Cryptocurrency And NFT Taxation And Divorce – Guidance From A Canadian Tax Lawyer – Tax

Introduction – Cryptocurrency and NFTs should be disclosed as
matrimonial property

A divorce will result in many financial changes and one of the
major issues for divorcing couples is division of matrimonial
property. As cryptocurrency and NFT investments continue to grow, a
rising issue is whether they should be disclosed as matrimonial
property.

This article first discusses how to deal with cryptocurrency
assets and NFT during a marriage breakdown, then it identifies the
factors courts tend to review regarding whether to characterize
gains from disposition from cryptocurrency or NFTs as income or
capital gains. The article then explains the Canada Revenue
Agency’s tax audit powers and offers tips regarding how the voluntary disclosure program may help if
taxpayers have unreported gains from dispositions of cryptocurrency
or NFT.

Cryptocurrency and NFTs must be disclosed during a marriage
breakdown

Because cryptocurrency and NFTs are assets like any other, they
must be disclosed on the date of valuation. Failure to do so may
lead to penalties imposed by the court. For example, in a recent
case in British Columbia, the BC Supreme Court in M.W. v
N.L.M.W., 2021 BCSC 1273 decided to penalize the spouse who
failed to make a fulsome cryptocurrency asset disclosure. In this
case, the husband who invested in cryptocurrency only disclosed one
cryptocurrency account in his financial statement but claimed to
have lost all his cryptocurrency investments. The judge found his
actions particularly egregious and attributed $60,000 to his
cryptocurrency assets even though he suffered investment
losses.

Transferring capital property between separated and former
spouses without triggering any income tax liability

Under 73(1) of the Income Tax Act, capital property can be
transferred between separated and former spouses without triggering
any income tax liability via an automatic rollover if the following
conditions are met:

• The property is capital property,




• The property is transferred to a separated spouse, a former
  spouse or a spousal trust in settlement of marital property;
  and




• Bother parties are resident in Canada at the time of
  transfer.

There is no requirement to file an election or form with the CRA
if the conditions mentioned above are met and the rollover is
automatic. Therefore, when crypto assets are transferred between
divorcing spouses, there is no tax consequence. The transferor can
also elect out of the rollover irrespective of the consent from the
transferee. The capital gain or loss is then triggered and reported
in the transferor’s personal income tax return.

Tax consequences regarding gains or losses from disposition of
cryptocurrency or NFTs

The recipient spouse, whether a former spouse or a separated
spouse, will be taxed on the gains from a subsequent disposition of
cryptocurrency or NFTs based on the transferor’s adjusted cost
base. The tax consequences will be grossly different based on how
the profits are characterized, i.e. business income is fully
taxable while only 50% of capital gains are subject to tax
(https://taxpage.com/articles-and-tips/trading-stocks-and-cryptocurrency/).

According to case law, courts and therefore CRA will generally
treat gains as business income if a business is being carried on or
if the gains resulted from an adventure in the nature of trade
based on the following factors:

• The nature of the property sold.Where property
  acquired by a taxpayer is of such a nature or of such a magnitude
  that it could not produce income or personal enjoyment to its owner
  by virtue of its ownership, courts will generally assume the
  taxpayer engaged in an adventure in the nature of trade. As for
  property acquired that is capable of producing income, if the
  taxpayer is not in a position to operate it and could only make use
  of it by selling it, courts will generally make the same
  presumption.




• The length of period of ownership.Generally, property
  meant to be dealt in is realized within a short time after
  acquisition. Nevertheless, there are many exceptions to this
  general rule.




• The frequency or number of other similar transactions by
  the taxpayer.If the same sort of property has been sold in
  succession over a period of years or there are several sales at
  about the same date, courts will likely presume that there has been
  dealing in respect of the property.




• Work expended on or in connection with the property
  realized.If a taxpayer put into effort to bring the property
  into a more marketable condition during the ownership of the
  taxpayer, then it’s likely it’s income from an adventure in
  the nature of trade.




• The circumstances that were responsible for the sale of the
  property.There may be an explanation for a taxpayer to
  suddenly sell cryptocurrency due to a sudden emergency
  or an opportunity calling for ready money. In that case, courts
  will likely preclude a finding that the plan of dealing in the
  property was what caused the original purchase.




• This is the most important factor. The intention at the time of
  acquiring an asset as inferred from surrounding circumstances and
  direct evidence is one of the most important elements in
  determining whether a gain is of a capital or income nature.
  Alternatively, if a taxpayer has a secondary intention to sell the
  property in case things don’t pan out before purchase, then
  courts will treat it as income from business.

T1135 foreign reporting requirements regarding
cryptocurrency

A taxpayer is required to report any “specified foreign
property” with a total cost of more than $100,000 at any time
during the year to the Canada Revenue Agency (CRA) and file the T1135 form. The definition of “specified
foreign property” under the Income Tax Act generally includes
cryptocurrency, NFTs or other blockchain-based assets. However, it
excludes property that is used or held exclusively in the course of
carrying on an active business.
(https://taxpage.com/articles-and-tips/a-canadian-tax-lawyers-guidance-on-t1135-for-cryptocurrencies/)

Failure to file the T1135 form may result in a penalty of at
least $100 or $25 per day for each day that the form is late with a
maximum of $2,500. If the CRA issues a demand for the return, and
if the person fails to file the T1135 form knowingly or under
circumstances amounting to gross negligence, the penalty if $1,000
per month for each that the form is late with a maximum of $24,000.
Further penalties may apply if the form is late by more than 24
months.

Voluntary Disclosure and failure to file T1135

Taxpayers who fail to file their T1135 forms on time don’t
need to panic as the Voluntary Disclosure Program (VDP) is designed
as a second chance for taxpayers to correct their previous errors
on their tax returns or disclose unreported income in exchange for
penalty or interest relief. However, for the CRA to accept a VDP
application, it must be

1. Voluntary;




2. Complete;




3. Involve the application or potential application of a
   penalty;




4. Include information that is at least one year past due;
   and




5. Include payment of the estimated tax owing.

The CRA has made it clear that it is not obligated to accept all
VDP applications and each VDP application will be reviewed based on
its own merit. Regarding whether to accept an application, it is
subject to the CRA’s own discretion (https://taxpage.com/voluntary-disclosure/).

F.A.Q.

When a capital property is transferred between former
spouses during a marriage breakdown, will it trigger any income tax
consequences?

There is no tax triggered when a capital property is transferred
between former spouses during a marriage breakdown, a rollover
which is essentially a tax-free transfer is automatic if certain
conditions are met and there is no requirement to file an election
or form with the CRA.

When is the due date for filing the T1135
form?

Due date for filing the T1135 Your T1135 is due on or before the
due date of your income tax return. For individuals the filing
deadline is generally April 30 of the following year. Corporations
and some testamentary trusts may have an off-calendar year-end,
therefore they may have different filing deadlines.

What kind of relief does the VDP provide?

The VDP offers two streams of programs, one is the
general program which is more lenient and the other is the limited
program which is more restrictive regarding interests and penalty
relief.

Under the general program, the taxpayer will not be charged
penalties and will not be referred for criminal prosecution. The
CRA may also grant a 50% interest relief in respect of assessments
for years preceding the three most recent years of returns required
to be filed.

Under the limited program, the taxpayer will also not be charged
for criminal prosecution and will not be charged gross negligence
penalties, However, there is no interest relief.

Regarding both programs, the CRA’s ability to grant penalty
relief is limited any taxation year that ended within the previous
10 years before the calendar year in which the application is
filed.

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.