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A Crypto Tax Lawyer's Guide to paying employees in crypto, the income tax classification, withholding requirements, and the benefits and drawbacks. As mainstream adoption of cryptocurrency becomes more prevalent, prudent employers would be well-advised to develop the capacity to respond to demands for such schemes of compensation. It is essential to understand the methods through which cryptocurrency compensation can be offered, the income and payroll tax consequences, and the associated benefits to both employees and employers. This article will discuss these topics in depth.   Methods to Offer Digital Currency Compensation   Currently, there are two common ways to compensate employees and independent contractors in cryptocurrency.   One option is for employers to directly pay their employees or independent contractors in cryptocurrency. Either the full amount or a portion of their salary, wages, or other remuneration can be paid in digital assets directly to the recipients’ digital wallets. In this approach, employers would purchase cryptocurrency through a cryptocurrency exchange with a corporate account. Numerous exchanges are available to Canadian businesses, including WonderFi, Newton, Shakepay, and Coinbase. Upon purchasing cryptocurrencies from an exchange, the employer can directly transfer the amounts owing to the digital wallet addresses of their employees or independent contractors from either the exchange or their own digital wallet. The second option available is for the employer to retain the services of a third party. This third party will receive the compensation in fiat from the employer and will convert it to the designated cryptocurrency based on the employee or independent contractor’s chosen allocation. The amounts will then be transferred to their specific digital wallet addresses. Currently, companies such as Bitpay and Bitwage all provide these services. Although the we do not endorse any particular service in Canada, these services generally operate in the following manner to enable employers to pay their employees in cryptocurrency: the employer and its employees will create an account with the service; the employer will create a payroll account and fund the account with fiat currency or cryptocurrency; and the employee will select their desired method and allocation of payment. The service will calculate the appropriate withholding and deposit the appropriate amount of cryptocurrency as wages to the employee less applicable deductions. Although both options are frequently utilized, if a business is considering purchasing cryptocurrency for more than just its payroll needs, creating a corporate account on an exchange provides the flexibility to hold, trade, and make other business transfers seamlessly. Exchanges also provide supporting documentation of a user’s transaction history, which can be given to accountants for tax filing purposes or uploaded to crypto accounting websites. These websites allow users to calculate their tax liability arising from cryptocurrency transactions by combining transaction records from multiple trading platforms. They generate tax reports and Schedule 3 Tax Forms to report capital gains (or losses). [1] However, if a business is only considering purchasing cryptocurrency for its payroll needs, the use of a third party may be the preferred option. These services are dedicated to processing payroll in digital currencies and will reduce administrative hurdles. Income Tax Considerations   Employees and Independent Contractors In Canada, many of the same rules which apply to paying wages to employees are applicable to paying remuneration to employees in cryptocurrency. From the employee’s perspective, subsection 5(1) of the Income Tax Act (the “ Act ”) [2] provides that a taxpayer’s employment income includes “salary, wages and other remuneration, including gratuities” [3] received by the taxpayer within the relevant taxation year. This provision has been interpreted broadly so as to capture most payments made to employees by virtue of their employment status. Further, any employment income earned by the taxpayer is recognized in the year that it was received. As a result, if an employer elects to pay remuneration to an employee in cryptocurrency, the fair market value of that cryptocurrency at the time it was received must be included in the taxpayer’s income for the relevant tax year. Accordingly, the Canada Revenue Agency (the “ CRA ”) has taken the position that: [4] "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 for services rendered in the form of cryptocurrency. Unlike employees, the characterization of income earned by independent contractors is characterized as being from a business or property under the Act. [5] Very generally, characterization as business income is preferable for independent contractors, as this provides a more favourable tax treatment for the deduction of expenses. More precisely, independent contractors can make certain deductions to their taxable income for business expenses incurred in the process of carrying on business that are not available to employees. A discussion of whether an individual worker is an employee or an independent contractor is beyond the scope of this article, but like any employee, independent contractors must include remuneration earned in the form of cryptocurrency into their income. In addition, paragraph 6(1)(a) of the Act provides that “the value of board, lodging and other benefits of any kind whatever received or enjoyed by the taxpayer, or by a person who does not deal at arm’s length with the taxpayer . . . by virtue of the taxpayer’s office or employment” [6] (emphasis added) is generally included in the taxpayer’s income for the year that the benefit was received. Thus, if an employer decides to confer any non-cash benefits upon an employee by virtue of the recipient’s employment status (including cryptocurrency), the fair market value of the benefit must be included in the taxpayer’s income and is subject to taxation. Moreover, an employer may not make “voluntary payments” to an employee to circumvent this provision of the Act. As articulated by the CRA in Income Tax Folio S3-F9-C1: [7] . . . sometimes individuals receive a voluntary payment or other valuable transfer or benefit by virtue of an office or employment from an employer, or from some other person. 