Tax Benefits of Cryptocurrency-Trading Business as a CCPC

Tax Benefits of Cryptocurrency-Trading Business as a CCPC

Tax Benefits of Cryptocurrency-Trading Business as a CCPC

Introduction: Cryptocurrency-Trading Businesses in Canada

Canadian cryptocurrency-trading businesses face unique challenges. The mostly unregulated cryptocurrency, non-fungible token (NFT), and blockchain markets brings higher risk of fraud and cyber-crime. The developments in blockchain technology bring about an ever-increasing range of opportunities, arrangements, and assets—smart contracts, cryptocurrency liquidity mining and yield farming, and non-fungible tokens (NFT), to name a few. And some cryptocurrency traders don’t even realize that they’re carrying on a business, thereby misreporting their profits as capital gains.

This article is meant for cryptocurrency-savvy Canadians who seek to understand the tax advantages of operating their cryptocurrency-trading businesses through a corporation. This article therefore assumes that some or all of your cryptocurrency transactions, NFT transactions, or other blockchain transactions generate business income, as opposed to capital gains. (If you don’t know whether your cryptocurrency profits or NFT profits constitute business income or capital gains, read our article “Canadian Income-Tax Implications of Buying and Selling Blockchain Non-Fungible Tokens (NFTs).” You may also wish to consult one of our expert Canadian tax lawyers for advice.)

This article first discusses how a corporate vehicle might allow a Canadian cryptocurrency trader to access the small-business-deduction tax rate and take advantage of tax-deferral opportunities. This article then reviews how a Canadian cryptocurrency trader can transfer cryptocurrency, non-fungible tokens, and other blockchain-based assets to a corporation on a tax-deferred basis under section 85 of Canada’s Income Tax Act. Finally, it concludes by offering expert Canadian tax guidance for Canadian taxpayers seeking to incorporate a cryptocurrency-trading business.

Canadian-Controlled Private Corporations: Canadian Tax Benefits for Traders of Cryptocurrency, Non-Fungible Tokens (NFT),  & Other Blockchain-Based Assets 

A Canadian taxpayer who operates a cryptocurrency-trading business derives two tax benefits from using a corporation. First, a Canadian-controlled private corporation (CCPC) qualifies for the small business deduction (SBD) and enjoys a reduced tax rate on its first $500,000 of active business income. Second, the individual shareholders can defer shareholder-level tax to the extent that retained earnings stay within the corporation.

After discussing the small business deduction and explaining what constitutes a “Canadian-controlled private corporation,” we illustrate the tax-deferral advantage of operating a cryptocurrency-trading business through a corporation.

Small Business Deduction (SBD) & Canadian-Controlled Private Corporations (CCPC)

Subsection 123(1) of Canada’s Income Tax Act sets the basic federal corporate tax rate—currently, 38 percent of a corporation’s taxable income. Subsection 124(1), however, reduces the federal rate by 10 percent on the amount of income that a corporation earned in a Canadian province. This 10 percent abatement provides relief for the corporation’s provincial or territorial tax burden. Further relief from provincial and territorial tax comes from a 13 percent general-tax reduction. So, after the 10 percent provincial abatement and the 13 percent general-tax reduction, a Canadian corporation’s net federal tax rate is 15 percent of its taxable income.

Yet for tax policy reasons certain corporations and types of income enjoy more favorable rates. Subsection 125(1) provides a “small business deduction” in certain limited circumstances. Simply put, a Canadian-controlled private corporation qualifies for an additional tax credit on the corporation’s first $500,000 of active business income. A Canadian-controlled private corporation therefore pays federal tax at a rate of 9 percent its active business income up to $500,000.

Canadian provinces and territories offer a similar small business deduction. For instance, the Ontario small business deduction reduces the corporate provincial income-tax rate to 3.2 percent on a Canadian-controlled private corporation’s active business income. (As of May 10, 2021, the combined federal and Ontario SBD tax rate is 12.2 percent.)

The phrase “small business deduction” or SBD is a misnomer. First, a deduction is claimed against income to reduce income; a credit is claimed against tax payable to reduce tax liability. So, the small business deduction is not a deduction; it is in fact a tax credit. Second, the small business deduction is not available to all businesses. Only certain incorporated businesses enjoy the tax credit. Finally, a corporation need not be small to benefit from the small business deduction. A qualifying corporation receives the full small business deduction tax credit until its “taxable capital employed in Canada” exceeds $10 million. At this point, the corporation’s small business deduction is reduced on a linear basis until the corporation’s taxable capital reaches $15 million. At that point the small business deduction tax credit is eliminated.

