As a result of China’s recent crackdown on bitcoin mining, in July 2021, Black Rock Petroleum Company, a Nevada corporation, announced that it entered into an agreement with Optimum Mining Host Limited Liability Co. to relocate up to one million Bitcoin miners from China to Alberta, Canada. They agreed to deploy these miners across three natural gas producing sites in Alberta. The first 200,000 units will be relocated to the Quick Creek Gas plant, operated by Caledonian Midstream Corporation. Experts estimate that this agreement could represent up to 1/3 of global bitcoin mining capacity. This article will discuss the tax implications of Bitcoin mining in Canada.
What is Bitcoin Mining?
Bitcoin is a digital currency also known as a cryptocurrency. One of the unique features distinguishing cryptocurrency from other digital currencies is that it is created and distributed using a decentralized ledger system, known as the blockchain. The blockchain is hosted by thousands of independent computers around the world called nodes. Each node has a copy of an identical ledger, and the ledgers are publicly accessible by anyone. When a transaction of Bitcoin happens, each node independently verifies it from data called blocks. Blocks are connected in chains that comprise the entire record of transactions since the inception of an individual Bitcoin.
Bitcoin miners are essentially auditors who verify blocks of Bitcoin transactions. Miners ensure that the transactions of Bitcoins contained in blocks are accurate. This process of verification requires solving complex mathematical puzzles with expensive and high-powered computers. As a reward for accurately verifying blocks of Bitcoin transactions, Bitcoin miners are rewarded with new Bitcoin.
There are two implications of mining Bitcoin. First, it ensures the accuracy and legitimacy of the blockchain. Miners make sure that no transactions are duplicated or recorded twice. Second, when a Bitcoin miner accurately verifies a block of Bitcoin transactions, new Bitcoin is produced, similar to how a physical mining operation may extract gold from minerals. Whenever miners add a new block of transactions to the blockchain, they are rewarded with Bitcoin. However, not all miners who verify transactions will get paid out. Bitcoin mining operation is competitive: only the first miner to solve the computational problem will earn the Bitcoin. This process of mining can be a lucrative operation, especially in places where electricity is cheap.
Canadian Taxation of Bitcoin mining
The tax consequences of Bitcoin mining depends not only on the nature of Bitcoin mining itself, but also on the circumstances in which the taxpayer acquired the Bitcoin through mining.
The Hobbyist Canadian Bitcoin Miner
If a taxpayer mines Bitcoin solely as a hobby or personal endeavour without commercial intent, then the mining itself is not a source of income. In other words, when the hobbyist Canadian taxpayer acquires Bitcoin units through mining, the taxpayer need not report the value of those mined Bitcoin units as income. In such scenarios, the income inclusion will occur only when the taxpayer disposes of the mined Bitcoin units. The disposal of the mined Bitcoin is a separate activity, and the resulting gain or loss is reportable either on income account or on capital account. At the time of disposal, if the taxpayer sells the mined Bitcoin without commercial intent, the gain or loss will be capital gain or loss. On the other hand, if the taxpayer sells the mined Bitcoin with commercial intent, the gain or loss will be business income or loss.
Bitcoin Mining as Inventory Acquisition
If a taxpayer’s Bitcoin mining operation is merely a part of an oning business activity, the mining is not itself the taxpayer’s source of income – rather, it is an aspect of the taxpayer’s primary source of income. In order for this characterization to be appropriate, the taxpayer’s primary source of income must consist of selling and trading the mined Bitcoin. Just as a gold miner does not recognize an income inclusion upon unearthing gold deposits, a cryptocurrency trader need not recognize income when acquiring Bitcoin through mining. Instead, the mining activity will constitute an activity of acquiring inventory. The taxpayer in this view will realize income when the taxpayer disposes of the mined Bitcoin units.
Therefore, this view is only appropriate if the Bitcoin mining occurs in the context of a broader cryptocurrency-trading business. In this view, the Bitcoin mining activity is merely instrumental to the primary business model – which is to acquire Bitcoin and sell them for profit.
Bitcoin Mining as the Provision of Services
Unlike the above two cases, if a Bitcoin miner does not operate a cryptocurrency-trading business and the miner carries out the Bitcoin mining activity with commercial intent, the Bitcoin miner is essentially providing a type of service. Under this view, the taxpayer’s Bitcoin reward from mining is itself a source of income and the taxpayer must report the value of the mined Bitcoin units as income for the year of acquisition. The Bitcoin mining activity in this scenario is akin to providing third-part software services.
