Canada Proposes New GST/HST Rules For Cryptocurrency Mining – Canadian Tax Guidance From A Canadian Tax Lawyer – Sales Taxes: VAT, GST

Introduction – Draft Legislative Proposals Concerning GST/HST
Treatment of Cryptocurrency Mining

Since 2019, Canada has steadily introduced new GST/HST rules aimed at cryptocurrency. In May
2019, for instance, Canada’s Department of Finance released
draft legislation that rendered cryptocurrency trading an exempt
supply of financial services. These proposals received royal
assent-and therefore became law-on June 29, 2021. Canada’s
Excise Tax Act now officially contains tax rules that
define most cryptocurrency as a “virtual payment
instrument,” the purchase, sale, or transfer of which is
exempt from GST/HST.

In February 2022, Canada’s Department of Finance released
draft legislation concerning the GST/HST treatment of
cryptocurrency mining. These proposals have not yet taken effect.
If the legislation is passed, these tax rules will retroactively
come into force as of February 5, 2022.

After briefly reviewing Canada’s GST/HST system and
discussing the nature of cryptocurrency mining, this article
examines the proposed GST/HST rules for cryptocurrency mining. This
article concludes by offering pro tax tips from our expert crypto
tax lawyer in Toronto.

Canada’s GST/HST Regime: A Brief Introduction

Subsections 165(1) and (2) of Canada’s Excise Tax Act impose GST/HST on
“every recipient of a taxable supply made in Canada.” A
“taxable supply” captures most business transactions-in
particular, it refers to a sale, transfer, barter, exchange, rent,
or donation of a property or service if the transaction is done in
the course of conducting business (see: subsection 123(1)).

Yet while GST/HST is levied on the recipient of the property or
service (the purchaser), the person who makes the supply (the
vendor) bears the obligation to actually collect and remit the tax
(subsection 221(1)). To this end, the Excise Tax Act
requires a person to register for and collect GST/HST if, in the
course of conducting business, that person sells, transfers,
barters, exchanges, rents, or donates a property or service in
Canada.

Granted, the Excise Tax Act exempts various businesses
from the obligation to collect GST/HST. For example, a taxpayer
need not register nor collect GST/HST if its worldwide revenues
didn’t exceed $30,000 during the last four calendar quarters
combined (see: subsections 240(1), 148(1)). The threshold is
increased to $50,000 if the taxpayer is a public service body-i.e.,
a non-profit organization, a charity, a municipality, a school
authority, a hospital authority, a public college, or a
university.

A financial-services business is another example of a business
that need not charge or collect GST/HST. The Excise Tax
Act‘s definition of a “financial service”
captures various transactions involving a “financial
instrument,” such as:

• The purchase or sale of a financial instrument;




• The use of a financial instrument as a method of payment;




• The lending or borrowing of a financial instrument;




• The issue, acceptance, or transfer of ownership of a financial
  instrument;




• The provision of a financial instrument; and




• The payment or receipt of money as dividends, interest,
  principal, benefits, or any similar payment or receipt of money in
  respect of a financial instrument.

In June 2021, the definition of a “financial
instrument” was officially amended to include a “virtual
payment instrument.” A virtual payment instrument
refers to “property that is a digital representation of value,
that functions as a medium of exchange and that only exists at a
digital address of a publicly distributed ledger.” So,
fungible cryptocurrency-like Bitcoin, Ethereum, or Chainlink-falls
squarely within the definition of a virtual payment
instrument. As such, cryptocurrency trading or the use of
cryptocurrency as a method of payment are GST/HST exempt because
they each qualify as a “financial service” under the
Excise Tax Act.

(Interestingly, non-fungible tokens, or NFTs, don’t clearly
fall under the definition of a virtual payment instrument.
NFT artwork, for instance, often consists of a digital
representation of a piece of art or music, not a “digital
representation of value.” As such, it arguably doesn’t
“function as a medium of exchange.” So, although a cryptocurrency-trading business qualifies as a
GST/HST-exempt supply of financial services, commercial NFT
sales remain a taxable supply under Canada’s Excise Tax
Act.)

Cryptocurrency Mining: Verifying Cryptocurrency Transactions on
a Proof-of-Work Blockchain

The various cryptocurrency platforms-such as Bitcoin (BTC),
Ethereum (ETH), Tether (USDT), Solana (SOL), and Ripple (XRP)-all
depend upon a decentralized-ledger technology known as a
“blockchain.” A blockchain is a specific type of data
structure. It stores and transmits data in packages called
“blocks,” which are connected to each other in a digital
“chain.” Blockchain technology allows transactions and
data to be recorded and shared in a synchronized and decentralized
way across network participants. The result is that transactions
between network participants can be processed without involving an
intermediary or central party.