To qualify for the small business deduction (“SBD”), a corporation must be a “Canadian-controlled private corporation” earning active business income. Subsection 125(7) defines a “Canadian-controlled private corporation.” Basically, a Canadian-controlled private corporation (or CCPC) must satisfy three criteria:

  • It must be a private corporation. Essentially, its shares cannot be listed on a designated stock exchange.
  • It must be a Canadian corporation. Simply put, a Canadian corporation is one that is both resident and incorporated in Canada.
  • It cannot be controlled by either a non-resident person, a public corporation, or any combination thereof.

Notably, despite its name, a Canadian-controlled private corporation need not be controlled by Canadian residents. The corporation may still qualify as a “Canadian-controlled private corporation” so long as it isn’t controlled by non-residents, by public corporations, or by some combination of non-residents or public corporations. For example, suppose that a Canadian resident individual owns 50% of an unlisted Canadian corporation, and a public corporation owns the other 50% of the Canadian corporation. The Canadian corporation still qualifies as a CCPC because it isn’t controlled by non-residents, public corporations, or a combination of public corporations and non-residents.

The Income Tax Act also contains additional rules that buttress the CCPC definition. These rules deal with cases where a private Canadian corporation is subject to complex ownership structures. Moreover, because associated corporations must share the small business deduction, the Income Tax Act also contains complicated definitions stipulating what constitutes an “associated corporation.” Canadian courts have also rendered a number of decisions about how these tax rules apply in specific cases. For more details, you should consult a Canadian tax lawyer who is a Certified Specialist in taxation.

Tax-Deferral Advantage of Incorporating a Cryptocurrency-Trading Business in Canada

To illustrate the tax-deferral advantage of operating a cryptocurrency-trading business through a corporation, we compare the income-tax implications for a Canadian trader of cryptocurrency, NFT, or blockchain-assets who operates as a sole proprietor, on the one hand, and through a corporation, on the other.

Suppose that, in 2020, a Canadian taxpayer generated $1.2 million in business income from trading cryptocurrency, such as Bitcoin, Ethereum (ETH), or Litecoin (LTC), from trading non-fungible tokens, or from creating and selling NFTs. We will also assume that the $1.2 million is subject to the relevant combined federal and Ontario tax rates.

Let’s first look at the income-tax consequences for the Canadian cryptocurrency trader who earns $1.2 million in business profit while operating as a sole proprietor (that is, while operating the business personally without using a corporate vehicle).

In 2020, the combined federal and Ontario top marginal tax rate for individuals was 53.53%. So, if operating as a sole proprietor, the Canadian cryptocurrency trader receives the following tax treatment:

  • Net income from cryptocurrency trading: $1,200,000
  • Personal tax at 53.53% = (642,360)
  • Net cash retained after tax = $557,640

In other words, if the sole proprietorship generated $1.2 million in profit in 2020, the Canadian cryptocurrency trader would incur $642,360 in Ontario and federal income tax, leaving $557,640 in after-tax profits.

Now, let’s examine the the income-tax consequences for the Canadian cryptocurrency trader who earns $1.2 million in business profit through a Canadian-controlled private corporation.

Canada’s corporate income-tax regime has two facets: (1) corporate-level tax when the corporation earns income and (2) shareholder-level tax when the corporation distributes its retained earnings to shareholders by a dividend.

At the corporate level, as mentioned above, a CCPC enjoys a favorable small-business-deduction tax rate on its first $500,000 of active business income. The 2020 combined federal and Ontario SBD rate was 12.2%.  The corporation’s income beyond $500,000 is subject to the general corporate tax rate. The 2020 combined federal and Ontario general corporate rate was 26.5%. So, if the Canadian cryptocurrency trader operates the business through a corporation, the corporation receives the following tax treatment:

  • Net income from cryptocurrency trading: $1,200,000
  • SBD tax at 12.2% on $500,000 = (61,000)
  • Income subject to general corporate rate: 1,200,000. – 500,000 = $700,000
  • General corporate tax at 26.5% on $700,000 = (185,500)
  • Net cash retained in corporation after tax = 439,000 + 514,500 = $953,500

In summary, if the corporation generated $1.2 million in profit in 2020, the corporation would incur $246,000 in total Ontario and federal income tax, leaving it with $953,500 in retained earnings.

The second facet of Canada’s corporate income-tax regime speaks to a shareholder’s personal income-tax liability when the shareholder receives the corporation’s retained earnings in the form of a dividend. (For the purposes of this discussion, we assume that the shareholder is a natural person. If the shareholder is itself a corporation or a trust, the tax rules will vary. Corporate shareholders, for example, can essentially receive dividends on a tax-free basis. This doesn’t apply to portfolio dividends, which trigger Part IV tax liability for the corporate shareholder.)

