Tax Implications: Ontario Crypto Trading Exchanges Introduce Net Annual Purchase Limit for Retail Investors
Published: September 30, 2022
Understanding the net buy limit: retail investors cannot buy more altcoins beyond the $30,000 net limit per year
On August 16, Newton, a leading Canadian cryptocurrency exchange based out of Toronto, announced that it would impose an annual “net buy limit” of $30,000 for certain crypto assets. As of now, residents of BC, Alberta, Manitoba, and Quebec will not be affected. However, investors who live in other Canadian provinces will be subject to this new measure.
Under the new rule, there will be an annual net buy limit of $30,000 on all cryptocurrencies excluding 4 “unrestricted cryptocurrencies” consisting of Bitcoin, Ethereum, Litecoin, and Bitcoin Cash. Investors purchasing altcoins, or “restricted cryptocurrencies” as designated by Newton, can use some of their limit and can regain the limit by selling some of the coins. Newton also noted that the investors need to fill out a “trading questionnaire” in order to continue to trade on the platform. The questionnaire is aimed at collecting information such as the investors’ experience and knowledge of crypto trading, financial situation, and risk tolerance. According to Newton, the net buy limit will reset each year on the date that the investor completed the trading questionnaire.
In the announcement, Newton highlighted this new measure as part of its effort to ensure compliance with the Ontario Securities Commission (OSC), the securities regulator in Ontario, and securities regulatory authorities in other provinces. By requiring investors to fill in a questionnaire, this measure will better protect retail investors and make sure they are aware of the potential market risks. As Newton has registered as a restricted dealer with the OSC, it is required to implement some important Know Your Customer (KYC) and anti-money laundering measures in order to continue its process of eventually receiving Investment Industry Regulatory Organization of Canada (IIROC) membership and becoming a full investment dealer.
This new compliance move has become a common theme among Canadian cryptocurrency exchanges or crypto asset trading platforms (CTPs) as termed by the OSC. Bitbuy, another major exchange, has announced a similar “net purchase limit” of $30,000 for retail investors while capping at $100,000 for some eligible investors and a further unrestricted amount for accredited investors. Similar annual limits were also introduced by platforms such as Wealthsimple and VirgoCX, which obtained registration with regulators in different provinces earlier than Newton.
Impacts on Investors: averaging down and other investment strategies may become unfeasible
In the highly competitive and sophisticated markets that many crypto-savvy investors participate in, much depends on the freedom to carry out a transaction as quickly as possible and to use trading strategies to secure gains and protect against losses. Notwithstanding its creditable goal of investor protection, the net annual buy limit will effectively make some trading strategies difficult to execute or untenable. For example, when the market falls, an investor may want to mitigate their loss by buying additional crypto assets at a discounted price, hoping that in the long run, there will be a market uptrend (average down purchasing). The main benefit of this strategy is that the investor will enjoy a lowered average cost base for these assets. Conversely, investors can buy into a market rally to amplify future returns. These are widespread and effective strategies investors use in liquid and volatile markets such as cryptocurrencies.
With the annual net buy limit rule in place, investors who have maxed out this amount will find themselves in a difficult situation when additional buys are disallowed. Fortunately, they can take a few approaches to overcome, or at least partially minimize, the impacts of such a rule. The remainder of this article will analyze some of the available options for investors and their respective tax consequences. However, if a crypto investor is adversely affected by the inability to purchase additional altcoins, then an argument could be made that the value of the old coin is less than the posted price. This would be a strategy to be discussed with one of our experienced Canadian crypto tax lawyers in appropriate circumstances.
How to work around the limit: doing a “coin to coin” exchange or registering multiple accounts on different exchanges
Investors can buy unrestricted cryptocurrencies (such as Bitcoin and ETH) from their account on a centralized exchange, then transfer these coins to a decentralized exchange. Investors can then purchase as many altcoins as they want. Generally, centralized exchanges are riskier because they can be subject to thefts, hardware failures, or poor management. Moreover, each user on a centralized exchange has no control over their private keys. In contrast, on decentralized exchanges, users retain control of their private keys because there’s no integrated hot wallet.
Using decentralized storage will also provide a higher level of privacy because many allow transactions to remain anonymous. However, there are some disadvantages to trading on decentralized exchanges. Firstly, decentralized exchanges are usually less liquid, so transactions may happen slower. This can become particularly problematic if the investors need to execute a trade as fast as possible before the market reacts to the news. Secondly, because liquidity is lower on decentralized exchanges, this can sometimes enable large “whale investors” to manipulate prices at the expense of smaller investors.
Another way to bypass this restriction is to set up accounts at multiple exchanges. By doing this, investors are able to take advantage of the different trading limits offered by each exchange. For example, Bitbuys allows an annual 30k net purchase limit for retail investors, while for more sophisticated investors, this limit can be increased or waived.
Tax consequences: anonymous trades are taxable and can still be traced; taxpayers should beware of the risk of increased transaction frequencies
Although transactions on a decentralized exchange may be anonymous, they are still traceable by the CRA. It is worth mentioning that taxpayers who are holding or trading cryptocurrencies have the option to participate in the CRA’s Voluntary Disclosure Program (VDP) before potential audits. If selected for a cryptocurrency tax audit, investors will be probed to report their trading information, including the types of cryptocurrencies they have bought and sold and the use of third-party exchange wallets.
