How to Pay Employees with Crypto in Canada?

A Crypto Tax Lawyer's Guide to Paying Employees in Crypto: Income Tax Classification, Withholding Requirements, and Benefits and Drawbacks

As mainstream adoption of cryptocurrency becomes more prevalent, employers should develop the capacity to respond to demands for crypto compensation. Understanding how to offer cryptocurrency compensation, the income and payroll tax consequences, and the associated benefits is essential for both employees and employers. This article will explore these topics in depth.

Methods to Offer Digital Currency Compensation

Currently, there are two common ways to compensate employees and independent contractors in cryptocurrency.

Direct Payments

One option is for employers to pay their employees or independent contractors directly in cryptocurrency. This can be the full amount or a portion of their salary, wages, or other remuneration. Employers can purchase cryptocurrency through a corporate account on an exchange. Numerous exchanges are available to Canadian businesses, including WonderFi, Newton, Shakepay, and Coinbase. After purchasing cryptocurrencies, employers can transfer the amounts owed directly to the digital wallets of their employees or independent contractors.

Third-Party Services

The second option is for employers to use a third party. This third party receives the compensation in fiat from the employer and converts it to the designated cryptocurrency based on the employee or independent contractor’s chosen allocation. Companies like Blockrewards, one of Canada's largest bitcoin compensation operator, provide these services. The process generally involves creating an account with the service, funding a payroll account, and selecting the desired method and allocation of payment. The service will calculate the appropriate withholding and deposit the correct amount of cryptocurrency as wages to the employee, less applicable deductions.

Both options are frequently utilized. If a business is considering purchasing cryptocurrency for more than just payroll needs, creating a corporate account on an exchange provides flexibility to hold, trade, and make other business transfers seamlessly. Exchanges also provide supporting documentation of transaction history, which can assist accountants with tax filing. These websites allow users to calculate their tax liability from cryptocurrency transactions by combining records from multiple platforms, generating tax reports and Schedule 3 Tax Forms to report capital gains or losses.

However, if a business is only considering purchasing cryptocurrency for payroll, using a third party may be the preferred option. These services are dedicated to processing payroll in digital currencies and can reduce administrative hurdles.

Income Tax Considerations

Employees and Independent Contractors

In Canada, many rules that apply to paying wages to employees also apply to paying remuneration in cryptocurrency. According to subsection 5(1) of the Income Tax Act (the “Act”), a taxpayer’s employment income includes “salary, wages, and other remuneration, including gratuities” received within the relevant taxation year. This provision has been interpreted broadly to capture most payments made to employees by virtue of their employment status. Employment income earned by the taxpayer is recognized in the year it is received. Therefore, if an employer pays remuneration in cryptocurrency, the fair market value of that cryptocurrency at the time it is received must be included in the taxpayer’s income for the relevant tax year. The Canada Revenue Agency (the “CRA”) has stated:

"Where an employee receives digital currency as payment for salary or wages, the amount (computed in Canadian dollars) will be included in the employee’s income pursuant to subsection 5(1) of the Act.”

Independent contractors may also choose to receive compensation in cryptocurrency. Unlike employees, the income earned by independent contractors is characterized as being from business or property under the Act. Generally, this characterization is preferable for independent contractors, as it allows for more favorable tax treatment for the deduction of expenses. Independent contractors can deduct certain business expenses that are not available to employees. A discussion of whether a worker is an employee or independent contractor is beyond this article's scope, but like employees, independent contractors must include cryptocurrency remuneration in their income.

Additionally, paragraph 6(1)(a) of the Act states that “the value of board, lodging, and other benefits of any kind whatever received or enjoyed by the taxpayer” by virtue of their employment is generally included in the taxpayer’s income for the year the benefit is received. Thus, if an employer confers non-cash benefits, including cryptocurrency, the fair market value of the benefit must be included in the taxpayer’s income and is subject to taxation. Employers cannot make “voluntary payments” to circumvent this provision. The CRA has articulated:

“Sometimes individuals receive a voluntary payment or other valuable transfer or benefit by virtue of an office or employment from an employer. In such cases, the amount of the payment or the value of the transfer or benefit is generally included in employment income pursuant to subsection 5(1) or paragraph 6(1)(a).”

