The T1135 Foreign-Reporting Exemption & Canadian Cryptocurrency-Trading Businesses & Canadian NFT-Trading Business: Are Canadian Cryptocurrency And NFT Traders Required To File A T1135 Form?
05 January 2022
by David Rotfleisch Rotfleisch & Samulovitch P.C.
Introduction: Canada's Foreign-Reporting Rules & Canadians Operating Cryptocurrency-Trading Businesses
Canada's Income Tax Act contains five basic foreign-reporting rules. These rules require a Canadian-resident taxpayer to report certain transactions involving foreign parties or certain interests in foreign property:
Section 233.1 requires a Canadian resident to file a T106 form if the resident entered a business transaction with a related non-resident.
Section 233.2 requires a Canadian resident to file a T1141 form if the resident transferred or loaned property to a non-resident trust or similar entity.
Section 233.3 requires a Canadian resident to file a T1135 form if the resident owns or has an interest in "specified foreign property."
Section 233.4 requires a Canadian resident to file a T1134 form if the resident has a "foreign affiliate."
Section 233.6 requires a Canadian resident to file a T1142 form if the resident is a beneficiary of—and receives a distribution from—a non-resident trust.
The Canadian government enacted these reporting rules as a means of gathering information. Before these rules came into existence, a Canadian taxpayer wasn't required to reveal offshore holdings or transactions unless they resulted in tax payable. The Canada Revenue Agency therefore had limited means of identifying taxpayers who owned foreign property or engaged in offshore transactions and who therefore might potentially be evading taxes. Hence, these reporting rules alert the CRA about offshore assets or transactions that warrant a closer inspection.
This article focuses on the T1135 form (a.k.a., the Foreign Income Verification Statement), which stems from the foreign-reporting rule under section 233.3. In brief, section 233.3 requires a Canadian-resident person or partnership to file a T1135 if that person or partnership owns "specified foreign property" with a total cost exceeding $100,000. This foreign-reporting rule doesn't hinge upon tax liability. Although the T1135 form is also called a "Foreign Income Verification Statement," a Canadian taxpayer may be required to file a T1135 form even if the specified foreign property doesn't generate taxable income. Likewise, if a Canadian-resident taxpayer files a T1135 form, this doesn't by itself trigger additional tax liability for that taxpayer. (You will, however, incur steep penalties by failing to file the T1135 form when required to do so. We discuss failure-to-file penalties in more detail below.)
Canadian cryptocurrency-trading businesses face unique challenges. The mostly unregulated cryptocurrency, non-fungible token (NFT), and blockchain markets brings higher risk of tax 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. Cryptocurrency and non-fungible tokens seemingly meet the Income Tax Act's definition of "specified foreign property." So, are Canadian taxpayers who operate cryptocurrency-trading businesses required to file T1135 forms if their cryptocurrency cost exceeds $100,000?
This article provides Canadian tax guidance on the T1135-filing requirement for Canadian cryptocurrency- and NFT-trading businesses. After reviewing the tax rules concerning the T1135-filing requirement and analyzing whether cryptocurrency/NFT inventory qualifies as "specified foreign property," it concludes by offering expert Canadian tax guidance for Canadian taxpayers engaging in cryptocurrency or NFT transactions.
The T1135-Filing Requirement under Section 233.3 of the Income Tax Act: "Specified Foreign Property" with Cost Exceeding $100,000
The T1135-filing requirement only applies to certain Canadian tax residents. A non-resident for tax purposes need not file foreign-information returns, like T1135 forms. Some Canadian-resident entities are also excluded—e.g., mutual-fund corporations and trusts; tax-exempt entities, like charities and non-profit organizations; and registered investments, such as TFSAs and RRSPs. In addition, section 233.6 exempts certain first-year-resident individuals from filing a T1135 form.
Thus, a taxpayer must file a T1135 form for each tax year in which the following conditions applied:
The taxpayer was a Canadian tax resident (and not a first-year-resident individual or other excluded entity);
The taxpayer held "specified foreign property" during the year; and
The taxpayer's aggregate tax cost for the "specified foreign property" exceeded $100,000 (in Canadian currency) at any point during the year.
If these conditions apply, the taxpayer's income-tax return must include a T1135 form (Foreign Income Verification Statement), and the T1135 form must list all "specified foreign property" that the taxpayer held during the year.
For more information about the T1135 form, please read our "Complete Guide to CRA T1135 Forms" here.
"Specified Foreign Property" & The Business-Use Exemption
The Income Tax Act's definition of "specified foreign property" very likely catches cryptocurrency, non-fungible tokens, and other blockchain-based assets. In particular, "specified foreign property" includes (among other things) "funds or intangible property situated, deposited or held outside Canada." Cryptocurrency, NFTs, and other blockchain-based assets qualify as "intangible property." And because they exist on decentralized digital platforms, they're not situated, deposited, or held inside any particular country—much less inside Canada. They must, then, be "situated, deposited or held outside Canada." As such, cryptocurrency, NFTs, and other blockchain-based assets will generally require the filing of a T1135 form for each year in which their total cost exceeds $100,000.
("Specified foreign property" includes many other types of property—e.g., real property and shares in foreign corporations. But this discussion focuses on blockchain-based assets like cryptocurrency and non-fungible tokens. For more information about other types of "specified foreign property," please read our "Complete Guide to CRA T1135 Forms" here.)
Yet "specified foreign property" excludes "property that is used or held exclusively in the course of carrying on an active business." For example, a business's offshore inventory will fall under this business-use exemption. This same is true for inventory in the form of cryptocurrency, non-fungible tokens, or other blockchain-based assets. They're not "specified foreign property." This means that you need not report your cryptocurrency, non-fungible tokens, or other blockchain-based assets on T1135 form if you use them as inventory in a cryptocurrency- or NFT-trading business. It also means that you exclude the cost of your cryptocurrency/NFT inventory when determining whether any other specified foreign property meets the $100,000-cost threshold.