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 eventually disposes of the cryptocurrency paid by an employer for services rendered, the income that the taxpayer receives will be characterized as either business income or a capital gain. [8] For the employee, this characterization is important because only one-half of a capital gain must be included in a taxpayer’s income, whereas all business income must be included in the taxpayer’s income and is subject to tax at the applicable marginal rate. The CRA has opined that the following are relevant factors to consider when determining whether a taxpayer who deals with cryptocurrency is engaged in a business:   The taxpayer carries on activity for commercial reasons and in a commercially viable way; The taxpayer undertakes activities in a businesslike manner, which might include preparing a business plan and acquiring capital assets or inventory; The taxpayer promotes a product or service; The taxpayer shows that he/she/they intended to make a profit, even if he/she/they is unlikely to do so in the short term; The date on which the taxpayer’s alleged business activities began; and The taxpayer is engaged in an adventure of concern in the nature of trade. [9]   The Act also defines the term “business” to include “an adventure or concern in the nature of trade.” [10] Courts have held that an “adventure or concern in the nature of trade” may include an isolated transaction (that lacks the frequency or system of trade) in which the taxpayer buys property with the intention of selling it at a profit, and subsequently sells it (usually at a profit, but sometimes at a loss). Although a taxpayer who enters 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, the transaction would likely be considered to be in the nature of business. [11] Employees who receive cryptocurrency as remuneration should aim for capital gains treatment by avoiding characterization as business income. Each individual’s particular circumstances will vary, but in general, taxpayers should limit the number of transactions pertaining to their cryptocurrency holdings, avoid engaging in cryptocurrency trading, and hold their cryptoassets for a prolonged period of time so as to be characterized as an investment. If an employee’s income derived from cryptocurrency is considered a capital gain, then whenever the employee eventually disposes of the cryptocurrency, he or she will realize a capital gain or a capital loss which will depend on the fair market value at the time of the disposition less the adjusted cost basis of the cryptocurrency. [12] However, as discussed above, the initial fair market value of any cryptocurrency paid to an employee by an employer must be included in income the year that such cryptocurrency was received.   Employers From the employer’s perspective, if it elects to pay its employees in cryptocurrency, it is still responsible for withholding and remitting an appropriate amount of source deductions to the Receiver General in respect of employment income. [13] In general, these amounts will include income tax withholding, contributions to the Canada Pension Plan and employment insurance unless a relevant exception applies. As a result, it is imperative that employers ensure that they calculate the correct fair market value of any cryptocurrency paid as remuneration to their employees in order to ensure that proper remittances are made to the CRA. An employer who fails to comply with the withholding and remittance requirements under the Act may be held liable for the employee’s Canadian tax and any applicable penalties. [14]   Payments and Remittances to Non-Residents A Canadian employer may wish to make payments to non-resident employees with cryptocurrency. In general, there is no provision under the Act which would prevent a Canadian-resident business from distributing employment income to a non-resident. However, employers should be cognizant of certain tax consequences which may apply when paying non-resident employees. More precisely, paragraph 153(1)(a) of the Act [15] and section 102 of the Income Tax Regulations (the “ Regulations ”) [16] impose a withholding and remittance requirement on amounts paid to both a resident employee and a non-resident employee who performs employment duties inside Canada. Moreover, if a non-resident individual (who is not an employee) renders services in Canada, paragraph 153(1)(g) of the Act [17] and subsection 105(1) of the Regulations [18] operate in conjunction to require the payor to withhold tax on fees, commissions, and other amounts paid to non-residents of Canada. Currently, the rate of withholding for these individuals is 15% of the gross amount paid. [19] Therefore, if a Canadian employer elects to pay its non-resident employees or non-resident individuals who are not employees (such as independent contractors) in cryptocurrency for services rendered in Canada, it