Your Legal Fees are Tax Deductible if You Hired a Canadian Tax Lawyer for a Cryptocurrency Tax Audit, Cryptocurrency Tax Objection, or Cryptocurrency Tax Court Appeal

Introduction – The CRA’s Cryptocurrency-Targeting Campaign

The Canada Revenue Agency hasn’t been shy about its campaign targeting Canadians who engaged in cryptocurrency transactions. The CRA seeks to identify Canadians who dealt in cryptocurrency and confirm that those taxpayers accurately reported their crypto transactions on their Canadian income-tax returns.

The Canada Revenue Agency will often target specific Canadians after forcing a cryptocurrency exchange or financial institution to release records for an entire class of taxpayers. For example, in March 2021, the CRA obtained a court order compelling the Canadian cryptocurrency exchange Coinsquare to identify all Canadian customers holding cryptocurrency accounts with a value of $20,000 or more during the 2014-2020 period. The account holders are then shocked when they receive the CRA’s 13-page tax-audit questionnaire about their transactions involving cryptocurrency such as Bitcoin (BTC), Bitcoin Cash (BHC), Litecoin (LTC), Ethereum (ETH), Chainlink (LINK), Dash, Zcash (ZEC), and Ripple (XRP).

Fortunately, many Canadian cryptocurrency users have avoided or mitigated tax liability and criminal prosecution through early engagement of an experienced Canadian crypto lawyer, who may need to represent these taxpayers not only with the cryptocurrency tax audit but also with a subsequent cryptocurrency tax objection or cryptocurrency tax appeal.

Unbeknownst to many Canadians, Canada’s Income Tax Act permits taxpayers to deduct legal fees relating to income-tax disputes. The same holds true for income-tax disputes concerning a taxpayer’s cryptocurrency transactions or cryptocurrency holdings. After providing a general overview of the tax-dispute process, this article discusses the tax rules allowing taxpayers to claim deductions for the legal fees that they incurred in relation to cryptocurrency-tax audits, cryptocurrency-tax objections, and cryptocurrency-tax appeals.  After discussing these crypto-tax deductions, this article ends by giving pro crypto tax tips from our top certified specialist in taxation Canadian crypto-tax lawyers to Canadian cryptocurrency traders and investors.

Canadian Cryptocurrency Tax-Dispute Process

As mentioned above, the CRA triggers a cryptocurrency tax dispute by selecting a taxpayer for a cryptocurrency tax audit. The Canada Revenue Agency’s crypto-tax auditor typically begins that process by sending the taxpayer a letter that includes the CRA’s 13-page tax-audit questionnaire.

The latest version of the CRA’s tax-audit questionnaire contains over 50 questions covering a range of topics, such as the taxpayer’s timeline of owing or using cryptocurrency; the source of the cryptocurrencies purchased and the source of the funds used to purchase those cryptocurrencies; the use of third-party exchange wallets; the taxpayer’s record-keeping practices; the taxpayer’s participation in initial coin offerings (ICOs); participating in cryptocurrency mining (i.e., proof-of-work validation), cryptocurrency staking (i.e., proof-of-stake validation), and liquidity mining or yield farming; the sort of mining hardware used and energy expenses related to mining; acceptance of cryptocurrency as payment for goods or services; the frequency of cryptocurrency transactions; and the time spent studying cryptocurrency markets. The taxpayer must also turn over bank-account statements, crypto-exchange records, crypto-wallet records, and any other records allowing the CRA crypto-tax auditor to verify the taxpayer’s questionnaire answers.  

When the CRA’s Audit Division completes its review of the taxpayer’s cryptocurrency-transaction records and other supporting documents, the CRA’s Audit Division will decide whether to adjust the cryptocurrency-related income that the taxpayer reported. If the CRA decides to conclude the crypto-tax audit without making any adjustments to the taxpayer’s income, the crypto-tax auditor will notify the taxpayer of this decision. 

If, on the other hand, the CRA decides that an adjustment is warranted, the crypto-tax auditor will send the taxpayer a letter outlining the income adjustments and penalties (e.g., gross-negligence penalties) that the Canada Revenue Agency proposes to apply. The letter will also summarize the crypto-tax auditor’s reasons for proposing the income adjustments and penalties, and it will generally give the taxpayer 30 days to deliver a response; otherwise, the CRA will reassess the taxpayer in accordance with the crypto-tax auditor’s proposal.

Upon receiving this letter (commonly called a proposal letter or 30-day letter), the taxpayer should, if the taxpayer hasn’t already do so, retain a knowledgeable Canadian crypto-tax lawyer, who can ensure that the crypto-tax auditor has acted in accordance with the taxpayer’s rights, identify the assumptions and errors underlying the crypto-tax auditor’s proposal, advise the taxpayer of the supporting documents required to demolish the crypto-tax auditor’s assumptions, and prepare a comprehensive response to the auditor’s proposal letter.