The dividend is included in the shareholder’s taxable income and taxed accordingly. But the shareholder also receives a dividend-tax credit, which reduces the shareholder’s tax otherwise payable by an amount that is roughly equivalent to the income tax that the corporation paid on the profits underlying the dividend. The result is a regime that approximately integrates the overall tax payable between the corporation and the shareholder.

Yet the corporation isn’t required to pay a dividend. The corporation’s directors maintain full discretion over dividend declarations. So, until the corporation actually pays a dividend, the shareholder need not pay tax on the corporation’s retained earnings.

Hence, the incorporated Canadian cryptocurrency trader enjoys a significant tax-deferral advantage by keeping the cryptocurrency-trading profits in the corporation. The cryptocurrency-trading corporation generating $1.2 million in business profit pays $246,000 in total Ontario and federal income tax, leaving the corporation with $953,500 in after-tax retained earnings. The sole proprietor, on the other hand, pays $642,360 in Ontario and federal income tax, leaving $557,640 in after-tax profits.  So, in comparison to the cryptocurrency trader who operates as a sole proprietor, the incorporated Canadian cryptocurrency trader hangs onto an additional $395,860 in after-tax cash by delaying a dividend payment and leaving the 2020 cryptocurrency-trading profits in the corporation.

Cryptocurrency Tax Planning: Transferring Cryptocurrency, Non-Fungible Tokens, and Other Blockchain-Based Assets to Your Corporation

Generally, Canada’s Income Tax Act deems a non-arm’s-length transfer to occur at fair market value. This means that, if you transfer appreciated assets to a corporation, you will incur a taxable capital gain. But section 85 of the Income Tax Act overrides this general rule.

Section 85 of the Income Tax Act contemplates the incorporation of an existing sole-proprietorship business, including a cryptocurrency-trading business. When a taxpayer transfers assets to a corporation in exchange for shares in that corporation, section 85 allows the taxpayer and the corporation to agree upon an amount other than fair market value for each transferred asset. Within certain limits, the agreed-upon amount becomes the vendor’s deemed proceeds for the transferred asset, and it becomes the purchasing corporation’s tax cost for acquiring that asset. Thus, within certain limits, section 85 allows the vendor to control the extent of the gain arising from the transfer. More specifically, section 85 allows the asset transfer to occur at the vendor’s cost, thereby resulting in a tax-deferred rollover with no immediate tax payable.

The tax rules surrounding section 85 are quite complex, and they pose a number of tax traps for a Canadian taxpayer who seeks to incorporate a cryptocurrency-trading business yet does not retain an expert Canadian tax lawyer. An improperly planned transaction can trigger unexpected tax liability from the shareholder-benefit rule in subsection 15(1) or the indirect-benefit rule in paragraph 85(1)(e.2). For example, when the shareholder transfers cryptocurrency, non-fungible tokens, or other blockchain assets to the corporation, the fair market value of the blockchain assets must match the fair market value of the shares and other consideration from the corporation. If the value of the corporation’s consideration exceeds the value of the cryptocurrency, non-fungible tokens, or other blockchain assets, then the excess value constitutes a taxable shareholder benefit. Subsection 15(1) of Canada’s Income Tax Act requires the shareholder to report that excess value as income. Similarly, if the value of the cryptocurrency, non-fungible tokens, or other blockchain assets exceeds the value of the corporation’s consideration, the shareholder might incur tax liability under the indirect-benefit rule in paragraph 85(1)(e.2). The indirect-benefit rule aims to prevent the vendor shareholder from conferring an economic benefit on a related person who also owns shares in the purchasing corporation. If the indirect-benefit rule applies, the vendor shareholder realizes a taxable gain equal to the amount of the benefit conferred upon the related party. Moreover, the resulting taxable gain does not increase the ACB of the vendor’s share consideration from the corporation. In other words, paragraph 85(1)(e.2) results in a punitive one-sided adjustment.

Furthermore, you cannot use the section 85 rollover to transfer assets to an offshore corporation. Section 85 applies only if you transfer assets to a “taxable Canadian corporation.” To qualify as a “taxable Canadian corporation,” the corporation must be incorporated in Canada—that is, incorporated under the Canada Business Corporations Act or under the corporate statutes of a Canadian province or territory. If you transfer your cryptocurrency to an offshore corporation, you cannot use section 85, and Canada’s Income Tax Act deems you to have disposed of your cryptocurrency at its fair market value. So, you’ll trigger Canadian tax liability if the value of the cryptocurrency exceeds your tax cost. Before proceeding with any cryptocurrency transactions involving offshore entities, you should consult our expert Certified Specialist in Taxation Canadian tax lawyer for advice on Canadian tax implications and tax-planning opportunities.

