Should Cryptocurrencies & NFTs be Included as Marital Property in Divorce?
Published: May 9, 2023
Introduction: It Is Advised That Cryptocurrency and NFTs Be Disclosed As Marital Property
Several financial changes may occur as a result of a divorce, and the distribution of marital property is one of the main concerns for divorcing spouses. As cryptocurrency and NFT investments expand in popularity, a new question arises: should they be included as marital property?
This article first covers how to handle cryptocurrency and NFT assets during a divorce, then it lists the considerations that courts often take into account when deciding whether to classify gains from the disposition of cryptocurrencies or NFTs as income or capital gains. The article continues by describing the tax audit authority of the Canada Revenue Agency and providing advice on how the voluntary disclosure program could be useful for taxpayers who have unreported earnings from sales of cryptocurrencies or NFT.
After a Divorce, It Is Necessary To Disclose Cryptocurrency and NFTs?
Cryptocurrencies and NFTs must be revealed on the valuation date since they are assets like any other and must be disclosed. Penalties imposed by the court might result from failure to do so. For instance, in the case of M.W. v. N.L.M.W., 2021 BCSC 1273, the BC Supreme Court of British Columbia chose to punish spouses who failed to disclose all of their cryptocurrency assets fully. Despite just disclosing one cryptocurrency account in his financial statement, the spouse in this example claimed to have lost all of his crypto assets. Even though he had financial losses, the judge thought his conduct was exceptionally heinous and gave his cryptocurrency holdings a $60,000 value.
A Capital Property Transfer Without Resulting in Any Income Tax Liability Between Separated and Former Spouses
According to Subsection 73(1) of the Income Tax Act, the capital property can be transferred to separated or ex-spouses via an automatic rollover without resulting in any income tax obligation as long as the following requirements are satisfied:
- The asset is a capital asset,
- In order to satisfy marital debts, the property is given to a separated spouse, an ex-spouse, or a spousal trust and;
- At the time of the transfer, both parties were residents of Canada.
If the aforementioned requirements are satisfied, the rollover is automatic, and there is no need to submit an election or form to the CRA. Hence, there are no Canadian crypto tax repercussions when crypto assets are transferred between separating couples. Without the transferee's permission, the transferor may also choose not to participate in the rollover. As a result, the transferor's personal income tax return is where the capital gain or loss is recorded.
Tax Consequences Relating to Gains or Losses From the Sale of Cryptocurrency or Non-Fungible Tokens (NFTS)
The profits from a future disposition of cryptocurrency or NFTs will be taxable to the receiving spouse, whether they are a current spouse or a separated spouse, according to the transferor's adjusted cost base. Depending on how the earnings are categorized, the tax ramifications will be significantly different; for example, business income is completely taxable while capital gains are only subject to tax at a rate of 50%.
Courts and the CRA, in accordance with case law, will often treat profits as business income if a business is being operated or if the gains were the result of an adventure in the nature of trade based on the following criteria:
- The nature of the sold property: Courts will often assume that a taxpayer participated in an adventure in the nature of trade where property purchased by a taxpayer is so large or of such a kind that it cannot generate revenue or personal enjoyment for its owner by virtue of its possession. Courts will typically assume the same thing in regard to property that has been bought and is capable of creating money if the taxpayer is unable to utilize it and can only benefit from it by selling it.
- The length of time the property has been owned: In most cases, after being acquired, property that is intended to be traded in is realized. To this general rule, there are several exceptions.
- The taxpayer's frequency or number of other similar transactions: The courts will likely assume that there has been trading in relation to the property if the same type of property has been sold repeatedly over a period of years or if there are many sales at or around the same time.
- Work that was done on or in relation to the property that was realized: If a taxpayer made an attempt to improve the property's marketability while it was under the taxpayer's possession, then it is probably revenue from a business operation.
- The events that resulted in the selling of the property: The quick sale of cryptocurrencies by a taxpayer may have been caused by an unexpected emergency or a chance that required fast cash. In that situation, it is likely that courts will prevent a conclusion that the original acquisition was motivated by an intention to sell the property.