In any event, if the CRA’s Audit Division decides to reassess the taxpayer as proposed by the crypto-tax auditor, the Canada Revenue Agency will issue to the taxpayer a notice of reassessment reflecting the proposed income adjustments and penalties. To challenge the reassessment, the taxpayer or the taxpayer’s Canadian crypto-tax lawyer must file a notice of objection within 90 days from the date on the crypto-tax assessment. If the taxpayer fails to meet that 90-day deadline, the taxpayer might qualify for a time  extension, but the taxpayer or the taxpayer’s Canadian crypto-tax lawyer must apply for this extension within one year and 90 days from the date on the crypto-tax reassessment.

A notice of objection triggers the CRA’s administrative dispute-resolution process, and the Canada Revenue Agency’s Appeals Division will assign an appeals officer to review the merits of the cryptocurrency-tax objection. If the CRA’s appeals officer renders an unfavourable decision, the taxpayer or the taxpayer’s Canadian crypto-tax litigation lawyer may initiate a cryptocurrency-tax appeal by filing a notice of appeal to the Tax Court of Canada.

To initiate a cryptocurrency-tax appeal, the taxpayer or the taxpayer’s Canadian crypto-tax litigation lawyer must appeal to the Tax Court of Canada within 90 days from the date on the notice of confirmation from the CRA’s Appeals Division. Taxpayer or the taxpayer’s Canadian crypto-tax litigation lawyer may apply for an extension of time if the taxpayer missed the 90-day deadline, but it is far harder to obtain an extension from the Tax Court of Canada (than from the CRA’s Appeals Division at the objection stage). If you don’t exercise your objection or appeal rights within the statutory deadlines, you’ll be personally stuck with the crypto-tax debt and crypto-tax penalties that the auditor initially assessed, even if the tax auditor made mistakes.

It should go without saying that, as with other forms of litigation, cryptocurrency-tax litigation is a complicated affair. It’s subject to numerous procedural rules governing almost every aspect of the lawsuit, including specific deadlines, acceptable evidence, settlement negotiations, and the contents of pleadings. Consult one of our skilled Canadian crypto-tax litigation lawyers who can simplify the cryptocurrency-tax litigation process, prepare your case for Tax Court, and either represent you during the hearing at the Tax Court of Canada or settle your appeal with the Canadian tax lawyer representing CRA.

Canadian Income-Tax Deductions for Legal Fees Relating to Cryptocurrency-Tax Audits, Cryptocurrency-Tax Objections & Cryptocurrency-Tax Appeals

Cryptocurrency-tax disputes often invoke numerous legal issues relating not only to the substantive tax rules governing the treatment of the cryptocurrency transactions themselves, but also to procedural rules and evidence law. Moreover, in tax disputes, the taxpayer bears the initial burden of disproving the CRA’s factual assumptions. As a result, the taxpayer’s Canadian crypto-tax lawyer must typically perform an extensive amount of work to properly represent the taxpayer. And this work is reflected in the lawyer’s legal bill.

Thankfully, Canada’s tax rules allow a taxpayer to claim deductions for the legal fees that the taxpayer incurred for representation during a cryptocurrency-tax objection or cryptocurrency-tax appeal. Subparagraph 60(o)(i) of Canada’s Income Tax Act permits a taxpayer to deduct “amounts paid by the taxpayer in the year in respect of fees or expenses incurred in preparing, instituting or prosecuting an objection to, or an appeal in relation to, an assessment of tax, interest or penalties under [the Income Tax Act] or an Act of a province that imposes a tax similar to the tax imposed under [the Income Tax Act].” This provision covers the legal fees relating to (1) the preparation and filing of a notice of objection to the CRA’s Appeals Division, (2) legal representation during the objection process, (3) the preparation and filing of a notice of appeal to the Tax Court of Canada, (4) legal representation during the tax-litigation process, and (5) legal representation during post-Tax Court appeals (e.g., a tax appeal to Canada’s Federal Court of Appeal or to the Supreme Court of Canada). The deduction under subparagraph 60(o)(i) also applies to accounting expenses that a taxpayer incurred in relation to a tax objection or tax appeal.

Moreover, even though subparagraph 60(o)(i) doesn’t explicitly mention tax audits, the Canada Revenue Agency accepts that this tax deduction also applies to “amounts expended in connection with legal and accounting fees incurred for advice and assistance in making representations after having been informed that the taxpayer’s income or tax for a taxation year is to be reviewed, whether or not a formal notice of objection or appeal is subsequently filed.” (Canada Revenue Agency, IT-99R5, December 11, 1998, “Income Tax Act: Legal and Accounting Fees,” at para 7.) In other words, as a matter of administrative practice, the CRA will allow a taxpayer to deduct legal fees and accounting fees relating to representation during a tax audit—even if that tax audit didn’t lead to a tax objection or tax appeal.

