Part 1

How does the CRA view cryptocurrency transactions for tax purposes

Part 2

How to minimize your taxes on cryptocurrency

Part 3

Offshore structures

How to minimize your taxes on cryptocurrency

In part 2 of our Taxation of Cryptocurrencies, we will be discussing the various avenues someone can take to help avoid paying tax to the CRA.

So, you’re going to make a profit from your cryptocurrency trading and don’t want to pay an exorbitant amount of tax for all your hard work? It may be time to start your own corporation.

What are the advantages of incorporation?

For starters, a corporation is treated as a separate legal entity; and, therefore no liability for wrongdoing by the corporation (to a certain extent) can be attributed to the individuals who ultimately control the company, such as shareholders or the directors. This means that if the corporation is sued, the plaintiff can only recover assets or money that the corporation itself owns. If the plaintiff gets a judgment against the corporation for more than its available assets, the corporation goes bankrupt but the shareholder’s personal assets are generally safe from collection. Another advantage of incorporating is the Lifetime Capital Gains Exemption that provides owners of Canadian-controlled private corporations (“CCPC”) a tax exemption on the first $892,218.00 (adjusted for inflation in 2021) earned on the sale of their corporation. Additionally, since the corporation is a separate legal entity, it requires a separate tax return to be filed each year. Despite the additional time, effort and expense of filing an additional tax return each year, this process allows the corporation to take advantage of the lower corporate tax rates for income earned by businesses.

What do you mean lower corporate tax rate?

If your cryptocurrency dispositions are treated by the Canada Revenue Agency as business income due to the frequency and volume of the trades being conducted, a significant advantage to incorporation is the lower corporate tax rate of 26.5%, as opposed to the individual tax rate of up to 53.5%, if you are in the top margin. Further, section 125(1) of Canada’s Income Tax Act (the “ITA”) provides for a small business deduction which allows a CCPC to claim a federal business tax credit. A CCPC qualifies for an additional tax credit on the corporation’s first $500,000 of active business income and pays federal tax at a rate of 9%. Similarly, the Ontario small business deduction reduces the corporation’s provincial tax to 3.2%. Therefore, the combined tax a CCPC will pay on its first $500,000 will be at a rate of 12.2% (as of May 2021).

I personally own my cryptocurrency, so does my new corporation have to buy it from me?

Section 85 of the ITA allows for an individual principal of the corporation to transfer property held personally by that individual to the corporation in exchange for shares of equal value. For example, when the principal shareholder transfers cryptocurrency, NFT’s or other blockchain assets to the corporation through s.85, the shareholder will receive shares of the corporation in exchange for transferred property. S. 85 makes provision for this by allowing compensation for the exchange to come in the form of fixed-value shares equal to the fair market value (“FMV”) of the property being “rolled-in” to the corporation. By engaging in a rollover, the tax liability is deferred until such time as the transferor sells the shares and realizes the gain.

How do I get my profits out of my corporation and into my own pocket?

Once your corporation has profits to distribute, another advantage of the corporate tax structure has to do with a shareholder’s personal income-tax liability when they receive the corporation’s retained earnings in the form of a dividend. Dividends are payments to shareholders by the corporation that are distributed from the after-tax earnings of the company and are included in the shareholder’s taxable income for the year. While dividends increase the shareholder’s taxable income, 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.

The advantages of incorporating become more apparent if trading cryptocurrency is your side gig. If you are able to pay the bills with steady income from a full-time job, then the profits made from trading can be kept in the corporation and will only be taxed at the corporate rate. The corporation isn’t required to pay a dividend and discretion is left with the corporation’s directors over when dividends will be declared. By leaving funds in the corporation, the individual shareholder can defer shareholder-level tax until they decide to pay the funds out of the corporation to themself as a dividend. So, until the corporation actually pays a dividend, the shareholder will not pay tax on the corporation’s retained earnings. Therefore, the incorporated cryptocurrency trader enjoys a significant tax-deferral advantage by keeping the cryptocurrency-trading profits in the corporation and can decide when to take money out of the corporation when needed.

Contact Millars Lawyers for all your corporation and section 85 inquiries.