This article is the first in a series analyzing issues that have arisen in the world of indirect tax via the Canada Revenue Agency’s (CRA’s) roundtable events with the Chartered Professional Accountants of Canada (CPA Canada) and the Canadian Bar Association.
As the world moves to an increasingly digitized marketplace, it is crucial for tax legislators to recognize the numerous options for digital currency and to contemplate how they should be treated for the purposes of value-added tax (VAT). On May 17, 2019, the Department of Finance Canada (Finance Canada) released for public consultation a series of draft legislative proposals which would significantly change how virtual currencies are treated for GST/HST purposes. CPA Canada has submitted to Finance Canada its response to the legislative proposals, highlighting a number of areas where there remains a lack of clarity.
Cryptocurrency vs. virtual currency
“Cryptocurrencies” are digital assets that are designed to work as mediums of exchange. Cryptocurrencies exist only digitally and rely on a decentralized control system based around distributed ledger technology such as blockchain. Prominent examples include Bitcoin, Litecoin and Ethereum.
“Virtual currency” is a broader term used to denote any unregulated digital currency issued (and often also controlled) by its developers for use within a specific virtual community.
While cryptocurrency is a form of virtual currency, it is not the only type of virtual currency available. In contemplating the various GST/HST implications of the transition of the world towards a digital economy, tax legislators, businesses and consumers alike should consider both the indirect tax and direct tax implications of cryptocurrencies such as Bitcoin and the plethora of other virtual currencies, including initial coin offerings through to gold-backed cryptocurrencies, and everything in between. These distinctions have not been contemplated by Finance Canada’s proposals.
Prior to the release of the draft legislative proposals, the CRA had generally taken the view that all forms of virtual currency would be considered as intangible personal property (IPP). This rendered all transactions where virtual currency was used to purchase goods and services to be barter transactions with the recipient of the goods or services simultaneously making a supply of IPP to the supplier of the goods and services, with the consideration of the virtual currency being equal to the value of the goods and/or service received in exchange.
Therefore, the recipient (i.e. the person paying in virtual currency) of the goods or services would be required to collect, report and remit GST/HST on the supply of the IPP/virtual currency (if registered or required to be registered for GST/HST purposes) equal to the fair market value (FMV) of the IPP or virtual currency, while the supplier of the goods and services would also collect, report and remit the GST/HST (or other sales tax, if applicable) on the FMV of the goods and services.
This position was broadly at odds with other VAT-based jurisdictions. For instance, following the judgment in the Hedqvist case, the European Commission’s VAT Committee has taken the position that the use of cryptocurrency (in this instance, specifically Bitcoin) for the acquisition of goods or services is outside the scope of European VAT and that no VAT should therefore be levied on the value of Bitcoin itself.
The draft legislation creates a new concept, that of a “virtual payment instrument” (VPI) under subsection 123(1) of the Excise Tax Act (Canada) (the ETA). To qualify as a VPI, the virtual currency must meet four conditions:
1. it must be a digital representation of value;
2. it must function as a medium of exchange;
3. it can only exist as a digital address of a publicly distributed ledger; and
4. it must not be property that:
- confers a right to be:
- exchanged or redeemed for money or specific property or services; or
- converted into money or specific property or services; or
- is primarily for use within, or as part of, a gaming platform, an affinity or rewards program or a similar platform or program.
Under the draft legislation, VPIs would be added to the definition of “financial instrument” in subsection 123(1) of the ETA. As such, the use of a VPI to pay for goods and services would be treated as an exempt or zero-rated financial service depending on the residence of the other party (i.e., zero-rated where the other party is not resident in Canada and the supplier is a financial institution, but exempt otherwise).
Issues raised by draft legislation
A number of issues have been raised by CPA Canada in respect of the draft legislation and have been summarized in CPA Canada’s response to the consultation.
Interaction of proposed legislation with financial institution rules
There is a concern that by using a VPI as a money equivalent (i.e., consideration for a supply), an entity could become a financial institution (FI) and be subject to potential restriction of input tax credits (ITCs) and increased compliance complexity. In particular, the acquisition or disposition of a VPI could be considered a “separate fee or charge for a financial service” under paragraph 149(1)(b) of the ETA. As such, a business that either collected a large proportion of its revenue in the form of VPIs, or made a large proportion of its purchases using VPIs could inadvertently become an FI. Further complications arise when an FI makes a payment using a VPI to a non-resident. In such a situation, it could be argued that the FI is making a supply of an exported financial service.
Certain virtual currencies not treated as VPI
The definition of VPI in subsection 123(1) of the ETA is drawn relatively narrowly and as such excludes a large number of virtual currencies. CPA Canada has indicated that it believes that the following payment mechanisms would not be covered by the proposed legislation:
- Utility tokens which confer a right to be exchanged for various goods and services rather than a specific good or service;
- Libra (Facebook coin) – a cryptocurrency proposed to start on a permissioned blockchain rather than a publicly distributed ledger;
- Stablecoins – digital coins anchored by a hard currency or similar;
- Gaming platform coins where such coins can be used to purchase non-game purchases.
If these virtual currencies do not meet the definition of VPI, the concern is that such virtual currencies will be taxed both on issuance and when used to purchase other goods and services.
Mining of cryptocurrency
The proposed legislation does not address cryptocurrency mining, although it is understood that Finance Canada is considering further legislation to bring clarity to this activity. Under the ETA there is a lack of clarity as to whether cryptocurrency mining constitutes a commercial activity, given that such mining may lead to the creation of a VPI or IPP. On this basis, the ability of a cryptocurrency miner to claim ITCs on the often substantial inputs that go into mining for cryptocurrency such as hardware, facilities and electricity may be in question. In its response to the consultation, CPA Canada argues that Finance Canada should adopt specific legislation to bring clarity around the GST/HST obligations and rights of cryptocurrency miners, but also for income tax purposes, including international tax treaties between Canada and the home countries of cryptocurrency miners.
Income tax considerations for non-residents
If a non-resident carries on business in Canada, they are generally liable for tax in Canada, unless the otherwise taxable income is protected by a tax treaty. As well, a non-resident that carries on business in Canada is generally required to file an income tax return, regardless of treaty protection.
Even if the non-resident may not otherwise be considered carrying on business according to common law principles or for GST/HST purposes, a non-resident engaged in cryptocurrency mining may be deemed to carry on business in Canada for income tax purposes if the non-resident “…produces, grows, mines, creates, manufactures, fabricates, improves, packs, preserves, or constructs, in whole or in part, anything in Canada whether or not the person exports that thing without selling it before exportation…”.
Where a non-resident is carrying on business through a permanent establishment they are generally liable for Canadian income tax on profits attributable to that permanent establishment and may also be liable for branch tax in Canada as well. The definition of permanent establishment varies among treaties, but generally includes (though not limited to) a fixed place of business (e.g. a place of management, a branch, an office, a factory, etc.) or a deemed permanent establishment if a person acting on behalf of the non-resident (other than an independent agent) has and habitually exercises in Canada an authority to conclude contracts.
Cryptocurrency and related IPP supplies connected to this emerging industry, whether it be mining, trading or even third party suppliers that deal with customers in this space, all possess unique direct tax and indirect tax issues to consider, particularly as legislation and administration thereof continue to evolve.
 Weber, Heather and Ball, Bruce, Letter to: Phil King (Director General, Sales and Excise Tax Division, Finance Canada), 2019, June 28
 Court of Justice of the European Union, judgment of 22 October 2015 in case C-264/14 Hedqvist.
 Value Added Tax Committee (Article 398 of Directive 2006/112/EC) Working Paper No. 892