When an employee disposes of cryptocurrency paid by an employer, the income received will be characterized as either business income or a capital gain. This characterization is important because only one-half of a capital gain must be included in a taxpayer’s income, while all business income is subject to tax at the applicable marginal rate. The CRA considers several factors to determine whether a taxpayer dealing with cryptocurrency is engaged in business:

1. The taxpayer carries on activity for commercial reasons and in a commercially viable way.

2. The taxpayer undertakes activities in a businesslike manner, which might include preparing a business plan and acquiring capital assets or inventory.

3. The taxpayer promotes a product or service.

4. The taxpayer shows intent to make a profit, even if unlikely in the short term.

5. The date on which the taxpayer’s alleged business activities began.

6. The taxpayer is engaged in an adventure of concern in the nature of trade.

   
   

The Act defines “business” to include “an adventure or concern in the nature of trade.” Courts have held that an “adventure or concern in the nature of trade” may include an isolated transaction where the taxpayer buys property intending to sell it at a profit. Although a taxpayer entering into an isolated transaction will not be considered a trader, if the transaction was intended to yield a profit and was not undertaken as an investment, it would likely be considered in the nature of business.

Employees receiving cryptocurrency as remuneration should aim for capital gains treatment by avoiding characterization as business income. Individual circumstances will vary, but generally, taxpayers should limit the number of transactions related to their cryptocurrency holdings, avoid trading, and hold their crypto assets for a prolonged period to be characterized as an investment. If an employee’s income from cryptocurrency is considered a capital gain, the eventual disposition will depend on the fair market value at the time of the disposition less the adjusted cost basis of the cryptocurrency. However, the initial fair market value of any cryptocurrency paid to an employee must be included in income for the year it was received.

Employers

From the employer’s perspective, if it pays employees in cryptocurrency, it is responsible for withholding and remitting the appropriate amount of source deductions to the Receiver General regarding employment income. Generally, these amounts will include income tax withholding, contributions to the Canada Pension Plan, and employment insurance unless a relevant exception applies. Therefore, employers must calculate the correct fair market value of any cryptocurrency paid as remuneration to ensure proper remittances to the CRA. Failure to comply with withholding and remittance requirements may result in liability for the employee’s Canadian tax and any applicable penalties.

Payments and Remittances to Non-Residents

A Canadian employer may wish to make payments to non-resident employees with cryptocurrency. Generally, there is no provision under the Act preventing a Canadian-resident business from distributing employment income to a non-resident. However, employers should be aware of certain tax consequences that may apply. Specifically, paragraph 153(1)(a) of the Act and section 102 of the Income Tax Regulations impose a withholding and remittance requirement on amounts paid to both resident and non-resident employees performing employment duties inside Canada. If a non-resident individual (not an employee) renders services in Canada, paragraph 153(1)(g) of the Act and subsection 105(1) of the Regulations require the payor to withhold tax on fees, commissions, and other amounts paid to non-residents. Currently, the withholding rate for these individuals is 15% of the gross amount paid. Therefore, if a Canadian employer pays non-resident employees or independent contractors in cryptocurrency for services rendered in Canada, it must withhold proper amounts and make appropriate remittances to the CRA.

The tax consequences of paying non-resident employees with cryptocurrency depend largely on whether an applicable treaty exists between Canada and the non-resident's country. For instance, the Canada-U.S. Treaty provides that any remuneration exceeding $10,000 Canadian dollars paid to a non-resident for services rendered in Canada will be subject to Canadian taxation. Additionally, if payment is made by or on behalf of a Canadian resident to a non-resident employee providing services in Canada, that non-resident employee will be subject to Canadian income tax.

Accordingly, the taxation regime of cryptocurrency for Canadian resident taxpayers will apply to non-resident Americans providing services in Canada under the Canada-U.S. Treaty. Subsection 200(1) of the Regulations imposes an obligation on a Canadian employer to provide a T4 slip annually to an employee captured by paragraph 153(1)(a) and to file a T4 information return annually to the CRA outlining the employee’s income and applicable deductions.

