Tax writeoff an option for defunct cryptocurrency exchange users
By AdvocateDaily.com Staff
With recovery efforts proving to be challenging so far, Canadians holding cryptocurrency on an insolvent exchange may be in a position to claim a tax loss, Canadian tax lawyer David J. Rotfleisch tells AdvocateDaily.com.
The exchange, which shut down in January after the sudden death of its owner, was recently granted an extension of its creditor protection in Nova Scotia, reports CBC News.
The search continues for $190 million in missing cryptocurrency owed to users of the platform, which has so far only turned up a small amount of digital assets. Those who invested on the exchange are owed a combined $260 million in cash and crypto-coins, according to reports from CTV News.
As Rotfleisch, founding tax lawyer with Rotfleisch & Samulovitch Professional Corporation, explains, “At this point, their cryptocurrency recovery is very problematic, and it is reasonable to argue that they can claim a writeoff, either in 2018 or 2019, for the loss of their currency.”
However, he says, in order to do so, it is important for affected investors to determine the timing of the loss as well as the type of loss that can be claimed.
In general, says Rotfleisch, when an individual purchases cryptocurrencies on an exchange, they are not buying a specific coin but rather an entitlement to withdraw it from the exchange’s corporate cryptocurrency wallet. Similarly, when one trades the currency held in one exchange for another cryptocurrency, typically nothing is physically moved from one wallet to another, but rather, the exchange adjusts its internal accounts to track what it owes to each account holder.
“In a sense, this would mean that what any cryptocurrency exchange is unable to pay back could be considered a bad debt. In that case, the loss can be claimed in the year that it is determined to be a bad debt. This determination is made by the creditor — the cryptocurrency holder in this case — with the application of the proper factors and acting in a reasonable and business-like manner.”
The Federal Court of Appeal, says Rotfleisch, has listed seven factors in this regard, including the history and age of the debt, the financial position of the debtor, changes in total sales of the debtor as compared with prior years, the debtor’s cash, accounts receivable and other current assets, their accounts payable and other current liabilities, the general business conditions of the country, the community of the debtor, and the debtor’s line of business and the past experience of the taxpayer in writing off bad debts.
“Looking at the factors, considering the chief executive has passed away, the high likelihood that the exchange’s corporate cryptocurrency wallet is irretrievable, the extremely high amount of debt, and the firm’s lack of continuing business, it would be reasonable for an investor to write off his investment as a bad debt in 2019 or possibly 2018,” says Rotfleisch.
Ultimately, he says: “Whether it is a capital loss or a business loss deductible against all sources of income will depend very much on the nature of the individual cryptocurrency holder.
“Similar to commodities and securities, buying and selling cryptocurrency can be characterized as an investment activity where proceeds/profits are considered capital gains or they can be characterized as trading or business activities where the proceeds/profits are considered business income,” adds Rotfleisch.
For example, he notes, if it is characterized as a bad debt, then investors can elect for s. 50(1) of the Income Tax Act to apply, which means the investor would be considered to have sold and then re-bought the debt at $0 value, resulting in a capital loss equal to the adjusted cost basis, also known as book value, of the debt.
The amount of the writeoff, says Rotfleisch, would be based on the amount an individual paid for the cryptocurrency, rather than the value at the time that the exchange shut down. For example, if an investor purchased a cryptocurrency at $100, but its value was $5,000 at the time it became a bad debt, the investor would only be entitled to a capital loss of $100, rather than $5000.
On the other hand, if a taxpayer is running a cryptocurrency trading business, the loss may be characterized as a non-capital loss.
“The difficulty is in determining whether one’s activities should properly be considered an investment or a business. Generally, when profits are involved, an investment/capital characterization is most beneficial because of the 50 per cent tax rate, but where losses are involved, a business/non-capital characterization becomes more attractive.
“The consequence of getting it wrong is that interest and penalties will apply if the CRA finds that the incorrect characterization resulted in insufficient tax being paid,” says Rotfleisch.