Pro Tax Tips – Expert Canadian Tax-Planning Guidance from a Canadian Tax Lawyer: Form T2057, Section 85 Asset-Transfer Agreements, Price-Adjustment Clauses, Tax on Split Income (TOSI) & Updated Will

By operating your cryptocurrency-trading business through a Canadian-controlled private corporation, you not only gain access to the SBD tax rate but also reap the benefits of tax-deferral opportunities. Section 85 of the Income Tax Act permits you to transfer your cryptocurrency, non-fungible tokens, or other blockchain assets to your corporation at cost, thereby deferring personal tax on any accrued, unrealized gains.

These rules are complex, and they require you to meet stringent formal requirements—section 85, for example, requires the transferor and transferee corporation to jointly file a form T2057 with the earliest due tax return between them. Although you may file the T2057 election form up to three years after the deadline, you must pay a late-filing penalty. The amount of T2057 late-filing penalty is the lesser of two figures:

  • 25% of the amount by which the value of the transferred property exceeded the section 85 election amount, multiplied by the number of months or part months by which the election is late; and
  • $100 for each month or part month by which the election is late, up to a maximum of $8,000.

This formula basically means that the T2057 late-filing penalty maxes out at $8,000 once the T2057 form is over 6 months late.

If the T2057 election form is over 3 years late, the Canada Revenue Agency requires both the $8,000 late-filing penalty and a written explanation as to what caused the delay, and the CRA will accept the late filing only if it determines that doing so is “just and equitable.”

Speak with one of our top Canadian tax lawyers about the strategy that makes the most sense for you. Our expert Canadian tax lawyers have assisted numerous clients with incorporating their cryptocurrency-trading business. For advice on whether incorporation will benefit your cryptocurrency-based business, meet with one of our seasoned Canadian tax lawyers. We can evaluate whether incorporation makes sense for your business, weighing the tax benefits against the compliance costs. Furthermore, we can plan the incorporation and the section 85 asset transfer, thereby avoiding tax traps. We can also create your corporation and draft the required asset-transfer agreements and corporate documents.

As mentioned above, the tax rules surrounding section 85 pose a number of tax traps for a Canadian taxpayer seeking to incorporate a cryptocurrency-trading business. The fair market value of the cryptocurrency, non-fungible tokens, or other blockchain assets that the corporation acquired must match the fair market value of the shares and other consideration that the corporation provided. A mismatch in value may trigger tax liability under the shareholder-benefit rule in subsection 15(1) or the indirect-benefit rule under paragraph 85(1)(e.2).

You can avoid some of these problems by inserting a price-adjustment clause into the section 85 asset-transfer agreement. But the CRA will respect such a clause only if the parties meet certain conditions. For instance, the parties must genuinely intend to transfer the property at fair market value. To learn more about how price-adjustment clause can ensure the success of your section 85 rollover, speak with one of our top Canadian tax lawyers today. Our knowledgeable Canadian tax lawyers will also draft your section 85 asset-transfer agreement so that it withstands scrutiny by the Canada Revenue Agency.

A corporation may allow you to divert income to family members who occupy a lower a tax bracket. In an effort to curb income splitting, however, Canada’s Parliament significantly revised section 120.4, which had previously levied top-rate tax on minors who received dividends from private corporations (formerly known as the “kiddie tax”). Section 120.4 now applies to adults, too. In particular, section 120.4’s tax on split income (TOSI) now catches income sprinkling to adult family members—typically accomplished by issuing them dividends from a private corporation. If the TOSI rule applies, the recipient incurs top-rate tax on any “split income” received during the year.

The TOSI rule contains various exceptions that depend on the age of the individual at the beginning of the calendar year in which he or she received the impugned income. For example, if the individual is at least 17 years old, the individual will incur top-rate tax on a dividend from a private corporation unless, during the year or during any five prior years, the individual was “actively engaged on a regular, continuous and substantial basis in the activities” of the corporation’s business. The individual will satisfy the “actively engaged” test if he or she “works in the business for at least an average of 20 hours per week during the portion of the year in which the business operates.” While the 20-hours-per-week condition is sufficient, it isn’t necessary. That is, the individual may still satisfy the “actively engaged” test even if that individual doesn’t work in the business for at least an average of 20 hours per week.