Benefits and Drawbacks of Paying Cryptocurrency as Remuneration

Employer Benefits

In a time of increased voluntary unemployment, employers need to differentiate themselves to attract and retain talent. Offering compensation through cryptocurrencies provides a comparative advantage when hiring and retaining the best talent. Such employers can position themselves as forward-thinking by adopting this compensation method early.

Employers also benefit from streamlined cross-border payments to remote or international contractors. Payments to any digital wallet, whether foreign or local, can be completed in minutes. Compared to wire transfers, digital currency payments are significantly faster, as wire transfers typically take one to five days. Moreover, cryptocurrencies operate on the Blockchain, providing a transparent and verifiable ledger. These payments can be made at any time without needing to go through a bank, and at a fraction of the cost of typical international payments, with no immediate impact from international currency exchange rates on employees.

Employer Drawbacks

The volatility of cryptocurrency may discourage employers from paying wages in this form. Rapid market fluctuations can add unwanted unpredictability for employers purchasing cryptocurrencies to pay employees. To mitigate this risk, employers could retain a service to pay cryptocurrency directly to employees.

Employers should ensure that employees understand the potential for dramatic losses in value when receiving cryptocurrency as wages due to market volatility. Proper education on this volatility is essential for both employees and candidates to make informed compensation decisions.

Employers who choose to pay employees in cryptocurrency remain responsible for remitting source deductions on employee income. Tax reporting may become more complicated when withholding and remitting source deductions for cryptocurrency wages compared to fiat currency. While services are available to assist businesses in fulfilling their reporting and tax obligations, these services may charge fees, adding costs to the process. Additionally, employers will likely need to take extra administrative steps to document the compensation scheme, including inserting an authorization to pay employee wages in cryptocurrency in relevant employment contracts.

Employee/Independent Contractor Benefits

The benefits of cryptocurrency have been widely discussed, and this article will highlight a few practical advantages that may entice employees to seek remuneration in cryptocurrency.

First, cryptocurrency is often viewed as a long-term hedge against inflation. Its finite nature and fixed cap lead some to conclude that it is an effective tool against inflation compared to fiat currency, which can be manipulated by central banks. For example, Bitcoin has a fixed supply cap of 21 million BTC, while the CAD is subject to manipulation, leading to a significant increase in the Canadian money supply. Employees may find comfort in knowing that their cryptocurrency may serve as a hedge against inflation.

Second, offering employees the opportunity to receive cryptocurrency as compensation may be particularly useful for non-resident employees or independent contractors in areas where access to bank accounts is difficult. Since cryptocurrency is generally paid directly to a digital wallet, this allows employers to bypass banks entirely.

Third, paying employees in cryptocurrency allows for almost instantaneous payments. This is especially beneficial for non-resident individuals, where fiat currency remittances could take days to clear and are subject to bank rules and fees. Commercial services enable immediate distributions of cryptocurrency, helping employees pay bills or rent on time without unnecessary delays. This method also lowers barriers for individuals who might be discouraged from holding cryptocurrency. Those receiving remuneration in cryptocurrency through third-party services only need to set up a digital wallet; they do not need to trade on an exchange or make purchases independently.

Finally, if employees use a cryptocurrency exchange app, transfers of cryptocurrency into fiat currency are nearly instantaneous. As previously mentioned, this transfer would likely result in a taxable disposition under Canadian income tax law. Employees should note the price at which they initially acquired the cryptocurrency to ensure that any capital gains or losses are accurately accounted for.

Employee Drawbacks

The most immediate concern for employees receiving wages in cryptocurrency is the rapid fluctuation in value. If an employee receives cryptocurrency when its value is high, they will receive fewer units than when its value is lower. Employees must be prepared for some degree of volatility when choosing to receive cryptocurrency as remuneration. One approach to mitigate this risk is to allocate a balance of income between cryptocurrency and fiat currency instead of receiving the entirety in cryptocurrency.