must withhold proper amounts and make appropriate remittances to the CRA. In general, the tax consequences of paying non-resident employees with cryptocurrency depend largely on whether an applicable treaty exists between Canada and the country in which the non-resident employee resides. For instance, the Convention Between Canada and the United States of America With Respect to Taxes on Income and on Capital, as amended (the “ Canada-U.S. Treaty ”) provides that any remuneration in excess of $10,000 Canadian dollars paid to a non-resident for services rendered in Canada will be subject to Canadian taxation. [20] Additionally, if payment is made by or on behalf of a person resident in Canada to a non-resident employee who provides services in Canada, that non-resident employee will be subject to Canadian income tax. [21] Accordingly, the taxation regime of cryptocurrency for Canadian resident taxpayers described above will apply to non-resident Americans providing services in Canada pursuant to the Canada-U.S. Treaty. Subsection 200(1) of the Regulations [22] 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/ Perspective At a time when many industries have faced increased voluntary unemployment, there is certainly a need for employers to differentiate themselves to attract and retain talent. Accordingly, employers offering compensation through cryptocurrencies have a comparative advantage when hiring and retaining the best and brightest talent. Such employers may be able to represent themselves as forward-thinking by being an early adopter of this method of compensation.   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 as little as a few minutes. When compared with wire transfers, digital currency payments are significantly faster, as wire transfer payments generally take between one to five days. Moreover, as cryptocurrencies operate on the Blockchain, there is always a transparent and verifiable ledger available. These payments can be made at any time of day, without the need to make transfers through a bank, and at a fraction of the cost of the 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 their employees’ wages in cryptocurrency. Rapid fluctuations in the market are fairly common and may add an element of unwanted unpredictability for employers who purchase their own cryptocurrencies to pay to their employees as wages. To mitigate the risk stemming from this volatility, employers could retain the services of a company to pay the cryptocurrency directly to their employees. Thus, employers would also be well-advised to ensure that their employees are aware that they could suffer a dramatic loss in value when receiving cryptocurrency as wages as a result of the current volatility of cryptocurrency. Proper education of the volatility of cryptocurrency is imperative to provide both employees and candidates with the knowledge and context necessary to make an informed decision in respect of compensation. As discussed above, an employer who elects to remunerate its employees in cryptocurrency is still responsible for remitting source deductions on the income of its employees. Tax reporting may become more complicated from an employer’s perspective when withholding and remitting source deductions for cryptocurrency paid to employees as wages as opposed to fiat currency. Although services are available to assist businesses in fulfilling their reporting and tax obligations in relation to paying cryptocurrency as wages, these services may charge a fee to the employer, which adds additional costs to the process. Moreover, an employer will likely be forced to take additional administrative steps to document the compensation scheme, including inserting an authorization to pay employee wages in cryptocurrency in the relevant employment contract.   Employee/ Independent Contractor Benefits The purported benefits of cryptocurrency have been discussed at length in the scholarship and by its advocates, and we do not intend to provide an exhaustive discussion of the advantages of cryptocurrency. Instead, we merely wish to identify a few of its practical benefits, which may entice employees to seek having their remuneration made in cryptocurrency. First, proponents of cryptocurrency have long extolled the virtue of cryptocurrency as a long-term hedge against inflation.36 The fact that cryptocurrency is finite in nature and has a fixed cap has led some to conclude that cryptocurrency is an effective tool against inflation when compared to fiat currency, which can be routinely manipulated by a country’s central bank. For instance, Bitcoin has a fixed supply cap of 21 million BTC, while in contrast, the CAD is subject to manipulation and we have seen a dramatic increase in the Canadian money supply. Accordingly, employees may find comfort in the fact that the stored value of their cryptocurrency may serve as a hedge against inflation arising from an increase in government expenditures. Second, offering employees an opportunity to receive cryptocurrency as compensation for services rendered may be particularly useful when paying non-resident employees or independent contractors who live in areas where access to bank accounts may be difficult. Since cryptocurrency is generally paid directly to a digital wallet, this allows employers to bypass banks entirely and remit payment directly to an employee or independent contractor. Third, and consistent with the second benefit discussed above, paying employees in cryptocurrency allows these individuals to receive payment almost instantaneously. This is particularly beneficial for payments to non-resident individuals, where remittances in a fiat