The foreign property tax implications associated with owning cryptocurrencies

National Post


f you hold foreign property whose total cost exceeds $100,000 at any point in a tax year, you’re required to file Form T1135. The form covers the obvious things, such as your Swiss bank account or Cayman offshore investment portfolio, but it’s also required for foreign stocks, such as Apple Inc., Microsoft Corp. or Google owner Alphabet Inc., that are held in a Canadian, non-registered brokerage account.

Excluded are foreign securities held inside pooled products, like Canadian mutual funds and registered retirement savings plans or other registered funds. Property for personal use, such as a vacation home in Florida that’s not ordinarily rented out , is also excluded.

The penalty for filing late is $25 per day to a maximum of $2,500, plus arrears interest. There have been at least 20 reported cases in which taxpayers have been assessed a late-filing penalty since the 1998 introduction of Form T1135. Many of these cases involved a purely innocent failure-to-file penalty that was assessed by the Canada Revenue Agency even though all the income from the foreign property and/or the capital gain/loss upon its disposition was fully declared on the Canadian return.

But is cryptocurrency considered foreign property, and, if so, must it be reported on the T1135?

Those questions were discussed in a recent article by William Musani and Ashvin Singh of Felesky Flynn LLP, a boutique tax law firm with offices in Alberta and Saskatchewan. They analyzed whether cryptocurrency falls under the technical definition of “specified foreign property” in the Income Tax Act, which includes “intangible property situated, deposited, or held outside Canada that is not used or held exclusively in the course of carrying on an active business of the taxpayer.”

Back in 2015, the CRA stated that “digital currency would be funds or intangible property and would be specified foreign property of a person or partnership to the extent that it is situated, deposited or held outside of Canada.”

But where, exactly, is your cryptocurrency located?

That’s where it can get a bit complicated, owing to the very nature — and appeal — of cryptocurrency generally. Many cryptocurrency investors believe they’re holding it in a digital wallet on a server, but this isn’t really the case since cryptocurrency, which is intangible property, is not actually physically situated, deposited or held anywhere.

In practice, an entitlement to your cryptocurrency exists in the form of a digital ledger on the related blockchain. But because it’s stored on a blockchain, it can simultaneously exist in several geographic locations.

These digital ledgers are considered both “distributed” and “decentralized” databases. The database that records the entitlements of a cryptocurrency holder is stored and updated in many locations at once — that is, distributed — which makes it difficult, if not impossible, to manipulate its records. The ledgers are also decentralized, since no single distributed database is the sole source of the true ownership of the particular cryptocurrency.

In essence, your digital wallet isn’t storing the actual cryptocurrency itself, but rather one (or a combination) of your public or private keys. Think of the public key as your account number, and the private key as your personal identification number needed to access the account’s information.

The article’s authors argue that in relation to the location of your cryptocurrency holdings, the geographic location of your private key is “arguably the most relevant factor in determining where such cryptocurrency is situated, deposited, or held for the purposes of the act.”

But the answer to this may depend on whether you are using a “hot” or “cold” digital wallet. Hot wallets are digital wallets connected to the internet, which is how nearly all cryptocurrency exchanges or online providers store your cryptocurrency. Cold wallets are not connected to the internet and are typically on a physical storage drive (think Gerald Cotten and the collapse of QuadrigaCX after $190 million of cryptocurrency disappeared).

It seems clear that the geographic location of a cold wallet is wherever the physical drive, computer or USB key with the private key on it is located. If the cold wallet is in Canada, then the associated crypto holdings associated with it are unlikely to be subject to the T1135 foreign property reporting requirements, the authors state.

On the other hand, when a hot wallet is used, “the primary server location used by the wallet provider should be strongly determinative of situs. If the server is located outside Canada, the associated holdings are more likely to be subject to foreign property reporting requirements.”

But things can get even more complicated if you store your private key in several places at once. Let’s say you keep a document containing your private key on a computer in Canada. In that case, it may be exempt from the T1135 foreign reporting requirements. But what if you back that document up to the cloud. Where are the cloud’s servers geographically located? Chances are, they aren’t in Canada, and, if that is so, your cryptocurrency could be considered by the CRA to be intangible property located outside Canada and, therefore, require foreign property reporting.

In the end, the best advice is probably to disclose your cryptocurrency on the T1135 or else risk harsh penalties from the CRA for non-disclosure. As Musani and Singh conclude: “This highly complex and unique form of intangible property flouts the traditional concepts and methods historically used to determine the situs of other types of intangible property. Given the CRA’s administrative position and the hefty penalties associated with a failure to file form T1135 … the cautious approach is to report cryptocurrency holdings if the situs of the holdings is ambiguous.”