Another potential disadvantage of receiving wages in cryptocurrency is the more complicated tax reporting obligations and compliance mechanisms compared to fiat currency. The CRA is increasingly aggressive in addressing non-compliance in cryptocurrency transactions. Therefore, employees receiving cryptocurrency as compensation should consider retaining accountants or tax advisors to assist with tax filings. This may add unexpected costs to receiving compensation in cryptocurrency. However, crypto accounting software is also available to individuals and can generate necessary tax forms and reports.

Conclusion

As cryptocurrency becomes more pervasive, employee interest in cryptocurrency remuneration will intensify. Employers should be prepared to meet these demands and understand the tax implications of compensating employees in cryptocurrency. Generally, employers have two options to pay employees in cryptocurrency: (1) open a business account with an exchange and purchase their own cryptocurrency, or (2) rely on third-party services to ease the process. It is crucial for employers to evaluate which option is most suitable for their business and the benefits and drawbacks that arise from this compensation method. Employers are encouraged to consult their tax practitioners to develop solutions that address their needs.

If you have not properly reported your crypto compensation to employees or if you are an employee who has received crypto but have not reported it to the CRA, consider the Voluntary Disclosure Application. It's important to report and disclose any cryptocurrency transactions to the CRA to avoid any Tax Audits.

Resources

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1 Koinly, “Bitcoin Tax Calculator for Canada” online: Koinly https://koinly.io/ canada/; Sam Stone, “Cryptocurrency Taxes in Canada” (April 23, 2019) online: CoinTracker https://www.cointracker.io/blog/cryptocurrency- taxes-in-canada.

2  R.S.C. 1985, c 1 (5th Supp) [“ITA”].

3  Ibid., at s. 5(1).

4 Canada Revenue Agency, “What You Should Know About Digital Currency” (March 17, 2015) online: Government of Canada https://www.canada.ca/ en/revenue-agency/news/newsroom/fact-sheets/fact-sheets-2013/what-you-should-know-about-digital-currency.html.

5  ITA, supra note 2 at s. 9(1).

6 Ibid., at s. 6(1)(a).

7 Canada Revenue Agency, “Income Tax Folio S3-F9-C1, Lottery Winnings, Miscellaneous Receipts, and Income (and Losses) from Crime” (July 3, 2020), online: Government of Canada https://www.canada.ca/en/reven-ue-agency/services/tax/technical-information/income-tax/income-tax-folios-index/series-3-property-investments-savings-plans/series-3-prop-erty-investments-savings-plans-folio-9-miscellaneous-payments-re-ceipts/income-tax-folio-s3-f9-c1-lottery-winnings-miscellaneous-re-ceipts-income-losses-crime.html.

8 Canada Revenue Agency, “Guide for cryptocurrency users and tax professionals” online: Government of Canada https://www.canada.ca/en/revenue-agency/programs/about-canada-revenue-agency-cra/compliance/digital-currency/cryptocurrency-guide.html (last modified December 13, 2023).

9 Ibid.

10  ITA, supra note 2 at s. 248(1).

11 Jinyan Li et al., “Principles of Canadian Income Tax Law”, 9th Edition, (Thomson Reuters: Toronto), citing to: MNR v. Taylor, [1956] CTC 189, 56 DTC 1125 (Can. Ex. Ct.) and Regal Heights v. MNR, [1960] CTC 384, 60 DTC 1270 (SCC).

12 Ibid.

14  ITA, supra note 2 at s. 39(1).

15  Ibid., at s. 153(1)(a).

16 Income Tax Regulations, CRC, c. 945 at s. 102 [ITA Regs].

17  ITA, supra note 2 at s. 153(1)(g).

18  ITA Regs, supra note 16 at s. 105(1).

19  Ibid.

20 Convention Between Canada and the United States of America With Respect to Taxes on Income and on Capital, (September 26, 1980), online: Government of Canada https://www.canada.ca/en/department-finance/ programs/tax-policy/tax-treaties/country/united-states-america-con- vention-consolidated-1980-1983-1984-1995-1997.html (Entered into force 16 August 1984) at art. XV, s. 2(a) [Canada-U.S. Treaty].

21  Ibid., at art XV, s. 2(b).

22 ITA Regs, supra note 16 at s. 200(1).