- The most crucial element is this: One of the most crucial factors in evaluating whether a gain is of a capital or income type is the purpose at the time of purchasing an asset, which may be inferred from the context and direct evidence. Alternately, courts will consider it income from a business if a taxpayer has a secondary plan to sell the property in the event that things don't work out before acquisition.
T1135 Foreign Reporting Requirements With Respect to Cryptocurrency
Any "specified foreign property" with a total cost of more than $100,000 must be reported to the Canada Revenue Agency (CRA) and the T1135 form must be submitted by the taxpayer at any time throughout the year. Cryptocurrencies, NFTs, and other blockchain-based assets are typically included in the definition of "specified foreign property" under the Income Tax Act. It does not, however, apply to property that is kept or utilized only for the purpose of running a business.
A penalty of at least $100 or $25 per day for each day the T1135 form is late, up to a maximum penalty of $2,500, may be imposed for failure to file the form. If the CRA issues a demand for the return, and if the individual fails to file the T1135 form willfully or under circumstances that constitute gross negligence, the penalty is $1,000 per month for each month the form is late, up to a maximum of $24,000. If the form is submitted more than 24 months late, further fines could be imposed.
Failure To File T1135 and Voluntary Disclosure
The Voluntary Disclosure Program (VDP) is intended to provide taxpayers a second chance to fix prior errors on their tax returns or disclose unreported income in exchange for a penalty or interest reduction, so taxpayers who fail to complete their T1135 forms by the deadline shouldn't worry. However, a VDP application must meet certain requirements in order for the CRA to approve it:
- involve the application of penalties or the prospect of penalties;
- Incorporate data that is at least a year old; and
- Incorporate the payment of the upcoming anticipated tax.
The CRA has stated that it is under no obligation to approve all VDP applications and that each VDP application would be evaluated on its own merits. (https://taxpage.com/voluntary-disclosure/) The CRA has the exclusive power to decide whether to accept an application.
Pro Tax Advice: A recipient spouse must accurately declare earnings from the subsequent sale of cryptocurrency or NFTs.
When a marriage fails and one of the partners received cryptocurrencies or NFTs, the former partner is required to accurately disclose any gains from the asset's subsequent sale. It is strongly advised that a taxpayer get professional guidance from a knowledgeable Canadian crypto tax lawyer if he or she is unsure of whether to classify the earnings as capital gains or business income. If a taxpayer fails to disclose such earnings, the VDP may provide a second chance to come clean with a portion of interest and penalties waived.
Question: Would there be any income tax ramifications if capital property is transferred between former spouses following a marriage breakdown?
Answer: If certain circumstances are satisfied, a rollover, which is basically a tax-free transfer, is automatic, and there is no need to submit an election or form with the CRA, no tax is triggered when the capital property is transferred between former spouses following a marriage breakdown.
Question: When is the deadline for completing the T1135 form?
Answer: The time limit for submitting the T1135 Your T1135 must be submitted no later than the deadline for your income tax return. The deadline for filing for individuals is typically April 30 of the following year. There may be differing filing dates for corporations and some testamentary trusts because of their potential for an off-calendar year-end.
Question: How much relief does the VDP offer?
Answer: The VDP provides two streams of programs: a general program that is more lenient and a restricted program that is more restrictive in terms of interest and penalty relief.
The taxpayer won't be penalized under the general program, and no criminal charges will be brought against them. The CRA may also waive 50% of the interest on assessments for years prior to the three most recent years of necessary returns.
There is no interest relief under the restricted scheme, but the taxpayer will not be penalized for excessive negligence or subject to criminal prosecution.
The CRA's capacity to provide penalty relief with respect to both programs is constrained to any taxation year that concluded within the preceding 10 years prior to the year the application is submitted.
"In this article, just a broad overview is given. It is just current as of the publication date. It may no longer be applicable because it hasn't been updated. Given that it doesn't provide legal advice, it cannot or shouldn't be relied upon. As every tax situation is unique to its own circumstances, it will differ from the situations mentioned in the articles. If you have particular legal queries, you should speak with a Canadian tax lawyer."