currency could take days to clear and are subject to bank rules and fees.38 Commercial services purport to allow for im- mediate distributions of cryptocurrency, which can be particularly useful for employees to pay their bills or rent on-time, and without unnecessary delay. This method of remuneration also provides the benefit of enabling individuals to avoid the barriers of entry which ordinarily might discourage users from holding cryptocurrency. Individuals who choose to receive remuneration in cryptocurrency through payment by a third-party service are only required to set up a digital wallet to receive payment; they are not required to trade on an exchange or make cryptocurrency purchases on their own initiative. This is an easy and cost-effective method of holding cryptocurrency. Finally, if the employee chooses to use a cryptocurrency exchange app, transfers of cryptocurrency into fiat currency are also almost instantaneous. As previously discussed, the transfer of cryptocurrency into fiat would likely result in a taxable disposition under Canadian income tax law. As a result, employees would be well-advised to note the price at which they initially acquired the cryptocurrency to ensure that any capital gains or losses are properly accounted for.   Employee Drawbacks The most immediate concern of most employees when receiving wages in the form of cryptocurrency is related to the rapid fluctuation in its value. For instance, if an employee receives cryptocurrency at a time when its value is high, he or she will receive fewer units of cryptocurrency than when its value is lower. Accordingly, employees must be amenable to some degree of volatility when electing to receive cryptocurrency as remuneration. One approach that an employee could adopt to mitigate the risk of fluctuating cryptocurrency is to allocate an appropriate balance of income to be received in cryptocurrency and fiat currency rather than receiving the entirety of their compensation in cryptocurrency. Another potential disadvantage of receiving wages as cryptocurrency is that the tax reporting obligations and compliance mechanisms are more complicated when compared to receiving wages in fiat currency. The CRA is becoming increasingly aggressive in addressing non-compliance in cryptocurrency transactions. Thus, it is advisable that an employee who receives cryptocurrency as compensation retain the services of accountants or tax advisors to assist in preparing tax-filings on the income received through cryptocurrency. This, of course, may add additional, unanticipated costs to receiving compensation as cryptocurrency for employees. However, crypto accounting software is available to individuals as well and can generate the necessary tax forms and reports. CONCLUSION As cryptocurrency becomes even more pervasive, employee interest in cryptocurrency remuneration will intensify. Employers should be prepared to meet these demands and understand the tax implications of compensating their employees in cryptocurrency. In general, employers have two options available to pay their employees in cryptocurrency: (1) they can open a business account with an exchange and purchase their own cryptocurrency to compensate employees, or (2) they can rely on the services of a third-party, which will ease the process. It is important that employers evaluate which of these options is most suitable to their business and the benefits and drawbacks that arise from this means of compensation. Employers are encouraged to consult their tax practitioners to develop solutions to address their needs. If you have not properly reported your crypto compensation to employees or if your are an employee who has received crypto but have not properly reported it to the CRA, consider the Voluntary Disclosure Application . It's important to properly report and disclose any cryptocurrency transactions to the CRA to avoid any Tax Audits . Resources 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).

The CRA's Guidance on NFTs The Canada Revenue Agency (CRA) and CPA Canada recently confirmed that NFT marketplaces and individuals selling NFTs may be subject to GST/HST on all their transactions. This guidance introduces a significant financial and administrative burden for many businesses. The CRA addressed whether businesses in Canada that buy and sell NFTs with revenue exceeding $30,000 should include GST/HST in all sale proceeds. This concern arises from the nature of NFT marketplaces and blockchain transactions, which are traditionally anonymous and region-agnostic. Key Conditions for GST/HST Application In response, the CRA stated that a supply of NFTs is deemed to be made in Canada and generally subject to GST/HST if: The NFT may be used, in whole or in part, in Canada. The supplier is considered a business operating in Canada. The business is not classified as a small supplier (generally an entity with revenue less than $30,000). It’s important to note that GST/HST may not apply if the supply of NFTs is exempt or zero-rated (subject to GST/HST at a rate of 0%). Certain cryptoassets, defined as virtual payment instruments, are considered exempt from GST/HST. These include Bitcoin and Ethereum. However, NFTs do not fall under this exemption category according to the CRA. Exemptions and Zero-Rated Supplies An NFT may be zero-rated if the supply is made to a non-resident who is not registered for GST/HST purposes at the time of the supply. This creates a complex situation for NFT marketplaces and individual suppliers operating in Canada. The Challenge of Anonymity The complication arises because users of NFT marketplaces often prefer anonymity. If a supplier cannot