Despite the increasing prevalence of cryptocurrency in our daily lives and businesses, the laws surrounding its regulation remain complex. Not recognized as legal tender, cryptocurrencies are regulated by an amalgamation of laws in Canada. Primarily, there are three areas of law that are key to understand when dealing with cryptocurrencies: securities law, taxation, and financial transactions. This guide outlines the key legal considerations in each area of law, as well as some of the obligations of businesses and individuals dealing in cryptocurrency.
Securities Law
Cryptocurrency in Canada is regulated as a security. Although securities law is administered through provincial and territorial law, there is great uniformity amongst the different laws. The Canadian Securities Administrators is an umbrella organization of these different provincial and territorial securities regulators that seeks to regulate the capital markets in Canada. Together with the Investment Industry Regulatory Organization of Canada, the CSA has released guidance in recent years adopting cryptocurrencies under securities law. Through these various instruments, Canada has regulated cryptocurrencies and outlined the obligations of Initial Coin Offerings, Crypto Asset Trading Platforms, and Reporting Issuers.
Cryptocurrency Offerings (Coins and Tokens)
If your company decides to raise funds from investors through an initial coin offering or an initial token offering, it is likely that these actions will be regulated by securities law in Canada. In 2017, the Canadian Securities Administrators released the CSA Staff Notice 46-307 Cryptocurrency Offerings, through which the CSA addressed the rising number of cryptocurrency offerings. While acknowledging that cryptocurrency offers unique opportunities for both startup companies and investors, there are inherent risks involved such as issues regarding volatility, transparency, valuation, etc. The CSA stated in this notice and the subsequent CSA Staff Notice 46-308 Securities Law Implications for Offerings of Tokens, that many ICOs and ITOs will be classified as securities. To determine whether your crypto instrument is classified as such, the four-pronged Investment Contract Test will be applied. The test states that for an instrument to be classified as a security (1) there must be an investment of money, (2) in a common enterprise, (3) with the intention or expectation of profit, (4) to come significantly from the efforts of others. In applying this test, the CSA looks to substance rather than form. If it is determined that the crypto instrument is a security, your company will need to abide by all relevant securities laws, including for example, prospectus requirements, registration requirements, or exemptions, etc.
Cryptocurrency Trading Platforms
Businesses involved in providing a platform for trading cryptocurrencies may also need to abide by securities legislation. Crypto Trading Platforms are entities that facilitate transactions relating to crypto assets, in buying and selling crypto assets. The key factual difference that would differentiate those companies that must abide by securities legislation and those that do not is the obligation to deliver the assets they hold immediately to their customers.
The CSA will make the distinction between the two on a factual basis, looking to the terms of the contracts that govern the relationship between the CPT and user (both written and unwritten) and surrounding circumstances to determine whether there is an obligation to immediately transfer ownership, possession, and control to the user.
So, when does the CSA consider that a crypto asset has been immediately delivered and therefore the company is exempt from abiding by the same securities laws? It is when the platform immediately transfers ownership, possession, and control of the crypto asset to the Platform’s user, and as a result the user is free to use or otherwise deal with the asset without further involvement or reliance on the platform and the platform ceases to retain any security interest or any legal right to the crypto asset. Following this transfer, the user is no longer at risk regarding insolvency, fraud, performance, or proficiency of the company.
Cryptocurrency Issuers
Businesses engaged as cryptocurrency issuers, those that hold or engage materially with cryptocurrency assets, are subject to certain disclosure obligations as noted in the CSA Staff Notice 51-363 Observations on Disclosure by Crypto Assets Reporting Issuers. The disclosure requirements are related to, for example, the retention of third-party custodians safeguarding all or a significant portion of their crypto assets, self-custody of crypto assets, issuers in the business of investing in crypto assets, etc. A summary of disclosure requirements for these types of businesses activities are summarized in the table below.
