptocurrency mining services to a known receiver who isn't a member of a mining pool. The cryptocurrency miner may be required to collect GST/HST and may be eligible for ITCs in certain circumstances.

Question: I've made a lot of money in recent years by mining and trading numerous cryptocurrencies. But I'm not sure how this affects my Canadian income tax obligations or my Canadian GST/HST requirements. What should I do?

Answer: When Canadian taxpayers trade, invest in, mine, or stake cryptocurrencies, NFTs, or other blockchain-based assets, they are engaging in taxable transactions that result in a variety of crypto tax-reporting duties. As a result, these taxpayers will benefit from receiving a private, privileged tax law memo that examines their GST/HST responsibilities under the Canada Excise Tax Act and their income tax requirements under the Canada Income Tax Act. Because different blockchain-validation systems have unique characteristics, Canadian taxpayers who have staked or mined cryptocurrencies will need professional and specialized advice on crypto tax in Canada. Our knowledgeable Certified Taxation Specialist Canadian tax lawyer who specializes in cryptocurrencies has helped a large number of customers disclose their cryptocurrency transactions and other blockchain-related agreements.

Question: I want to make sure that the Canada Revenue Agency is kept in the dark about the tax advice I obtain on my cryptocurrency holdings, non-fungible tokens, and other blockchain-based assets. What steps should I take to achieve that?

Answer: The confidential legal advice you receive from our experienced Canadian tax lawyers is protected by the solicitor-client privilege and is not disclosed to the Canada Revenue Agency. The creation of a tax-law memorandum created for you by your Canadian tax lawyer, for example, cannot be seized by the Canada Revenue Agency. But since there is no such legal protection between accountants and their customers, your conversations and correspondence with an accountant remain unprotected. Because of this, you should first contact our Canadian tax lawyers if you need tax guidance but wish to keep the information secret from the Canada Revenue Agency. If you also need an accountant's help, we can take steps to extend the solicitor-client privilege to interactions with the accountant.