identify the recipient of the supply, their residency status, or their GST/HST registration, the CRA states that GST/HST will apply to all such NFT supplies. The CRA will assume that all purchasers of NFTs are Canadian unless there is evidence to the contrary. This CRA commentary creates a significant financial and administrative burden on businesses producing taxable supplies of NFTs in Canada that cannot identify the residency of the purchaser. Implications for Canadian Purchasers Canadian purchasers who cannot identify the supplier of the NFTs will also be unable to claim the GST/HST on their NFT purchases. This situation can lead to increased costs for buyers and sellers alike. Potential Solutions for NFT Marketplaces If you are an NFT marketplace or an individual operating a business of buying and selling NFTs, your transactions may be subject to GST/HST. Depending on the specifics of your business, there are potential solutions to this issue. Our team at Solstice Law can provide guidance tailored to your situation. Feel free to reach out for a free consultation . Conclusion The recent guidance from the CRA regarding GST/HST implications for NFT transactions in Canada is a crucial development for businesses in this space. Understanding these regulations is essential for compliance and effective business operations. As the NFT market continues to evolve, staying informed about tax obligations will be vital for success. --- This article aims to clarify the complexities surrounding GST/HST for NFT marketplaces in Canada. By addressing these concerns, businesses can better navigate the regulatory landscape and make informed decisions.

In the ever-evolving landscape where digital assets play a vital role in corporate, commercial, and financial spheres, cryptocurrency transactions have become routine. This includes situations where digital assets are used as collateral for loans or transferred through crypto lending agreements. Scenario 1: Collateral for Loans Many borrowers are eager to use their substantial digital asset holdings to secure fiat currency loans. Pledging crypto assets as collateral can unfold in various ways. When borrowing, the terms may require the individual to sign a custodial agreement. This agreement appoints a custodian who assumes possession and control of the pledged digital assets. The terms of the custodial agreement are critical. According to the Canada Revenue Agency (“ CRA ”), a disposition of assets may occur, leading to potential gains or losses for the person pledging the assets. In these agreements, custodians typically assume legal interest in the collateral. A key question arises: has a disposition occurred? This often hinges on whether the custodian has also obtained beneficial ownership. Tax Implications of Custodial Agreements Subsection 248(1) of the Income Tax Act (Canada) defines “disposition.” Under paragraph (c), it includes “any transfer of the property to a trust or, where the property is property of a trust, any transfer of the property to any beneficiary under the trust, except as provided by paragraph (f) or (k).” Here, provisions (f) and (k) offer exceptions where there is merely a change in legal ownership without any change in beneficial ownership. Generally, custodial arrangements are viewed as trust relationships. In these cases, legal title moves to the custodian while beneficial ownership remains with the borrower. [* 1]* If digital assets are pledged in this manner, there may be no disposition, since only legal ownership changes and not beneficial ownership. However, if the agreement alters beneficial ownership, it can trigger a disposition under the Act. Non-Custodial Loan Scenarios Digital assets can also serve as collateral without a custodial agreement or trust relationship. In such traditional arrangements, the pledge of securities may not count as a disposition under the Act. Per subsection 248(1), a “disposition” does not include, under paragraph (j), “any transfer of the property for the purpose only of securing a debt or a loan.” Thus, in non-custodial loan transactions, there should be no taxable disposition if beneficial ownership remains unchanged. The CRA closely examines whether transferring digital assets—under either custodial or non-custodial agreements—constitutes a tax disposition, raising significant tax questions. Scenario 2: Lending Agreements In a recent CRA roundtable, a hypothetical case was presented. A taxpayer transfers bitcoin to a centralized crypto-asset exchange and lending platform in exchange for a variable return. [2] Here, the platform, owning the bitcoin in its name, could pledge, sell, lend, or otherwise use the bitcoin as it sees fit without notifying the taxpayer. [3] As the bitcoin was not held under a custodial agreement or in trust for the taxpayer, the beneficial interest of the deposited bitcoin transferred to the exchange. Based on the facts provided, the CRA noted that a disposition likely occurred in this context. [4] The CRA did not reference a specific part of the Act but pointed to the general definition of “disposition” in subsection 248(1). This roundtable discussion may have unexpected tax implications for the taxpayer involved in the bitcoin transfer agreement. Implications of Dispositions in Crypto Lending The definition of “disposition” in subsection 248(1) complicates understanding the tax consequences of digital asset transactions. The CRA emphasized that analyzing a crypto disposition requires examining events, transactions, and all relevant contractual details. [5] The potential unintended tax consequences illustrated in these scenarios highlight the importance of thoroughly