In the first known reported Canadian tax case involving the taxation of cryptocurrency, a Tax Court judge was tasked with deciding whether a taxpayer could write off her

bitcoin loss, and if so, whether it was a capital loss or an ordinary business loss.

The taxpayer’s crypto journey began back in 2017 when she opened an account and began investing with the now-defunct cryptocurrency exchange

QuadrigaCX , which at one point was Canada’s largest crypto exchange. QuadrigaCX collapsed in dramatic fashion in 2019, triggered by suspected fraud, and the sudden death of its chief executive,

Gerald Cotten , in late 2018. For “reasons unknown,” the taxpayer said her QuadrigaCX account balance “vanished” in late 2017. After initial recovery efforts failed, the taxpayer claimed a non-capital loss of $505,142 in her 2017 T1 tax return, representing the cumulative amount placed with QuadrigaCX, plus interest and other costs. Claiming it as a non-capital loss would allow her to deduct it against her income. The

Canada Revenue Agency denied this loss, and the taxpayer appealed to the Tax Court.

The taxpayer first heard about bitcoin from friends and family in 2016. She testified that she knew people who had made hundreds of thousands of dollars from investing in bitcoin. She therefore decided to open a QuadrigaCX account, and used it to buy bitcoin in 2017, deploying a combination of personal savings and borrowed funds. She testified that when she first learned about bitcoin, it was rapidly appreciating, which was evident by the copies of online statements she presented in court. She said she saw an opportunity, began buying bitcoin to make a profit, and good initial performance prompted her to continue.

The taxpayer had hoped to retire in her early 60s, and earning substantial profits from bitcoin was the quick pathway toward that goal. She also hoped to benefit her adult children with some of her potential profits. She testified that she made more than 100 bitcoin purchases through her QuadrigaCX account, and that by late 2017 her account was worth more than $2 million.

The taxpayer logged in and viewed her QuadrigaCX account daily, usually using her work laptop, and she spent several hours per week contemplating purchases. She proceeded to take advances on her credit card (at rates exceeding 20 per cent) to fund more bitcoin purchases, and got a second mortgage on her home (at an 11.99 per cent interest rate), and put some of those proceeds with QuadrigaCX. She also cashed in her registered retirement savings plan (RRSP), and placed the withdrawn funds with QuadrigaCX.

The taxpayer testified that in late December 2017, her QuadrigaCX account balance suddenly fell to nil. The taxpayer testified that she felt ashamed after the loss, and did not mention it to anyone for many months, although she finally confided in one of her sons in August 2018.

The taxpayer explained that she consulted with a computer recovery expert about strategies to salvage her QuadrigaCX account but was unable to afford it. In February 2018, in a last-ditch effort to see if she could somehow revive her account, the taxpayer twice funded her account with $1,000, hoping to recover some of her losses through this further investment. This did not work.

On her 2017 tax return, filed on April 30, 2018, the taxpayer reported employment income of just over $95,000, an RRSP withdrawal of approximately $264,000, and deducted her bitcoin loss against this income.

She testified in court that her activities had “indicia of commerciality,” in other words a legitimate business venture and therefore a source of income for tax purposes, and thus should be characterized as an “adventure in the nature of trade,” or a business activity. The taxpayer alleged that the non-capital loss she claimed on her 2017 return ought to be allowed as it resulted from the theft of her bitcoin held with QuadrigaCX in December 2017.

A few possible theories were offered to seek to explain what occurred with her QuadrigaCX account. One was that the taxpayer’s computer was remotely accessed by a hacker. Another was that perhaps someone accessed her G-mail account in which she stored, among other things, a list of her passwords. Finally, it is possible that the disappearance of her bitcoin may have been associated with fraud within QuadrigaCX.

This suspected fraud was the subject of a 2020 Ontario Securities Commission report, which was admitted into evidence, and confirmed the general circumstances of the fraud and failure of QuadrigaCX.

Ultimately, the judge had to decide whether the taxpayer incurred a financial loss in 2017 as a result of the loss of bitcoin that she claimed she purchased (plus expenses) and held with QuadrigaCX. In other words, did she actually spend the money she claimed to have spent to acquire bitcoin in 2017, and if so, was her bitcoin then lost or stolen?

The judge noted that the taxpayer went “all in” with QuadrigaCX in 2017, which he remarked was “not inconsistent with human behaviour. Modern cryptocurrency surges are like previous economic frenzies, such as Dutch tulip mania in the 17th century, various gold rushes or, in more recent times, the dot-com bubble. It is plausible that a person could get swept up in the momentum when they anticipate and achieve strong financial outcomes.”

While the taxpayer’s evidence was “imperfect,” the judge concluded that the taxpayer likely incurred the expenses she claimed to purchase bitcoin in 2017. Combined with the OSC report concluding that fraud did occur, the judge ruled that the taxpayer did, indeed, suffer a loss.

The final question was whether the loss was on account of income or capital. This is important because if it was a capital loss, the taxpayer could only claim against capital gains, while an income loss could be used to offset taxes owing on her employment income and RRSP withdrawal. The judge reviewed the classic tests of income versus capital: the taxpayer’s intention, their actual conduct, the connection to the taxpayer’s business (if any), the nature of the property, the financing and the holding period.

Weighing all these factors, the judge concluded that the taxpayer’s intention was to purchase bitcoin in 2017 with a view to profit. Her activities thus fell within the definition of a business, and therefore her loss was properly characterized as a non-capital loss, deductible against all sources of income.

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Jamie Golombek, FCPA, FCA, CFP, CLU, TEP, is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto. Jamie.Golombek@cibc.com

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