The Income Tax Act (the “Act”) and the Income Tax Regulations (the “Regulations”) in Canada provide the framework for determining taxable income in Canada. Neither the Act nor the Regulations contain any specific provision or the term “staking of cryptocurrency”. However, the Act and Regulations contain provisions which determine the taxable income and, thus, it can potentially include levying tax on income from staking of cryptocurrency.
In simple terms, staking is the process of locking up cryptocurrency assets for a predetermined period to support the functioning of the blockchain. In exchange for staking, participants earn additional cryptocurrency. The network members must "stake" set amounts of cryptocurrency to validate transactions and add new blocks to the blockchain. Staking is essential as it aids in validating transactions and adding data to the blockchain.
The Ontario Securities Commission has defined the staking of cryptocurrency in a staff notice[1] as “the act of committing or locking crypto assets in smart contracts to permit the owner or the owner's agent to act as a validator for a particular proof-of-stake consensus algorithm blockchain.” The notice[2] also mentioned that the Canadian Securities Administrator’s staff are of the view that staking may involve the issuance of a security or derivative, depending on how it is conducted. It is important to note that the Ontario Securities Commission defined “staking” only for the notice which was issued for investment funds that seek to invest in crypto assets, either directly or indirectly, under National Instrument 81-102 Investment Funds (NI 81-102).
Understanding the rationale behind the possible tax implications on cryptocurrency staking is important.
The Canada Revenue Agency (the “CRA”), in its publication on virtual currency[3], has explained that virtual currency, a digital asset used to buy or sell goods or services, includes cryptocurrency which is a blockchain-based currency. The publication explained how there could be tax implications when virtual currency is earned from mining or staking cryptocurrency. It mentions that proof of stake is an alternative distributed consensus mechanism where a person is selected out of a group of participants (forgers) to validate a block of transactions.
Essentially, a consensus mechanism in terms of cryptocurrency refers to the protocol or algorithm used to achieve agreement among participants in a decentralized network regarding the validity and order of transactions. It plays a crucial role in maintaining the integrity, security, and immutability of blockchain networks.
The participant, on the successful creation of a valid block, will receive two amounts in one payment, where one amount represents the creation of a new cryptocurrency on the network and the other amount represents fees from transactions included in the newly validated block[4]. Thus, there could be tax implications on such amounts received.
CRA in another publication[5] has explained that it is essential to determine the value of crypto assets when a transaction occurs. It also provided examples of events or transactions where one needs to determine the value of crypto assets for tax reporting purposes. A taxpayer is required to determine the value of crypto assets while staking or mining cryptocurrency as it is considered a “reward” while acquiring cryptocurrency[6]. Usually, the CRA will accept the fair market value for tax reporting purposes.
The income tax implication on staking depends on whether a taxpayer staked cryptocurrency as a hobby or in the course of business. In some instances, a transaction involving a crypto asset may result in business income/loss or a capital gain/loss. It is important to establish if the crypto-asset transactions have resulted in income or capital gains, as this determination will lead to different income tax outcomes.
If the taxpayer has disposed of cryptocurrency in the course of business with the intention of selling, then the proceeds from the sale are considered business income and not a capital gain. Buying a cryptocurrency to sell it for a profit may be treated as business income[7].
If the taxpayer disposed of cryptocurrency and it was not to carry on a business, then the difference between the purchase and sell price could be subject to income tax on account of capital gains[8].
Apart from the obligation to pay income tax on staking of cryptocurrency, a taxpayer is also required to maintain records of cryptocurrency transactions. Section 230 of the Act obligates Canadian taxpayers to maintain adequate books and records of cryptocurrency transactions. The CRA’s guide for cryptocurrency users and tax professionals[9] and IFA Roundtable[10] reiterate that taxpayers engaging in crypto-asset transactions are required to keep proper financial records of all their activities, including records related to the acquisition or disposition of crypto assets.
[2] Ibid at Paragraph 5(c)
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