Blockchain use consensus mechanisms to validate new
cryptocurrency transactions. In blockchain protocols that rely on
the proof-of-work validation mechanism (e.g., the Bitcoin network),
the verification process is known as “mining.”

In this system, the validator-that is, the cryptocurrency
miner-devotes computing power toward solving mathematical problems.
By doing so, the miner verifies new cryptocurrency transactions and
shares the results with other network participants by recording the
verified transaction as a new block on the blockchain.

The mathematical problems in proof-of-work systems aim to make
validation prohibitively expensive in terms of the computing power
and electricity required to solve these problems. As a result, a
malicious user can falsify the blockchain only if the attacker
incurs a significant cost. As a result, from an economic
standpoint, a malicious user will generally find it unprofitable to
attempt to falsify a blockchain transaction.

Cryptocurrency mining occurs on a competitive basis. A reward is
credited to the miner who validates the transaction first. The
mining reward usually consists of new tokens in the native
cryptocurrency or transaction fees (or both). (Another disincentive
for malicious users is that miners lose their mining rewards if
they repeatedly attempt to validate blocks that the remaining
network considers invalid.)

For information about cryptocurrency mining and about the
resulting Canadian income-tax implications, see our article on cryptocurrency mining.

Proposed GST/HST Tax Rules for Cryptocurrency Mining: 188.2 of
the Excise Tax Act

In February 2022, Canada’s Department of Finance proposed
the addition of section 188.2 to address the GST/HST treatment of
cryptocurrency mining. These proposals have not yet taken effect.
If the legislation is passed, these tax rules will retroactively
come into force as of February 5, 2022.

In short: Section 188.2 deems the provision of “mining
activity” to not be a supply. Cryptocurrency miners therefore
need not remit GST/HST on the mining rewards or other remuneration
that they receive for their mining activities. In addition, if a
cryptocurrency miner acquires, consumes, or uses any property or
service in relation to cryptocurrency mining, section 188.2 deems
the cryptocurrency miner to not have used that property or service
in the course of a commercial activity. This denies cryptocurrency
miners from claiming input tax credits (ITCs) for their
cryptocurrency-mining operations.

Hence, section 188.2 effectively treats cryptocurrency mining as
an exempt supply: the cryptocurrency miner need not collect and
remit GST/HST on the miner’s compensation from mining, but the
crypto miner also cannot claim input tax credits in Canada for the GST/HST
incurred by the miner when running the cryptocurrency-mining
operation.

But the proposed crypto-mining tax rules contain an exception:
They don’t apply when a person mines cryptocurrency for another
person whose identity is known to the first person and who
doesn’t qualify as a “mining group operator,” which
basically refers to a person who coordinates the
cryptocurrency-mining activity of a group (i.e., the coordinator of
a mining pool). In these limited circumstances-when a person mines
cryptocurrency for a known person who doesn’t coordinate a
mining pool-the cryptocurrency miner may need to collect GST/HST
and may qualify for ITCs.

Pro Tax Tips: Tax-Law Analysis of Proper Cryptocurrency Tax
Reporting

The proposed cryptocurrency-mining rules don’t mean that
Canadians who deal in cryptocurrency, non-fungible tokens, and
other blockchain-based assets need not worry about GST/HST. First,
these proposed tax rules don’t capture the creation and
commercial sale of non-fungible tokens. So, a Canadian NFT artist
or NFT content creator earning $30,000 or more in gross revenue
must register for a GST/HST number with the CRA, charge GST/HST on
NFTs sold in Canada, collect that GST/HST, and pay it to the Canada
Revenue Agency. The proposed GST/HST-mining exemption also
doesn’t apply when a person provides cryptocurrency-mining
services to a known recipient. And, of course, the proposed
GST/HST-mining exemption has no bearing on the income-tax
consequences of cryptocurrency trading and cryptocurrency
mining-both of which are fully taxable and must be reported for
income-tax purposes.

Therefore, Canadian taxpayers who trade, invest in, mine, or
stake cryptocurrency, NFTs, or other blockchain-based assets will
benefit from a confidential and privileged tax-law memorandum
examining their GST/HST obligations under Canada’s Excise
Tax Act and their income-tax obligations under Canada’s
Income Tax Act. The distinctive features of various
blockchain-validation systems means that Canadian taxpayers
who’ve mined or staked cryptocurrency will require competent
and expert Canadian tax guidance. Our experienced Certified
Specialist in Taxation Canadian crypto-tax lawyer has assisted
numerous clients with correctly reporting their cryptocurrency
transactions and other blockchain-related arrangements.

