Introduction: “Understanding Income Tax Deductions for Losses arising from Cryptocurrency Fraud and Crypto-Exchange Bankruptcy”

Many Canadian traders and investors in cryptocurrencies are suffering from significant financial losses as a result of different cryptocurrency exchanges and platforms engaging in fraudulent activity that has caused millions of dollars’ worth of investments and crypto assets to disappear. Large and small exchanges have been related to instances of theft and the mysterious disappearance of customer assets, which has left unwary investors with disastrous consequences.

Many of these cryptocurrency exchanges have declared bankruptcy as a result of these fraudulent operations, leaving trustees and the courts to deal with the difficult chore of liquidating the remaining assets and allocating them to the defrauded consumers. Nevertheless, the profits from these endeavors are frequently insufficient, and investors are lucky to get back a small portion of what they initially invested.

One of the most well-known examples is QuadrigaCX, a Canadian exchange that caused ripples in the cryptocurrency world by losing around $200 million in investor funds. Similar to this, FTX, a well-known exchange with headquarters in the United States, was embarrassed to learn that it had lost more than $1 billion in client funds, underscoring the widespread prevalence of fraud in the cryptocurrency space.

In terms of cryptocurrency-based investment fraud, FTX and QuadrigaCX are only the tip of the iceberg. The different cryptocurrency scams that target investors are often exposed by consumer watchdogs, anti-fraud groups from Canada and elsewhere, and anti-fraud organizations. Schemes like this one that aim to con gullible people appear on a daily basis. The Canadian crypto-tax lawyers at our law office regularly provide advice to clients who have been defrauded by similar schemes. This ongoing conflict emphasizes the necessity of exercising caution in the cryptocurrency market and the value of getting legal counsel to handle the intricacies of these situations.

Cryptocurrency investors in Canada who become victims of fraud may be allowed to deduct the loss from their income taxes, even if their money may sorrowfully never be recovered. To learn more, see the article we wrote about income-tax deductions for losses on investments generated by cryptocurrency.

When it came to questions regarding cryptocurrency assets that were managed through centralized crypto-exchange platforms, the Association de planification fiscale et financière (APFF) and the Canada Revenue Agency (CRA) had an important discussion in November 2023. The answers from the CRA are especially important when it comes to the eligibility for income-tax deductions for losses resulting from fraud or insolvency involving these kinds of platforms. These observations highlight how crucial it is to consult with an experienced Canadian crypto tax lawyer prior to filing any tax claims pertaining to cryptocurrency transactions.

This article explores at the discussion around the CRA’s latest revelations on the procedure for filing crypto tax deductions for losses related to fraud or bankruptcy at cryptocurrency exchanges. The article also includes insightful pro crypto tax tips from our esteemed Certified Specialist in Taxation, a renowned Canadian crypto-tax lawyer, specifically for Canadian cryptocurrency traders and investors. The article attempts to shed light on the intricacies of crypto taxes while offering practical advice on how to successfully manage these difficulties. It does this by discussing the CRA’s opinion and the ramifications for taxpayers who suffer losses as a result of fraud or bankruptcy inside cryptocurrency exchanges.

New CRA Analysis: Whether the Taxpayer Beneficially Owns the Cryptocurrency Is Determined by the Terms of Service of the Crypto Exchange

The Canada Revenue Agency highlighted a distinction between the following two arrangements in response to inquiries concerning cryptocurrency maintained through centralized cryptocurrency-exchange platforms during the November 2023 APFF roundtable:

1. A plan whereby the cryptocurrency exchange acts as a custodian for the taxpayer, holding

the cryptocurrency in the taxpayer’s exchange account; and

2. An another plan whereby the taxpayer is granted the ability to withdraw a certain amount of cryptocurrency (i.e., the balance on the taxpayer’s exchange account) and the cryptocurrency is owned by the cryptocurrency exchange

As per the first plan, the cryptocurrency in the taxpayer’s exchange account is owned by the taxpayer and not by the exchange. In terms of the cryptocurrency it keeps in wallets specified for clients, the cryptocurrency exchange just serves as a custodian. In the second scenario, on the other hand, the cryptocurrency is owned by the exchange and not the taxpayer. When it comes to determining the ownership status of cryptocurrencies for taxpayers, the terms of service of a cryptocurrency exchange are quite important, especially when they are examined by knowledgeable Canadian crypto-tax lawyers. These documents frequently specify if a taxpayer owns the cryptocurrency that is being discussed or whether they only have a contractual right in relation to the transaction. In cases when the exchange takes control of the cryptocurrency stored in wallets selected by clients, its terms of service grant the exchange complete ownership rights. Key acts like loan, staking, selling, and pledging the cryptocurrency are all covered by these rights, which also grant the exchange ownership of any gains that result. This basically means that the trade acquires the right to carry out these acts on its own, demonstrating a full ownership position.