understanding lending terms. Careful record-keeping is essential in the fast-moving world of digital asset transactions. Best Practices for Navigating Crypto Lending Importance of Record-Keeping As the crypto landscape evolves, participants must track their assets carefully. Maintaining detailed records provides clarity and can protect against unanticipated tax liabilities. This diligence is not only prudent; it is increasingly necessary for compliance with emerging regulations. Evaluating Lending Arrangements Potential borrowers should scrutinize lending terms closely. Understanding the terms of any custodial agreement and assessing potential tax implications can prevent misunderstandings. Investors and borrowers should consider consulting with tax professionals specializing in cryptocurrency. The Future of Cryptocurrency Lending Schemes for utilizing digital assets in borrowing and lending are likely to grow. As regulations evolve, so will the complexity of crypto financial transactions. Staying informed about regulatory changes will be vital for participants in the digital asset space. Conclusion Unexpected consequences often accompany crypto transfers. Participants must be vigilant and exercise due diligence. The challenge of tracking crypto asset movements underlines the necessity of thorough record-keeping. In the rapidly changing market, prompt and informed decisions are critical when engaging in alternative arrangements with digital assets. ---wix--{"type":"DIVIDER","id":"ncrb58782","nodes":[],"dividerData":{"containerData":{"width":{},"alignment":"CENTER","spoiler":{},"height":{},"textWrap":false},"lineStyle":"SINGLE","width":"LARGE","alignment":"CENTER"}}--wix-- References: [1] Although not defined in the Act, the CRA describes a bare trust for income tax purposes as a trust arrangement under which the trustee can reasonably be considered to act as agent for all the beneficiaries under the trust with respect to all dealings with all of the trust’s property. A trustee can reasonably be considered to act as agent for a beneficiary when the trustee has no significant powers or responsibilities, can take no action without instructions, and only holds legal title. [2] Association de Planification Fiscale et Financière, “2 November 2023 APFF Roundtable, – Q. 10 Disposition on bitcoin transfer to platform” (November 2, 2023). [3] Ibid. [4] Ibid. [5] Ibid.

Decentralized Autonomous Organizations (“ DAOs ”) continue to grow in popularity and provide utility to their members. As of May 2023, there were approximately 13,000 DAOs with a collective total treasury of almost $32 billion. [1] However, the uncertainty in the tax treatment of DAOs and the activities of their members persists. This article will examine the Canadian tax consequences of DAOs, with particular emphasis on the activities of individual DAO members (hereinafter referred to as “ Members ”). DAOs are entities operating without a traditional hierarchal structure or centralized leadership. Decision-making and governance is determined democratically by token holders. The more tokens a Member has, the more impact their vote has on a decision. The decisions made by the Members are automatically implemented by smart contracts which operate on a set of rules programmed by a core team of developers who create the DAO. DAOs can be for-profit or non-profit entities. There are various categories of DAOs, including: Protocol DAOs; Investment DAOs; SubDAOs; Service DAOs; Social DAOs; and Philanthropy DAOs In Canada, there is no legal structure that precisely captures all the characteristics of a DAO. Depending on specific activities of the DAO, it may be a corporation, joint venture or even a partnership or trust as a flow-through entity. Internationally, there is no common approach to the classification of a DAO. Some U.S. states (including Vermont, Wyoming and Tennessee) recently enacted legislation to allow DAOs to register as a customized limited liability company [2] , while other jurisdictions, such as the Cayman Islands, have incorporated DAOs as foundation companies. [3] To achieve legal certainty and limit the liability of Members, a DAO should be carefully “wrapped” or registered as a traditional legal entity. The taxation of the DAO will depend on its business structure and the activities it undertakes. While the following analysis focuses on the activities of Members, we will elaborate on the taxation of a DAO itself in a later article. Taxable Events for Individual DAO Members [4] The activities of individual Members may be taxable events under the Income Tax Act (Canada) (the “ ITA ”) for Canadian residents. [5] According to the Canada Revenue Agency (the “ CRA ”), a capital gain exists when you sell, or are considered to have sold, a capital property for more than the total of its adjusted cost base (“ ACB ”) and the outlays and expenses incurred to sell the property. [7] A capital loss exists when you sell, or are considered to have sold, a capital property for less than the total of its adjusted cost base and the outlays and expenses incurred to sell the property. [8] A taxpayer realizes business income rather than a capital gain when deemed to have earned income from a “profession, calling, trade or undertaking of any kind whatever” or an “adventure or concern in the nature of trade”. [9] In general, consistent and sustained activities undertaken with a view to profit will be labelled as a “business” activity within the meaning of the ITA. However, an “adventure or concern in the nature of trade” may still be captured by an isolated transaction in which a taxpayer makes a single, speculative purchase and ultimately sells