This obviously raises the question, "When do cryptocurrency and NFTs qualify as business inventory?"
Cryptocurrency & NFTs as Inventory in a Trading Business
Canada's Income Tax Act recognizes only two broad sorts of property for tax purposes:
capital property, which creates a capital gain or loss upon disposition; and
inventory, which figures into the computation of business income.
The type of income that the property generates upon sale—that is, capital gains or business income—determines whether that property is a capital property or inventory. Put another way: you start by determining the nature of the income, and then you characterize the property, not the other way around. Still, the determination is very often unclear and requires guidance from an experienced Canadian tax lawyer.
Over the years, Canadian tax courts have churned out an immense body of case law while grappling with the ambiguity between investing, which produces a capital gain, and trading, which results in business income. Courts assess a wide range of factors when deciding whether to characterize a transaction's gains or losses as on capital account or income account. These factors may include:
transaction frequency—e.g., a history of extensive buying and selling of cryptocurrency and non-fungible tokens or of a quick turnover of cryptocurrency/NFTs might suggest a business;
length of ownership—e.g., very brief periods of holding non-fungible tokens or cryptocurrency indicate business dealings, not capital investing;
knowledge of cryptocurrency and NFT markets—e.g., increased knowledge of or experience with cryptocurrency/NFT markets favours a business characterization;
relationship to the taxpayer's other work—e.g., if cryptocurrency/NFT transactions (or similar dealings) form a part of a taxpayer's employment or other business, it points toward business;
time spent—e.g., a greater likelihood of characterization as a business if a taxpayer spends substantial time studying cryptocurrency/non-fungible-token markets, researching potential purchases, or actively managing a portfolio of cryptocurrency/non-fungible tokens;
financing—e.g., leveraged NFT/cryptocurrency transactions indicate a business; and
advertising—e.g., increased likelihood of business characterization if the taxpayer has advertised or otherwise made it known that he deals in cryptocurrency or non-fungible tokens.
Ultimately, the taxpayer's intention at the time of acquiring the property is the most important criterion that tax courts consider when determining whether the transaction produced a capital gain or business income. Specifically, the question is whether the taxpayer acquired the property with the intent to trade. Still, to discern a taxpayer's intention, a court must review the objective factors surrounding both the purchase and the sale of the property. In other words, courts will deduce a taxpayer's intent by evaluating the factors listed above.
Therefore, if you acquired them with the intention to trade, your cryptocurrency/NFTs qualify as inventory. As mentioned above, the tax characterization of the cryptocurrency and non-fungible tokens themselves derive from the character of the income stemming from those assets upon disposition. For example, if a taxpayer carried on a cryptocurrency-trading or NFT-trading business—thereby using the cryptocurrency or NFTs to generate business income—that taxpayer's cryptocurrency and non-fungible tokens qualify as inventory. If, on the other hand, the disposition gives rise to a capital gain, the cryptocurrency or non-fungible token constitutes a capital property in the hands of the taxpayer for whom the disposition would result in the capital gain.
In summary: The capital/income test determines whether your cryptocurrency and non-fungible tokens qualify as inventory. If they do, they're excluded from the definition of "specified foreign property," and you don't need to report them on a T1135 form—even if their tax cost exceeds $100,000.
Pro Tax Tips – Legal Opinion on Proper Tax Reporting of Crypto/NFT Assets, T1135 Non-Filing Penalties & Voluntary Disclosures Program for Failing to Report Crypto/NFT Assets
As mentioned above, the capital/income test determines whether your cryptocurrency and non-fungible tokens qualify as inventory, thereby rendering them exempt from the T1135-reporting requirement. The problem, however, is that the capital/income test calls for an involved legal analysis. As a result, Canadian taxpayers engaging in cryptocurrency or NFT transactions will generally benefit from a tax memorandum examining whether their blockchain-based assets qualify as "specified foreign property" or as T1135-exempt inventory.
You'll face steep penalties by failing to file the T1135 form when required to do so. A simple failure to file can result in a penalty of up to $2,500 plus interest. And if the failure to file constitutes gross negligence, the maximum penalty can reach $12,000. Moreover, an additional 5% penalty may apply if your T1135 form is over 24-months late.
You'll also draw a hefty penalty by filing a T1135 form containing a false statement or omitting information about your specified foreign properties. If your T1135 form includes a false statement or omits information, the penalty is the greater of $24,000 and 5% of the unreported amount.
You may qualify for relief under the CRA's Voluntary Disclosures Program. If your VDP application qualifies, the CRA will renounce criminal prosecution and waive gross-negligence penalties (and may reduce interest). But your voluntary-disclosure application is time-sensitive. The CRA's Voluntary Disclosures Program will reject an application—therefore denying any relief—unless the application is "voluntary." This essentially means that the Voluntary Disclosures Program must receive your voluntary-disclosure application before the Canada Revenue Agency contacts you about the non-compliance you seek to disclose.
Our expert Certified Specialist in Taxation Canadian tax lawyer has assisted numerous Canadian taxpayers with unreported cryptocurrency and NFT holdings and transactions. We can carefully plan and promptly prepare your voluntary-disclosure application. A properly prepared disclosure application not only increases the odds that the CRA will grant tax amnesty but also lays the groundwork for a judicial-review application to the Federal Court should the Canada Revenue Agency unfairly deny your voluntary-disclosure application. To determine whether you qualify for the Canada Revenue Agency's Voluntary Disclosures Program, schedule a confidential and privileged consultation with one of our expert Canadian tax lawyers.