On the other hand, account holders generally have access to a limited range of benefits that are outlined in the terms of service. First and foremost, customers are still able to take their cryptocurrency balance—that is, the precise quantity of cryptocurrency that is stored on the exchange—out. This power of withdrawal basically means that the account user may obtain a certain amount of cryptocurrency from the exchange, highlighting their place in the ownership hierarchy.
It is critical to distinguish between outright ownership and contractual entitlements for tax reasons. The specific distinctions described in the terms of service of the exchange are crucial in figuring out each taxpayer’s tax duties and liabilities. Therefore, in order to navigate these intricate legal frameworks, ensure compliance, and reduce possible liabilities for taxpayers participating in cryptocurrency transactions, the experience of seasoned Canadian crypto-tax lawyers becomes invaluable. The Canada Revenue Agency states that not only do some agreements have special implications for Canadian crypto taxes when a taxpayer transfers cryptocurrency to or from an exchange of this kind, but they also have specific ramifications should the taxpayer lose access to the cryptocurrency that the exchange holds.

A fact pattern involving a taxpayer who has moved cryptocurrencies to a centralized cryptocurrency trading platform was given to the CRA at the November 2023 APFF roundtable. According to the platform’s terms of service, it is allowed to pledge, sell, and lend bitcoins while keeping all earnings. According to the terms of service, the taxpayer was allowed to take out as much bitcoin as they wanted at any time, and the withdrawals would be funded by bitcoins that were placed by other clients in a wallet.

The following inquiry was directed towards the Canada Revenue Agency to find out if the taxpayer’s transfer of bitcoins to this type of trading platform qualified as a “disposition” for tax reasons. The CRA provided a yes response. Since the terms of service for the crypto exchange likely implied that the taxpayer had transferred ownership of the bitcoins to the crypto-exchange platform, the taxpayer’s crypto deposit with the platform would probably be considered a disposition for tax purposes, according to the CRA. This is due to the fact that the taxpayer’s bitcoin deposit granted the cryptocurrency exchange permission to utilize those crypto assets, profit from them, and dispose of them as it saw appropriate under the terms of service of the platform.

Questions have been raised to the Canada Revenue Agency (CRA) about situations in which a taxpayer loses access to bitcoin stored in a cryptocurrency exchange because of things like fraud, financial mismanagement, or insolvency on the side of the exchange. From the perspective of the CRA, any loss of cryptocurrency—whether as a result of fraud, financial mismanagement, or bankruptcy—is deemed to have been suffered by the exchange itself rather than the taxpayer if the terms of service established by the crypto exchange stipulate that the exchange retains ownership of the deposited crypto assets while the taxpayer only has a contractual right to demand payment from the exchange. CRA states that even with the loss, the taxpayer still has a contractual right against the cryptocurrency exchange. Despite unfavorable conditions impacting the exchange, the taxpayer’s legal position is unaffected, since this position highlights the difference between ownership of assets and contractual rights. As such, the exchange has the primary responsibility for the loss, preserving the taxpayer’s contractual rights within the parameters set out in the exchange’s terms of service.

Granted, if the cryptocurrency exchange doesn’t have enough net assets to cover the entire amount of the taxpayer’s claim, its value can be reduced. But that’s another matter entirely—the claim’s value. Even in the event that the bitcoin exchange manages to lose the cryptocurrency that gave beings to the claim, the taxpayer still retains that contractual right. Because of this, the taxpayer might not yet be able to deduct the cryptocurrency loss from their taxes in these particular situations.

This means, according to the CRA, there are two distinct transactions and occurrences. The first is a disposition that results in a gain or loss when the cryptocurrency is transferred to an exchange. The second is a write-off of the contractual right to return the cryptocurrency from the exchange. It is important to note that these occurrences may occur in different taxation years, resulting in revenue in one year and a deduction in the next.

Alternatively, the terms of service of the cryptocurrency exchange can stipulate that the exchange keeps the cryptocurrency that has been deposited as a custodian for the advantage of the taxpayer. The CRA accepted that a loss of such cryptocurrency constituted a loss incurred by the taxpayer. Therefore, during the tax year in which the taxpayer’s cryptocurrency was lost by the crypto exchange, the taxpayer would be qualified to claim the cryptocurrency loss as a tax deduction.