the property. [10] Under these circumstances, as long as the transaction was intended to yield a profit, the transaction would likely be considered to be in the nature of business. [11] There is a litany of case law which discusses whether income should be characterized as received on account of business or capital; however, the following is a list of factors which the CRA considers indicative of carrying on a business: the taxpayer carries on the activity for commercial reasons and in a commercially viable way; the taxpayer undertakes activities in a businesslike manner, which might include preparing a business plan and acquiring capital assets or inventory; the taxpayer promotes a product or service; the taxpayer’s conduct shows that they intend to make a profit, even if they are unlikely to do so in the short term; and the taxpayer is engaged in an adventure or concern in the nature of trade. [12] The CRA has further opined that the most relevant factor it will consider when distinguishing between business and capital gains treatment is the intention of the taxpayer. [13] Ultimately, whether a DAO-related taxable event will receive capital gains treatment or business income treatment, among other possibilities, will depend on the circumstances at play. Notably, one-half of a capital gain must be included in a taxpayer’s income. Furthermore, one half of a capital loss (referred to as the allowable capital loss) may be deducted from capital gains. Capital losses may generally only be offset by capital gains, not other income. If the taxpayer does not have any capital gains against which to offset capital losses, the taxpayer can carry the net capital losses forward indefinitely, or alternatively, can carry the losses back for any of its preceding three years. [14] Conversely, all business income must be included in the taxpayer’s income and is subject to tax at the applicable marginal rate. [15] Analysis of Taxable Events DAOs may require the purchase of DAO Tokens or an NFT to join the DAO. Purchasing DAO Tokens or NFTs with fiat is not a taxable event. However, purchasing tokens or an NFT for membership with cryptocurrency is a taxable event which will ordinarily attract capital gains treatment, as the taxpayer will have disposed of the cryptocurrency used to buy the tokens or NFT for proceeds equal to the purchase price. The individual will realize a capital gain upon disposition of their cryptocurrency if the proceeds of the disposition are in excess of the ACB. [16] Purchasing tokens or an NFT membership with cryptocurrency may result in business income treatment as well if the proceeds of disposition on the purchase are deemed to have been earned from a “profession, calling, trade or undertaking of any kind whatever” or an “adventure or concern in the nature of trade”, per the analysis above. [17] Selling DAO tokens for other cryptocurrency or fiat will be subject to either capital gains tax or business income tax depending on the nature of the Member’s activity. Holding tokens long-term may help in classifying the proceeds from their sale as a capital gain or capital loss, whereas holding tokens for short periods and selling them frequently may reflect an intention to profit, classifying the proceeds as business income. [18] Profit distributions through the receipt of additional tokens to Members could be business income. [19] Members could be rewarded for their participation and contribution to the DAO which may include setting up the DAO, improving the DAO’s code and assisting with the administration of the DAO. Rewards from DAOs can include staking rewards, airdrops or unsolicited gifts. The receipt of rewards from staking DAO tokens would generally be taxed as business income, just as the traditional staking of cryptocurrencies. [20] The CRA has not released clear guidance on the tax treatment of staking, however, it has released guidance on the tax treatment of cryptocurrency mining. The CRA has stated that the income tax treatment of mining will depend on whether the mining activities are a personal activity/hobby or business activity. To note, the CRA maintains that a hobby pursued in a businesslike manner may still be taxed as business income. [21] If the CRA’s mining guidance applies to staking, there is a possibility to argue that a Member’s staking is a personal activity or hobby rather than a business activity, giving rise to a capital gain. [22] Ultimately, the CRA has not issued clear direction on the matter, and may argue in an audit that staking activity is business income. Receiving airdrops or gifts of DAO tokens can result in varying tax treatment. The receipt of unsolicited airdrops or gifts of DAO tokens, granted that the taxpayer does not intend to carry on the activity for profit, should not be considered a source of income; it could arguably be considered a personal endeavour and not a taxable event. [23] However, receiving multiple airdrops or “gifts” may be considered business income. [24] The receipt of multiple DAO tokens in this manner could constitute a pursuit of profit and thus be considered a source of income. [25] Similarly, proceeds from the sale or trade of gifted or airdropped tokens (including gifts to a person with whom a Member is at arm’s length [26] ) may be subject to capital gains tax or business income treatment, depending on whether the activity is for a pursuit of profit and accordingly a source of income. [27] Although regulators have yet to release clear guidance on the taxability of DAOs and the activities of Members, the author has presented his view of the likely taxable nature of these activities. It is important to proactively