Accordingly, the legal fees (and accounting fees) that a taxpayer incurred in relation to a cryptocurrency-tax audit, cryptocurrency-tax objection, or cryptocurrency-tax appeal are fully deductible for the year in which the corresponding invoice was issued. For example, the taxpayer may claim payments toward the invoices that the taxpayer’s Canadian crypto-tax litigation lawyer issued in 2023 as deductions on the taxpayer’s income-tax return for the 2023 taxation year.  

Pro Tax Tips: Early Engagement of an Expert Canadian Crypto-Tax Lawyer & Fast-Tracking a Tax Court Appeal

As mentioned above, if the CRA’s crypto-tax auditor intends to reassess a taxpayer for cryptocurrency-related income and penalties, the auditor will first send a proposal letter (also called a 30-day letter). If the taxpayer hasn’t already done so, the taxpayer should retain a knowledgeable Canadian crypto-tax lawyer upon receiving the Canada Revenue Agency’s proposal letter.

But the taxpayer should ideally involve an expert Canadian crypto-tax lawyer far earlier—in particular, when the CRA first notifies taxpayer about the pending crypto-tax audit. Although you need not answer every question that a CRA crypto-tax auditor asks during a cryptocurrency-tax audit, you should understand that the tax auditor may draw an unfavourable inference when you refuse to answer questions. The CRA is also free to make assumptions and to assess tax based on those assumptions. Moreover, during a Tax Court appeal, that taxpayer’s knowledgeable Canadian crypto-tax litigation lawyer bears the onus of rebutting any assumptions made by a CRA tax auditor. In other words, whether you face a cryptocurrency-tax audit or any other form of tax audit, you must pick your battles. Otherwise, you risk facing a slew of outlandish CRA assumptions.

Canadian cryptocurrency traders and investors can generally avoid these problems through early engagement of a Canadian crypto-tax lawyer, who can advise them of their rights, determine when it may actually help their case to answer a crypto-tax auditor’s questions, prepare them or other potential witnesses for the tax auditor’s questions, and ensure that their responses to the Canada Revenue Agency’s cryptocurrency tax-audit questionnaire are accurate, relevant, clear, and succinct. 

For some taxpayers in certain circumstances, it may prove strategically advantageous to skip the cryptocurrency-tax objection and fast-track a Tax Court Appeal. This might occur when, for example, the taxpayer’s case primarily turns not on documentary evidence but on oral testimony, which the Canada Revenue Agency’s Appeals Division will refuse to consider. If the approach makes sense strategically or practically, the taxpayer or the taxpayer’s Canadian crypto-tax litigation lawyer may effectively bypass the CRA’s Appeals Division and go directly to the Tax Court of Canada. To do this, the taxpayer’s Canadian crypto-tax litigation lawyer must first file the cryptocurrency-tax objection and wait 90 days. At that point, the taxpayer may file the notice of appeal to the Tax Court of Canada.  To determine whether this approach makes sense in your case, speak with one of our skilled Canadian crypto-tax litigation lawyers today.

Frequently Asked Questions

The Canada Revenue Agency sent me a letter saying that I’ve been selected for a cryptocurrency-tax audit. What can I expect? What should I do?

If you haven’t already, you should soon receive the CRA’s 13-page tax-audit questionnaire. The latest version of the CRA’s tax-audit questionnaire contains over 50 questions covering a range of topics, like the taxpayer’s timeline of owing or using cryptocurrency; the source of the cryptocurrencies purchased and the source of the funds used to purchase those cryptocurrencies; the use of third-party exchange wallets; the taxpayer’s record-keeping practices; the taxpayer’s participation in initial coin offerings (ICOs); participating in cryptocurrency mining (i.e., proof-of-work validation), cryptocurrency staking (i.e., proof-of-stake validation), and liquidity mining or yield farming; the sort of mining hardware used and energy expenses related to mining; acceptance of cryptocurrency as payment for goods or services; the frequency of cryptocurrency transactions; and the time spent studying cryptocurrency markets. You must also submit bank-account statements, crypto-exchange records, crypto-wallet records, and any other records allowing the CRA crypto-tax auditor to verify your answers in the questionnaire.  

When the CRA’s Audit Division completes its review of your questionnaire responses, cryptocurrency-transaction records, and other supporting documents, the CRA’s Audit Division will decide whether to adjust the cryptocurrency-related income that you reported. If the CRA decides to conclude the crypto-tax audit without making any adjustments to your income, the crypto-tax auditor will notify you of this decision.  If, on the other hand, the CRA decides that an adjustment is warranted, the crypto-tax auditor will send you a letter outlining the income adjustments and penalties (e.g., gross-negligence penalties) that the Canada Revenue Agency proposes to apply. The letter will also summarize the crypto-tax auditor’s reasons for proposing the income adjustments and penalties, and it will generally give you 30 days to deliver a response; otherwise, the CRA will reassess you in accordance with the crypto-tax auditor’s proposal.