| Activity | Disclosure Requirements |
| Third-Party Custodian Engagement | Identity and location of third-party.Identity and location of appointed sub-custodians.General discussion of services provided by the third-party.Whether the custodian is a Canadian financial institution or foreign equivalent and their regulations.Anything known to the issue about the third-party that would adversely affect the issuer’s ability to obtain an unqualified audit opinion on its audited financial statements.Relationship of the third party to the issuer.Quantity of percentage of the issuer’s crypto assets at the end of each period date.Any insurance for those assets held by the third party and limitations on the third-party liability.Treatment of assets in the event of an insolvency or bankruptcy of the custodian.If third party operates in a foreign jurisdiction, what due diligence the issuer has undertaken. |
| Self-custody of Crypto Assets | Description of the controls implemented to protect the crypto assets against the risk of loss and/or theft associated with holding crypto assets.Whether the issuer employs multi-signature wallets.The manner in which private keys are safeguarded, including the use of cold wallets.Whether the assets are insured and any limitations on making successful claims.Measures undertaken to mitigate cyber security risks.The frequency of monetization of crypto assets into fiat currency. |
| Use of Crypto Asset Trading Platforms | Disclosure requirements are the same as when using a third-party custodian. |
| Description of Business | Description of issuer’s business in its continuous disclosure filings and prospectus that clearly outlines any information necessary for investors to make informed decisions about their interest in the company. |
| Risk Factor Disclosure | Depending on the issuer, these may include risks pertaining to:(1) the availability and/or cost of electricity(2) decreased rewards for mining a particular crypto asset (4) risks related to access of crypto assets held at third-party custodians and crypto asset trading platforms |
| Promotional Activities | Issuers should not engage in promotional activities that provide unsubstantiated claims about their business. |
| Material Changes | Examples of material changes include:(1) entering into a custodial agreement with a third party(2) changing custodians(3) loss or theft of crypto assets (4) acquisition or sale of crypto mining equipment (5) entering into a mining pool arrangement |
| Investing into Crypto Assets | Investment fund requirements may apply if a material aspect of the issuer’s business is investing into crypto assets and the issuers do not have other substantial operations. Investment portfolio disclosure is also required. |
| Financial Statements | Cryptocurrency issuers have unique accounting and disclosure issues to consider regarding their financial statements. These include the disclosure of:(1) accounting policies and other information that would be relevant to the understanding of the company’s financial statements (such as the nature and types of cryptocurrencies held, judgements made in their accounting policies, etc.) (2) the cryptocurrencies recorded at fair value (3) accounting for the mining of cryptocurrency (4) cryptocurrency mining equipment (5) non-monetary transactions settled in cryptocurrencies |
Taxation
Although cryptocurrency is regulated by many areas of law in Canada, it is not considered legal tender. Rather, cryptocurrency is a digital currency. The Canadian Revenue Agency treats cryptocurrency as a commodity and its use for payments as a barter transaction. There are several tax considerations to keep in mind when using, exchanging, and mining cryptocurrencies.
Business Income or Capital Gain
One of these considerations is whether the income generated by transactions are to be taxed as business income or capital gain. Although processing or holding cryptocurrency is not taxable, what may be is the selling or making a gift of cryptocurrencies, trading or exchanging, converting cryptocurrency into legal money, or using crypto to buy goods or services. To determine whether the income generated from these transactions is business income, the CRA outlines certain signs to consider. For example, if you are carrying on an activity for commercial reasons in a commercially viable way, promoting a product or service, have the intention to make a profit, or undertake activities in a businesslike manner, the income generated may likely be considered business income. If not considered as business income, the income will be considered as capital gain only half of which will be taxed.
Exchanging Cryptocurrencies
When you exchange one type of cryptocurrency for another, barter transaction rules apply. You must convert the value of the cryptocurrency received into Canadian dollars, and the transaction will be considered a disposition reported on your income tax return as business income (gain or loss) or capital income (gain or loss).
Mining Cryptocurrencies
How mining cryptocurrency is taxed is dependent largely on the manner in which the activity is undertaken, whether as a personal activity (hobby) or as a business activity. This determination is made on a case-by-case basis, however if it is pursued in a sufficiently commercial and business-like way it can be considered a business activity for tax purposes.
Capital Property or Inventory
The valuation of your crypto assets will differ based on whether it is held as capital property or inventory. If it held as capital property, you must record and track the adjusted cost base to accurately report capital gains or loss. If it is held as inventory, you can either value each item in the inventory at cost when acquired or fair market value at the end of the year (whichever lower) or value the entire inventory at fair market value at the end of the year.
Books and Records
You must also ensure to keep accurate records of the acquisition or disposition of crypto assets. The records should include information regarding the date of transactions, receipts of purchase or transfers, value of the crypto in Canadian dollars at the time of transaction, digital wallet records and cryptocurrency addresses, description of the transaction and the other party, exchange records, accounting and legal costs, and the software costs related to managing your tax affairs. Miners of cryptocurrency should also keep receipts for purchase of cryptocurrency mining hardware, receipts to support expenses, and mining pool details and records.
Financial Transactions
On June 1st, 2021, the Canadian government implemented new amendments to the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA) and its associated regulations which brought businesses dealing in virtual currencies under its purview. These changes now require cryptocurrency businesses to register as an MSB with the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) and uphold certain obligations under the Act. These obligations include implementing a compliance program, “Know your Client” requirements, reporting, record keeping, the travel rule, and ministerial directives. For full details on how to register and the obligations of MSBs in Canada, please refer to the article linked here (link article for MSBs).
The content of this article is written for general information purposes only and does not constitute specific legal advice. This article should not be used as a substitute for competent legal advice from a licensed lawyer. Please contact us if you’d like to speak to an Emerge Law lawyer.