This blog post will discuss bookkeeping and taxation issues for blockchain-based technologies such as cryptocurrencies.
Full disclosure, this technical read is intended for accountants, bookkeepers, investment professionals, and those active in blockchain and cryptocurrencies.
Bookkeeping for Cryptocurrency
Bookkeeping for cryptocurrency, at its core, is not much different than bookkeeping for transactions in various currencies like CAD and USD. The most significant differences are:
- Bigger swings in value
- Harder to value data
- Evolving tax treatments
If you’re trading in cryptocurrencies, more details, especially about values in Canadian dollars at the time of transactions, are extremely important. Be sure to be as accurate as possible – the values at the time of the transaction, not only the date, can be fundamental as prices of cryptocurrencies can fluctuate significantly in a single day.
“Cryptocurrency exchanges have different standards for the kinds of records they keep and how long they keep them. If you use cryptocurrency exchanges, we suggest that you export information from these exchanges periodically to avoid losing the information necessary to report your transactions. You are responsible for keeping all required records and supporting documents.” – Canada Revenue Agency.
CRA Tax Guidance
In Canada, the onus of proof is on the taxpayer. That means you have to back up your deductions with receipts or evidence. If you are trading cryptocurrencies, keeping a very accurate record of your trades is essential. Cryptocurrencies are treated as a commodity. Depending on the nature of the business, trading cryptocurrencies creates either business income or capital gains (or related business or capital losses).
Capital Gains Vs. Business Income
A typical person who invests in cryptocurrency and makes the occasional trade is likely to generate capital gains or losses. A day trader making several weekly transactions is likely generating business income. The key considerations are:
- Is the activity businesslike in manner?
- Carried out for commercial reasons?
- Is a product or service being promoted?
- Do you intend to make a profit?
It’s essential to discuss each case with a tax professional to determine whether the activity is creating business income or capital gains.
CRA treats this as a barter transaction when you accept payment or make a purchase using cryptocurrency. It would be best to recognize the revenue or expense as though cash came in. Incidentally, this is how all barter transactions should be recorded. For more guidance on barter transactions from the CRA, click here.
Every time a cryptocurrency is disposed of, it creates a taxable event, including:
- Selling cryptocurrency for cash
- Gifting someone cryptocurrency
- Trading one cryptocurrency for another
- Paying for something with cryptocurrency
Notice that all of these transactions involve the disposal of cryptocurrency. Accepting payment by cryptocurrency for a sale creates a traditional taxable event – a sale. Accepting cryptocurrency does not, by itself, create a taxable event. When the cryptocurrency is disposed of in the future, it will create a taxable event like the one described above.
For the official guidance on cryptocurrency from the government of Canada, click here.
Record Keeping for Traders
According to the CRA, to maintain proper books and records regarding cryptocurrency transactions, you should keep the following records:
- the date and time of the transactions
- the receipts of purchase or transfer of cryptocurrency
- the value of the cryptocurrency in Canadian dollars at the time of the transaction
- the digital wallet records and cryptocurrency addresses
- a description of the transaction and the other party (even if it is just their cryptocurrency address)
- the exchange records
- accounting and legal costs
- the software costs related to managing your tax affairs.
Let’s look at some examples of journal entries related to cryptocurrencies. Note that the values used are entirely arbitrary. We’ve chosen to show the transaction fee charged as a separate line item in these examples.
Purchase of a Cryptocurrency for Cash
This transaction sets the cost of the cryptocurrency purchased. It will be vital to identify gains or losses in the future. Note that we have separated the transaction fee. Some people may choose to include that fee in the value of the cryptocurrency purchased to provide an Adjusted Cost Base (ACB) of $15,150 for the cryptocurrency acquired.
Sale of a Cryptocurrency for Cash
|Gain on Sale||3,483|
This transaction shows the change in the value of the cryptocurrency purchased initially and recognized its disposal for cash. The gain on disposal of the cryptocurrency is recognized at this time. Note that if the trader had lost money on the disposal, there would be a debit, or loss, on sale instead of a gain on sale (credit.)
Sale of a Cryptocurrency for Another Cryptocurrency
|Gain on Sale||3,483|
This transaction shows that there has been an exchange of one cryptocurrency for another while recognizing the change in the value of the cryptocurrency used as payment. Note that the values of both cryptocurrencies need to be recorded in Canadian dollars.
Purchasing a Good or Service using Cryptocurrency
|Asset or Expense||18,000|
|Gain on Sale||4,089|
This transaction recognizes the change in the value of the cryptocurrency used to make a purchase, the cost of the asset or expense purchased, the payment of GST/HST related to the transaction and, of course, the transaction fee.
Accepting Payment by Cryptocurrency
This transaction shows a sale, taxes being collected, and establishes the cost of the cryptocurrency acquired.
Bookkeeping for Miners
Bookkeeping for cryptocurrency miners is much like the bookkeeping for many traditional production businesses, with one key exception. If the cryptocurrency is held for any time, the value difference between when it is created and when it is sold needs to be recorded.
For the most part, bookkeeping for these types of businesses involves recording the purchase of fixed assets (computers) and expenses and recognizing revenue as the cryptocurrency mined is sold into the open market. Everyday items to record include computer equipment (and, of course, depreciation), the sale of mined coins, expenses such as utilities or smaller computer hardware required for mining rigs, and other traditional business expenses.
Record Keeping for Miners
Miners have the documentation they need to keep in addition to the documentation required for traders, including:
- receipts for the purchase of cryptocurrency mining hardware
- receipts to support your expenses and other records associated with the mining operation (such as power costs, mining pool fees, hardware specifications, maintenance costs, and hardware operation time)
- the mining pool details and records
Non-Fungible Tokens, commonly referred to as NFTs, are unique digital assets that can be created and traded on the open market. The most famous of these is the NBA Top Shot, which received much media attention when first released. Collectors could purchase “packs” of NFTs that were unique or serialized, with only a specific number being released. These NFTs are short video clips of plays made by certain players. Some have become quite valuable and sought after – even by the players in the clip. Top Shots can be bought or sold in the Top Shot marketplace.
For businesses producing or trading NFTs, sales tax must be considered. Although there is no direct guidance from the CRA about whether or not sales tax should be charged, it is the position of KATA Accounting that businesses producing or trading NFTs should register for and collect the appropriate sales taxes. NFTs are a good, not a commodity.
For the hobbyist, this shouldn’t be a factor.
Key Risk Considerations
Client documentation is the most challenging part of dealing with blockchain businesses. Many clients approach documentation as an afterthought. Frequently, they think they can go back and look up values after the fact. It is not always possible with cryptocurrency. A prospect approaching you with documentation in order is a critical sign that they’ll be easy to work with.
Clients Shopping for Answers
It is a common risk faced by all bookkeepers and accountants. We’ve all heard stories of, “My buddy’s accountant does X,” or “I heard you can Y,” or “Can’t we just….” Be sure you are giving sound advice, not just satisfying prospective clients’ desire to get the answer they want to hear. In the end, you’ll be happy you took a pass on the shifty prospects.