The Canada Revenue Agency cannot compel the production of a
tax-law memorandum protected by solicitor-client privilege. Thus,
solicitor-client privilege bars the CRA from learning about the
confidential legal advice that you receive from our tax lawyers.
But your communications with an accountant remain unprotected
because no such privilege exists for accountants. For that reason,
if you seek tax advice but want to keep that information away from
the Canada Revenue Agency, you should first approach our Canadian
tax lawyers. If you also require the assistance of an accountant,
we can take measures to extend our solicitor-client privilege to
communications involving the accountant.

Frequently Asked Questions

Question: I hear that Canada has proposed new GST/HST
rules for cryptocurrency mining. What is cryptocurrency mining? And
what are the GST/HST implications of mining if the proposed GST/HST
rules take effect?

Answer: Cryptocurrency mining refers to the
transaction-validation process in blockchain protocols that rely on
a proof-of-work validation mechanism. The cryptocurrency miner
devotes computing power toward solving mathematical problems. By
doing so, the miner verifies new cryptocurrency transactions and
shares the results with other network participants by recording the
verified transaction as a new block on the blockchain. A reward is
credited to the miner who validates the transaction first. The
mining reward usually consists of new tokens in the native
cryptocurrency or transaction fees (or both).

Canada’s Department of Finance proposed the addition of
section 188.2 to address the GST/HST treatment of cryptocurrency
mining. Section 188.2 deems the provision of most “mining
activity” to not be a supply for GST/HST purposes.
Cryptocurrency miners therefore need not remit GST/HST on the
mining rewards or other remuneration that they receive for their
mining activities. In addition, if a cryptocurrency miner acquires,
consumes, or uses any property or service in relation to
cryptocurrency mining, section 188.2 deems the cryptocurrency miner
to not have used that property or service in the course of a
commercial activity. This denies cryptocurrency miners from
claiming input tax credits (ITCs) for their cryptocurrency-mining
operations.

In other words, section 188.2 effectively treats cryptocurrency
mining as an exempt supply: the cryptocurrency miner need not
collect and remit GST/HST on the miner’s compensation from
mining, but the crypto miner also cannot claim input tax credits
for the GST/HST incurred by the miner when running the
cryptocurrency-mining operation.

But the proposed GST/HST rules contain an exception when a
person provides cryptocurrency-mining services to a known
recipient. In those cases, the cryptocurrency miner may need to
collect GST/HST and may qualify for ITCs.

Question: Over the past few years, I made a lot of money
by mining and trading various cryptocurrencies. But I don’t
understand how this bears upon my Canadian income-tax obligations
or my Canadian GST/HST obligations. What can I do?

Answer: Canadian taxpayers who trade, invest
in, mine, or stake cryptocurrency, NFTs, or other blockchain-based
assets have thereby engaged in taxable transactions which trigger
various tax-reporting obligations. These taxpayers will therefore
benefit from a confidential and privileged tax-law memorandum
examining their GST/HST obligations under Canada’s Excise
Tax Act and their income-tax obligations under Canada’s
Income Tax Act. The distinctive features of various
blockchain-validation systems means that Canadian taxpayers
who’ve mined or staked cryptocurrency will require competent
and expert Canadian tax guidance. Our experienced Certified
Specialist in Taxation Canadian crypto-tax lawyer has assisted
numerous clients with correctly reporting their cryptocurrency
transactions and other blockchain-related arrangements.

Question: I want to ensure that the Canada Revenue
Agency cannot learn about the tax advice that I receive in relation
to my cryptocurrency, non-fungible tokens, and other
blockchain-based assets. How can I go about doing
that?

Answer: Solicitor-client privilege bars the
Canada Revenue Agency from learning about the confidential legal
advice that you receive from our knowledgeable Canadian tax
lawyers. The Canada Revenue Agency cannot, for instance, compel the
production of a tax-law memorandum prepared for you by your
Canadian tax lawyer. Your communications with an accountant,
however, remain unprotected because no such privilege exists for
accountants. For that reason, if you seek tax advice but want to
keep that information away from the Canada Revenue Agency, you
should first approach our Canadian tax lawyers. If you also require
the assistance of an accountant, we can take measures to extend our
solicitor-client privilege to communications involving the
accountant.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.