The TOSI rules demand careful planning by a competent advisor. Our expert Certified Specialist in Taxation Canadian tax lawyer has assisted numerous Canadian taxpayers with structuring income-splitting arrangements that steer clear of the TOSI rules. For advice on income-splitting options and avoiding the TOSI rules, schedule a confidential and privileged consultation with one of our expert Canadian tax lawyers.

Finally, after incorporating your cryptocurrency, NFT, or blockchain-asset portfolio, you will own a new asset—namely, the shares in your cryptocurrency-trading corporation. So, if you fail to revise your will accordingly, your shares may fall into intestacy and end up in the hands of an unanticipated beneficiary. Don’t forget to revise your will to account for the shares in your cryptocurrency-trading corporation. Consult one of our experienced Canadian tax lawyers about revising your will and pursuing other tax-saving strategies for your estate.

Frequently Asked Questions

I’m a Canadian trader of cryptocurrency, NFT, or blockchain-assets who operates as a sole proprietor. How can I reduce Canadian income tax on my cryptocurrency-trading profits?

You might reduce your Canadian income-tax liability by incorporating your cryptocurrency-trading business. A Canadian taxpayer who operates a cryptocurrency-trading business derives two tax benefits from using a corporation. First, a Canadian-controlled private corporation (CCPC) qualifies for the small business deduction (SBD) and enjoys a reduced tax rate on its first $500,000 of active business income. Second, the individual shareholders can defer shareholder-level tax to the extent that retained earnings stay within the corporation.

Can I use a corporation for income-splitting?

A corporation may allow you to divert income to family members who occupy a lower a tax bracket. But, to curtail income-splitting, Canada’s Parliament enacted new tax rules. As of 2018, section 120.4’s tax on split income (TOSI) now catches income sprinkling to adult family members—typically accomplished by issuing them dividends from a private corporation. If the TOSI rule applies, the recipient incurs top-rate tax on any “split income” received during the year. The TOSI rule contains various exceptions that depend on the age of the individual at the beginning of the calendar year in which he or she received the impugned income. But these exceptions are notoriously convoluted, imposing a different set of conditions for those under the age of 17, for those between 17 and 24, and for those over 24 years old. The TOSI rules demand careful planning by a competent advisor. Our expert Certified Specialist in Taxation Canadian tax lawyer has assisted numerous Canadian taxpayers with structuring income-splitting arrangements that steer clear of the TOSI rules. For advice on income-splitting options and avoiding the TOSI rules, schedule a confidential and privileged consultation with one of our expert Canadian tax lawyers.

I operate a cryptocurrency-trading business as a sole proprietor, and I want to transfer my cryptocurrency inventory to an offshore corporation. Can I avoid tax by transferring my cryptocurrency to the offshore corporation under section 85 of the Income Tax Act?  

No. You may use the section 85 rollover only if you transfer assets to a “taxable Canadian corporation.” To qualify as a “taxable Canadian corporation,” the corporation must be incorporated in Canada—that is, incorporated under the Canada Business Corporations Act or under the corporate statutes of a Canadian province or territory. If you transfer your cryptocurrency to an offshore corporation, you cannot use section 85, and Canada’s Income Tax Act deems you to have disposed of your cryptocurrency at its fair market value. So, you’ll trigger Canadian tax liability if the value of the cryptocurrency exceeds your tax cost. Before proceeding with any cryptocurrency transactions involving offshore entities, you should consult our expert Certified Specialist in Taxation Canadian tax lawyer for advice on Canadian tax implications and tax-planning opportunities.

I’ve already transferred cryptocurrency and non-fungible tokens to my corporation for shares under section 85 of the Income Tax Act, but I missed the deadline to file the T2057 election form. Does this render the transaction invalid?

Not necessarily. You may file the T2057 election form up to three years after the deadline, but you must pay a late-filing penalty. The amount of T2057 late-filing penalty is the lesser of (A) 25% of the amount by which the value of the transferred property exceeded the section 85 election amount, multiplied by the number of months or part months by which the election is late; and (B) $100 for each month or part month by which the election is late, up to a maximum of $8,000. In other words, the T2057 late-filing penalty maxes out at $8,000 once the T2057 form is over 6 months late. If the T2057 election form is over 3 years late, the Canada Revenue Agency requires not only the $8,000 late-filing penalty but also a written explanation as to what caused the delay, and the CRA will accept the late filing only if it determines that doing so is “just and equitable.”  Our experienced Canadian tax lawyers have assisted numerous taxpayers with convincing the CRA to accept T2057 election forms that have been filed over 3 years late. Properly prepared written submissions not only increase the odds that the CRA will accept your late-filed T2057 form but also lay the groundwork for a judicial-review application to the Federal Court should the CRA unfairly deny your T2057 filing.

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