If you are mining bitcoins or alt-coins or have been considering getting involved with mining, it is important to be aware of the tax implications. The Canada Revenue Agency (“CRA”) has let it be known in a technical interpretation that mined digital currency, unsurprisingly, is not immune from tax treatment.
For tax purposes, a key consideration to be made is whether your mining consists of a personal or a business activity. If the activity is considered a business activity the mined bitcoins may be considered inventory or capital property and taxed accordingly. If it is a business activity then expenses and certain losses associated with the mining operation can also be deducted. We know from previous CRA bulletins, that payments received in respect of, or in connection with, a business carried on by the taxpayer, must be included in the taxpayer’s income from that business. Bitcoins rewarded to miners for supporting the network and verifying transactions, where the mining activities are considered business activity, must be calculated as income.
Whether your mining operation is a business or personal activity is determined on a case-by-case basis. However, there are some key elements that can facilitate making the distinction. A personal activity is endeavored to provide a personal benefit rather than a financial one; it is primarily undertaken for pleasure, entertainment, or enjoyment rather than for profit, business, or commercial reasons. Drawing on the Supreme Court’s decision Stewart v. Canada, the CRA explains that “In order for an activity to be classified as commercial in nature, the taxpayer must have the subjective intention to profit and there must be evidence of businesslike behavior which supports that intention”. Even a personal hobby can be considered a business activity if it is pursued in a sufficiently commercial and businesslike way – and consequently would be considered income under the Income Tax Act. For example, you may be a bitcoin enthusiast and for fun in your spare time, decide take a bunch of old computers you have lying around and set them up to start mining bitcoins or dogecoins. Is this a personal or business activity?
The determination of whether an activity is undertaken for profit is based on facts and determined case-by-case. In light of this understanding, it is very possible that your mining operation is a business activity and you just don’t know it.
For some, mining is merely a hobby activity and for others it represents a major commercial undertaking in which significant sums have been invested with the expectation of very high returns. Not all mining activity will be subject to this test –large-scale mining operations that involve multiple stakeholders and external financing are clearly business activities. Only where there is a personal and hobby element involved might bitcoins or altcoins generated through mining activity not be considered business income. An activity that has been financed externally is an indication that an activity is being operated in a business like manner (Stewart v. Canada par. 59). A reasonable expectation of profit is another one of several factors taken into account in making the determination. Other factors that may be considered include, without limitation, the taxpayer’s training, the taxpayer’s intended course of action, and the capability of the venture to show a profit.
If the activity is a business activity then the bitcoins may be evaluated as inventory. It will be necessary to determine the value of the taxpayer’s inventory for the purposes of computing a taxpayer’s income from business. There are specific rules pertaining the valuation of inventory. Different methods exist for valuing inventory and which one is used can be relevant.
The CRA also indirectly references the consequences of loss of bitcoins from theft when they are acquired in the context of business activities. A loss of trading assets, such as inventory, which would include mined bitcoins, or cash, through theft, defalcation or embezzlement is normally deductible in computing income from a business if such losses are an inherent risk of carrying on the business and the loss is reasonably incidental to the normal income-earning activities of the business (see IT-185R). One wonder’s whether mined bitcoins that were lost in connection to Mt. Gox would be considered “reasonably incidental” to the activities of the business.
Exchanges operating entirely in digital currency fall within reach of the taxation rules – says the CRA. The purchasing of one digital asset with another, through an exchange would be treated as a barter transaction and the value of the goods must be brought into the taxpayer’s income if they are business related. The value received from such an exchange might also result in a capital gain.
While this post aims to provide some clarity with respect to your tax obligations the greatest comfort can come from your bitcoin legal expert. Note that the technical interpretation provides general comments and is intended only to assist in making determination. For greater clarity –consult your bitcoin legal professional. Note that the technical interpretation does not confirm the income tax treatment of a particular situation, it is aimed to assist taxpayers engaging in activities related to the creation of, or trading of, digital currency.