Taxpayers should not underestimate the tax authority’s willingness and ability to trace and track their transactions, especially when the wallets can be tied to themselves and or businesses they own. The CRA also has the power to compel third parties, including exchanges, to disclose a taxpayer’s account information, even if the taxpayer is not being audited. In fact, in 2020, CRA obtained a court order requiring the Coinsquare exchange to disclose confidential information about its clients’ cryptocurrency trading and holding.
Although sending coins between wallets will not trigger taxes, selling or exchanging cryptocurrencies are taxable events. When taxpayers exchange one crypto asset for another, for example, swapping BTC for DAO, the exchange effectively consists of two transactions. The first is where the crypto assets are disposed of, and the second is where the new crypto assets are purchased. As a rule of thumb, when a taxpayer sells a property, the income can either be characterized as business income or capital gain. Regardless of the characterization, the disposition of the first type of crypto asset will be taxable, while there’s no additional tax liability for the second crypto asset they exchanged it for. This is clearly outlined in the recent CRA Guide for cryptocurrency users and tax professionals. The CRA states that business income or capital gains may arise from the disposition of a cryptocurrency and that a “disposition” may include “trade or exchange cryptocurrency, including disposing of one cryptocurrency to get another cryptocurrency.”
Assuming the investor is not buying/trading as a hobbyist (who usually does not engage in large-volume, high-value transactions), frequent buying and withdrawing from an exchange may indicate that the taxpayer’s intention is not to trade but to invest. As a result, the use of the withdrawn coins might be capital property instead of inventory, and the proceeds from future dispositions of the crypto assets may be considered capital gain/loss instead of business income/loss. Characterizing the income as capital gain could be desirable if the crypto assets have appreciated in value because the capital gains are only taxable at 50%. This treatment of cryptocurrency tax in Canada is particularly useful for investors expecting profits.
To the contrary, when investors have suffered a loss, they may want the crypto assets to be characterized not as capital assets but as inventory. Only half of a capital loss is allowable and it can only be used to set off capital gains (which they may not have). In contrast, the full amount of business loss is deductible against income from all sources.
The taxpayer may be able to prove that they are, in fact, in the business of trading or vice versa. The taxpayer could achieve this by showing such evidence that after retrieving crypto assets from one exchange, he or she moved such assets to a different exchange where he or she maintains an active trading account. Establishing such a claim depends on the correct reporting of crypto taxes and all relevant transactions.
Similarly, if the taxpayer has multiple trading accounts across exchanges, there is a risk of artificially increasing the frequency of transactions. This is not as significant a problem if the investors are expecting losses (as discussed above, there are tax advantages in characterizing losses as business losses). However, if the investors foresee appreciated crypto asset prices, it will increase the difficulty for them to claim the proceeds as capital gains.
Pro-Tax Tips: consult a crypto tax lawyer before implementing new crypto investment strategies
As securities regulators across Canadian provinces and territories are making progress in creating a standardized regulatory framework for crypto asset exchanges, the number of exchange registration will continue to increase. This trend will likely compel the exchanges to enforce more stringent KYC and Anti-Money Laundering initiatives in order to maintain compliance with the regulation. Taxpayers who formerly invested on these exchanges may be required to make changes to their portfolios or switch to an alternative platform. More importantly, depending on the types of crypto assets involved, the amount invested, and the duration of the holdings, among other factors, the taxpayer may face a complex challenge in reporting the potential proceeds that arise when the crypto assets are disposed of. Specifically, the taxpayer may seek to report the proceeds as capital gain to take advantage of the lower taxable amount, which in turn requires careful examination of the records and tax planning. Advance tax planning is key to maximizing your chances of a successful capital gains claim. Our team of experienced Toronto crypto tax lawyers can research your specific circumstances and provide you with tax planning advice or with a reasonable filing position so you can withstand a vigorous CRA crypto tax audit.
Are the proceeds business income or a capital gain if I sell my crypto assets in exchange for fiat currencies or another crypto token?
Characterizing income earned through the disposition of crypto assets is heavily fact-dependent. The taxpayers are best advised to consult a legal expert to comprehensively analyze their particular cases. For further information, please see Taxation of Buying and Selling Stocks and Cryptocurrency: Capital Gains or Income?—A Canadian Tax Lawyer Analysis
Can I deduct exchange withdrawal fees when I report my income?
Suppose the income is characterized as capital gain. In that case, the gain is calculated by subtracting the adjusted cost base and the selling expenses (which includes the withdrawal fee your exchange charges) from the proceeds of disposition.
If the income is characterized as business income, the withdrawal fee can be deducted as part of the operating expense of the business.
Is a transfer of crypto from one exchange to another exchange a taxable transaction?
Suppose an investor moves cryptocurrencies between two wallets that he or she owns, regardless of whether this is done between accounts or exchanges. In that case, there is no disposition, and the transaction will not be taxable. Even if the transfer is made to himself/herself, he or she still needs to maintain proper records, including the price paid for the crypto. This is because the original cost will determine the cost base of the asset once it is sold.