You should retain a knowledgeable Canadian crypto-tax lawyer, at the very latest, upon receiving this letter (commonly called a proposal letter or 30-day letter). Our Canadian crypto-tax lawyers can ensure that the crypto-tax auditor has acted in accordance with your rights, identify the assumptions and errors underlying the crypto-tax auditor’s proposal, advise you of the supporting documents required to demolish the crypto-tax auditor’s assumptions, and prepare a comprehensive response to the tax auditor’s proposal letter.

That said, you should ideally involve our expert Canadian crypto-tax lawyers long before you receive the CRA’s proposal letter—in particular, right now. Although you need not answer every question that a CRA crypto-tax auditor asks during a cryptocurrency-tax audit, you should understand that the tax auditor may draw an unfavourable inference when you refuse to answer questions. The CRA is also free to make assumptions and to assess tax based on those assumptions. Moreover, during a Tax Court appeal, you bear the onus of rebutting any assumptions made by a CRA tax auditor. So, without intervention by an expert Canadian crypto-tax lawyer, you risk facing a slew of outlandish CRA assumptions. You can generally avoid these problems through early engagement of our Canadian crypto-tax lawyers, who can advise you of your rights, determine when it may actually help your case to answer a crypto-tax auditor’s questions, prepare you or other potential witnesses for the tax auditor’s questions, and ensure that your responses to the Canada Revenue Agency’s cryptocurrency tax-audit questionnaire are accurate, relevant, clear, and succinct.

The Canada Revenue Agency has reassessed me for crypto tax and crypto penalties. I want to hire a Canadian crypto-tax lawyer to represent me, but I’m concerned about legal fees. Is there any tax relief available for the legal fees that I incur because of the Canada Revenue Agency?

Yes. Canada’s tax rules allow a taxpayer to claim deductions for the legal fees that the taxpayer incurred for representation during a cryptocurrency-tax objection or cryptocurrency-tax appeal. Subparagraph 60(o)(i) of Canada’s Income Tax Act permits a taxpayer to deduct “amounts paid by the taxpayer in the year in respect of fees or expenses incurred in preparing, instituting or prosecuting an objection to, or an appeal in relation to, an assessment of tax, interest or penalties under [the Income Tax Act] or an Act of a province that imposes a tax similar to the tax imposed under [the Income Tax Act].” This provision allows you to deduct the legal fees that your Canadian crypto-tax lawyer charged to represent you with your crypto-tax objection.

Those legal fees are fully deductible for the taxation year in which the corresponding invoice was issued. For example, you may claim payments toward the invoices that the taxpayer’s Canadian crypto-tax lawyer issued in 2021 as deductions on your income-tax return for the 2021 taxation year. 

I recently received a crypto-tax reassessment, and I want to dispute the resulting crypto taxes in the Tax Court of Canada. What should I do now?

Even if you want to take the dispute to Tax Court, you must still file a notice of objection with the Canada Revenue Agency’s Chief of Appeals. The objection itself must be filed within 90 days of the date on the reassessment. After filing your objection, you must then allow at least 90 days to elapse. After that period elapses, you may file a notice of appeal with the Tax Court of Canada.

You should keep in mind that this approach might not be the best for your particular circumstances. For some taxpayers in certain circumstances, it may prove strategically advantageous to skip the cryptocurrency-tax objection and fast-track a Tax Court Appeal. This might occur when, for example, the taxpayer’s case primarily turns not on documentary evidence but on oral testimony, which the Canada Revenue Agency’s Appeals Division will refuse to consider. To determine whether this approach makes sense in your case, speak with one of our skilled Canadian crypto-tax litigation lawyers today.

Moreover, as with other forms of litigation, cryptocurrency-tax litigation is a complicated affair. It’s subject to numerous procedural rules governing almost every aspect of the lawsuit, including specific deadlines, acceptable evidence, settlement negotiations, and the contents of pleadings. Consult one of our skilled Canadian crypto-tax litigation lawyers who can simplify the cryptocurrency-tax litigation process, prepare your case for Tax Court, and either settle your appeal with the Crown and the CRA or represent you during the hearing at the Tax Court of Canada.

DISCLAIMER: This article provides only general information and contains no legal advice. This article is current only as of the publishing date. It will not be updated, so it may no longer be relevant on the day that you read it. This article is not a substitute for legal advice. Each tax circumstance is unique to its facts and may not qualify for any perceived remedy described in this article. You should contact a Canadian tax lawyer if you have specific legal inquiries.