There are 5 basic foreign-reporting rules in Canada's Income Tax Act, to report specific transactions involving foreign interest.
These are the relevant rules:
- A Canadian resident must file a T106 form if he is doing business with a non-resident.
- A Canadian resident must file a T1141 form if transferring or loaning property to a non-resident trust.
- A Canadian resident must file a T1135 form if either owning or has an interest in foreign property.
- A Canadian resident must file a T1134 form if they have a foreign affiliate.
- A Canadian resident must file a T1142 if they are a beneficiary and receive a distribution from a foreign trust.
Before this regulations, Canadian taxpayers didn't have to share details of offshore transactions or foreign holdings. This meant the Canada Revenue Agency couldn't identify taxpayers owning property or dealing in offshore transactions. Today, these regulations allow the Canadian government to get information.
What is a T1135 Form?
Also known as a Foreign Income Verification Statement, the T1135 form involves the Section 233.3 foreign-reporting role. A Canadian resident files this form if they own specified foreign property costing over $100,000. A Canadian taxpayer might need to complete the form even if the offshore property in question earns no taxable income. Also, filing the T1135 won't automatically increase tax liability, although there are steep fines if you fail to file the form when you're supposed to.
Unique challenges often arise when Canadian trading companies use cryptocurrencies, NFTs, and blockchain markets that struggle with cyber-crime and tax fraud risks. Blockchain technology developments bring even more assets, arrangements and opportunities into play.
Besides this, some traders might not realize what they're doing is carrying on a business, which means they could wrongly report their profits as capital gains.
T1135 Filing for Specified Foreign Property Valued over $100,000
Do Canadian taxpayers with crypto-trading companies have to file a T1135 form when their crypto cost exceeds $100,000? The simple answer to this question is no. This doesn't apply to every Canadian tax resident. For tax purposes, a non-resident doesn't have to file foreign information returns such as the T1135. There are also excluded entities like charities, non-profits, mutual fund trusts and corporations. Registered investments like RRSPs and TFSAs are exempt too. Also, some first-year residents are exempt.
After the tax-exempted first year, a taxpayer must file the form for every tax year that the following criteria apply:
- The taxpayer was a Canadian tax resident, not a first-year resident or otherwise exempt.
- The taxpayer had foreign property in the year.
- The aggregate tax cost for the foreign property went over $100,000 sometime during the year.
If these conditions apply, the taxpayer must include a T1135 with their income tax return, listing all specified property the taxpayer held during the year.
Business-Use Exemption for Foreign Property
According to the Income Tax Act, 'specified foreign property' should include cryptocurrency, blockchain-based assets and fungible tokens. Since these are 'intangible' assets that only exist on digital platforms, they aren't kept or held in any place or country. This means they must be held or deposited outside Canada and will need a T1135 filed for any year they amounted to over $100,000.
Because 'specified foreign property' doesn't include property held or used to run a business (e.g., a company's offshore inventory or cryptocurrency owned overseas), you don't have to report them on a T1135 if you're using them as inventory in a crypto-based business. You can deduct the cost of your cryptocurrency inventory when calculating whether your foreign holdings exceed the $100,000 threshold.
So, when is Cryptocurrency 'Business Inventory'?
The Income Tax Act recognizes two property types for tax purposes:
- Inventory, which is used to compute income and
- Capital property, which upon disposition creates a capital gain or loss
It is up to you to determine the nature of the income before characterizing the property. This can be tricky, though, so contact one of our tax accountants for guidance.
There is so much ambiguity between trading (which results in a business income) and investing (which results in a capital gain), and courts often must consider various factors to determine whether the gains or losses from a transaction would be on capital or income. It is essential to consider the risks.
Some of those factors include the following:
- Length of ownership
- Transaction frequency
- Relationship with the taxpayer's other work
- Knowledge of cryptocurrency markets
- Financing
- Time spent working with crypto
- Advertising
- The taxpayer's intention when the property was acquired
So, if you intend to trade when acquiring cryptocurrency or NFTs, they are counted as a part of your inventory. Say a taxpayer continued a crypto-trading business, then the cryptocurrency counts as inventory. But if the disposition led to a capital gain, the crypto or NFTs would be capital property for the taxpayer. This is essentially the formula to determine whether your crypto counts as inventory (and therefore does not need to be reported on a T1135).
The problem is that complex legal analyses are required to determine which assets qualify for which treatment. Fail to file a T1135 form when you should, and you can expect a steep fine. Failing to file can mean a $2,500 fine, and that's before interest. This can increase to $12,000 if gross negligence is involved. And if you file more than 2 years late, there could be an additional 5% penalty. There are also fines for writing a false statement or leaving out any details.
Luckily, the CRA's Voluntary Disclosures Program can help those who qualify for relief. Through this program, criminal prosecution can be renounced, and gross negligence penalties can be waived. However, you must submit your voluntary disclosure application before the Revenue Agency contacts you about non-compliance.
Because it can be so complicated to determine whether you must fill out a T1135 and what you need to include, we recommend you contact us at info@taxpartners.ca or call us at (905) 836-8755.
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