consider your crypto activity. Maintaining records and working with a tax professional will help avoid negative tax consequences. Our team of lawyers and accountants are experienced in crypto audits and offshore tax planning. If you need assistance with your cryptocurrency-tax concerns, please contact us. [1] All amounts referenced in this article are in Canadian dollars. [2] See the following for discussion on the state-level legislation in the United States allowing DAOs to register as modified limited liability companies: DeFi Education Fund, “DAO Legislation at the State-Level: Overview” (January 30, 2023), online: < https://www.defieducationfund.org/post/dao-legislation-at-the-state-level-a-brief-overview >. Wyoming and Tennesee have both enacted legislation creating DAO-specific LLCs, while Vermont has allowed DAOs to register as blockchain-based LLCs. [3] See the following for discussion on the use of the Cayman Islands’ Foundation Company structure for DAOs: Carey Olsen, “Cayman Islands Foundation Companies for DAOs, Defi and NFTs” (April 6, 2022), online: < https://www.careyolsen.com/briefings/cayman-islands-foundation-companies-daos-defi-and-nfts >. Like a traditional corporation, the foundation company has a separate legal personality and limited liability, affording DAOs abilities such as being able to execute contracts. The foundation company may also be an appealing option for DAOs as the structure can function without shareholders, making it ownerless, and powers can be wielded by persons other than directors. [4] The analysis in this article only applies to individual DAO members. It does not apply to flow-through entities such as trusts or partnerships. These entities will have different tax treatment as members of DAOs. [5] If the DAO is established in a foreign jurisdiction, there may be additional foreign tax considerations that have not been contemplated by this article. [6] The author is attempting to highlight the likely income tax treatment for each of these activities that a Member may undertake. Depending on the specific circumstances of the Member, the applicable income tax treatment may vary. This article does not consider the excise tax considerations for each of these activities. [7] Income Tax Act , RSC, 1985, c 1 (5th Supp), ss 39(1)(a) and 40(1)(a) [ ITA ]; Canada Revenue Agency, “T4037 Capital Gains 2021” at “Definitions” (January 18, 2022), online: https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/t4037/capital-gains.html . [8] ITA , supra note 7, ss 39(1)(b) and 40(1)(b); Canada Revenue Agency, “T4037 Capital Gains 2021” at “Definitions” (January 18, 2022), online: < https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/t4037/capital-gains.html >. [9] ITA , supra note 7 , s 248(1). [10] Jinyan Li et al, “Principles of Canadian Income Tax Law”, 9th Edition, (Thomson Reuters: Toronto, 2020), citing to: Minister of National Revenue v Taylor, [1956] CTC 189 (Can Ex Ct) 56 DTC 1125 and No 476 v Minister of National Revenue, [1960] CTC 384 (SCC) 60 DTC 1270. [11] Ibid. [12] Canada Revenue Agency, “Guide for cryptocurrency users and tax professionals” (June 26, 2021), online: < https://www.canada.ca/en/revenue-agency/programs/about-canada-revenue-agency-cra/compliance/digital-currency/cryptocurrency-guide.html > [ Crypto Guide ]. [13] Canada Revenue Agency, Interpretation Bulletin IT-459, “Adventure or Concern in the Nature of Trade” (September 8, 1980), online: < https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/it459/archived-adventure-concern-nature-trade.html > [ IT-459 ]. [14] Crypto Guide , supra note 12. [15] ITA , supra note 7, ss 38(a) and 9(1); See our previous article on the Taxation of NFTs titled “Taxation of Cryptocurrencies: The Current Utility of NFTs and their Practical Future Use Cases” for a more detailed analysis of capital gains treatment and business income treatment. [16] ITA, supra note 7, ss 39(1)(a) and 40(1)(a). [17] Ibid, s 248(1). [18] IT-459, supra note 13; Happy Valley Farms Ltd v Minister of National Revenue , [1986] 2 CTC 259, [1986] FCJ No 465 at para 14; Canada Revenue Agency, “Income Tax Audit Manual Chapter 29” (July 2020), online: < https://www.canada.ca/en/revenue-agency/services/tax/technical-information/income-tax-audit-manual-domestic-compliance-programs-branch-dcpb-29.html >. [19] ITA, supra note 7, ss 9(1) and 248(1). [20] ITA, supra note 7, ss 9(1) and 248(1); Michelle Legge, “Crypto Tax Canada: Ultimate Guide 2023” (April 12, 2023), online: < https://koinly.io/guides/crypto-tax-canada/ > [ Koinly ]. [21] Crypto Guide, supra note 12. [22] Ibid . [23] ITA, supra note 7, s 3; Stewart v Canada , 2002 SCC 46 at paras 48–60 [ Stewart ]. [24] ITA, supra note 7, ss 9(1) and 248(1). [25] Stewart, supra note 26 at paras 48- 60. [26] ITA, supra note 7, s 69(1). An individual may be subject to capital gains tax when gifting a token to another person with whom they do not deal at arm’s length by operation of subsection 69(1) of the Act. Subsection 69(1) will deem the donor of the token to have disposed of it for proceeds equal to its fair market value on the date of the gift. In sum, subsection 69(1) requires that a donor recognize a gain upon gifting a token for tax purposes where the fair market value of the token exceeds its ACB on the date of the gift, even where no consideration was received by the donor. When such a gift is completed, the donee of the token will generally not be subject to tax on the gift, and the donee’s new ACB will be equal to the fair market value of the token at the time of the gift. [27] Ibid , ss 39(1)(a) and 40(1)(a); Koinly , supra note 21; Stewart , supra note 26 at paras 48- 60.