The service-provision view finds support from the role of mining in maintaining the integrity of the Bitcoin network and the portion of the mining reward that consists of a platform transaction fee. In particular, through Bitcoin mining, the miner expends computing power to validate Bitcoin transactions and thereby provides a service to Bitcoin users collectively. In exchange, the miner receives compensation.
As explained above, this view is reserved for cases in which the taxpayer mines Bitcoin with commercial intent yet does not operate a cryptocurrency-trading business.
The New Bitcoin Mining Agreement Between Black Rock Petroleum Company and Optimum Mining Host Limited Liability Co.
The tax consequences of the mined Bitcoin from Optimum Mining Host Limited Liability Co. will depend on the circumstances in which the corporation acquired the Bitcoin through mining. First, it is self-evident that the mining operation which involves relocating 200,000 Bitcoin mining units to the Quick Creek Gas plant during the first wave of operation, will be categorized as a business activity. Thus, the hobbyst miner approach which was discussed earlier in this article is not an appropriate characterization for this type of operation – Optimum Mining Host Limited Liability Co. has commercial motives.
If the Bitcoin mining activity involved in this operation is merely incidental to a cryptocurrency trading business, then the mined Bitcoin rewards will not be a source of income. Instead, the Bitcoin mining activity will be viewed as an act of acquiring inventory. On the other hand, if Optimum Mining Host Limited Liability Co. will not carry on a cryptocurrency-trading business, then the mining activity itself will constitute a source of income. In such a scenario, Optimum Mining Host Limited Liability Co. will have to report the value of the mined Bitcoin units as income for the year of acquisition. Therefore, the tax implications of the mined Bitcoin will depend on the circumstances on which Optimum Mining Host Limited Liability Co. acquired the Bitcoin through mining.
Pro Tax Lawyer Tips: Keeping Records
If you are a Bitcoin miner, you should always keep records of all documents related to the operation. For example, some of the records that should be kept are receipts of cryptocurrency mining hardware and software, receipts of expenses related to the mining operation such as power costs and maintenance costs, and mining pool details. You should also consult with a knowledgeable Canadian tax lawyer to determine the best tax structure for your bitcoin mining operation.
If you have an ongoing Bitcoin mining operation and have some questions regarding the tax implications of your mining activities, consider consulting with an expert Canadian crypto income tax lawyer. Our firm has assisted numerous clients with cryptocurrency and NFT issues from tax planning and compliance to tax disputes with the Canada Revenue Agency. Our experienced Canadian tax lawyers have dealt with Canada Revenue Agency objections, voluntary disclosures, planning tax-efficient structures for cryptocurrency holdings, incorporating cryptocurrency-trading business, reorganizations, and analyzing the proper tax-law characterization of cryptocurrency transactions. If you are a Bitcoin miner and have any tax inquiries related to your operations, contact one of our knowledgeable Toronto tax lawyers.
What is a T1135 Form?
The Foreign Income Verification Statement, also known as the T1135 form, is used to report foreign investment property to the CRA. The CRA requires a Canadian resident individual, corporation, trust, or partnership to file this form if the owner has “specified foreign property” at any time during the taxation year and if the specified foreign property costs more than $100,000. CRA takes the position that the T1135 requirement extends to cryptocurrencies situated, deposited or held outside of Canada. So if a taxpayer has cryptocurrency with a total cost of more than $100,000 at any point during the year, they may be required to file a T1135 Form. Contact one of our Toronto tax lawyers if you have any questions regarding cryptocurrency tax reporting obligations.
Can You Report Gains From Disposing Cryptocurrency as Capital Gains?
Cryptocurrency is subject to taxation when a taxpayer disposes of it as either an income from a business source or as capital gains from the disposition of property. Suppose the characterization of income from disposition of cryptocurrency is capital gains. In that case, the taxpayer will be taxed only 50% of the gain as a result of the capital gains inclusion rate. However, the characterization of income from the disposition of cryptocurrency will depend on whether the taxpayer’s activities involving cryptocurrency have sufficient commercial nature. If you have questions regarding the characterization of your income from the mining or disposition of cryptocurrency, contact one of our knowledgeable Toronto tax lawyers.