The last question raised to the CRA concerned the kinds of proof that a taxpayer may present in order to establish their right to file a claim for a loss resulting from a crypto-scam in cases where they have lost access to more relevant documents. The following objects were listed as being produced by the taxpayer by the Canada Revenue Agency: Publicly available information about the cryptocurrency platform’s fraud or bankruptcy; confirmation of account activation documents; signed contracts between the taxpayer and the crypto platform; a copy of any claim filed with the trustee of the crypto platform; pleadings from any proceedings the taxpayer started in order to recover cryptocurrency; evidence that the taxpayer had previously declared revenue or losses associated with cryptocurrency; evidence that the taxpayer had not sold any cryptocurrency before the platform went bankrupt; exact computations of the loss claimed; any documentation pertaining to recovery or compensation; and evidence that the taxpayer did not sell their claim to the cryptocurrency platform’s bankruptcy trustee.

Pro Tax Tips: Legal Advice on Entitled to Crypto Tax Deductions & Appropriate Cryptocurrency Tax Reporting-Losses from Scams

According to a recent statement from the Canada Revenue Agency, taxpayers may be able to deduct income taxes from cryptocurrency losses that result from centralized cryptocurrency exchange platform fraud or insolvency. The responses provided by the CRA further highlight the need to consult a skilled Canadian crypto-tax lawyer for tax counsel prior to filing any claims pertaining to cryptocurrency transactions.

The Canada Revenue Agency (CRA) advises traders and investors in cryptocurrencies to consult with knowledgeable Canadian tax lawyers and carefully read the terms of service of any cryptocurrency exchange platform where they store cryptocurrency assets. They should also carefully go through any contracts they have with cryptocurrency exchanges or independent cryptocurrency wallet suppliers. It’s important to realize that people participating in seemingly identical agreements may have quite distinct legal rights and duties. These differences may have specific financial ramifications, such as the ability to deduct losses from taxes suffered as a consequence of cryptocurrency frauds.

Additionally, it is suggested to save a copy of any official legal advice issued by acknowledged Canadian crypto-tax lawyers. For example, those experts may write extensive tax memorandums examining the ability to claim tax deductions for losses incurred as a consequence of cryptocurrency frauds. They can also decide whether cryptocurrency losses should be recorded as capital losses, business losses, or a mix of the two. This privileged document is an important resource for ensuring correct information on tax returns, reducing the chance of inconsistencies that may draw CRA attention.

People can more confidently and assuredly traverse the complicated world of cryptocurrency taxes by working with knowledgeable legal advice. These professionals are equipped with the knowledge and skills needed to decipher complex legal systems and offer customized counsel based on the unique circumstances of each client. Proactive compliance procedures are crucial to protect one’s financial interests and preserve compliance with tax responsibilities in an emerging regulatory environment where cryptocurrency-related activities are scrutinized more closely.

The following examples of admissible proof were provided by the Canada Revenue Agency during the November 2023 APFF discussion for taxpayers wishing to claim losses from cryptocurrency scams in the event that access to relevant documents is lost:

• Information that is accessible to the public on the fraudulent acts or insolvency of the cryptocurrency platform.
• Paperwork certifying the account’s activation.
• Signed agreements, if any exist, between the taxpayer and the cryptocurrency platform.
• Copies of the claims filed with the bankruptcy trustee for the cryptocurrency network.
• Legal pleadings from any crypto-recovery case that has been started.
• Proof of revenue or losses from cryptocurrency transactions that have already been disclosed.
• Verification that the cryptocurrency was not lost before the platform filed for bankruptcy.
• Comprehensive computations of the purported loss.
• Any paperwork pertaining to efforts at compensation or recovery.
• Evidence proving the taxpayer did not give the platform’s bankruptcy trustee ownership of their claim.

Additionally, in order to avoid loss, cryptocurrency exchange users should routinely export their transaction data. To further protect against data loss, it is advised to use offsite or cloud storage for document and file backups.

Furthermore, in the event that you come to realize that you were deceived by an initial belief that your cryptocurrency investment was legal, you should collect as much evidence as you can to demonstrate that the company represented itself as a legitimate investment and to demonstrate the amount that you lost.

Bank account statements or cryptocurrency exchange statements that reflect the funds you transferred to the fraudulent business, wire transfer records, screenshots of your account on the fraudulent cryptocurrency platform, emails or screenshots of correspondence with the people running the fraudulent cryptocurrency platform, and police reports are examples of acceptable evidence.

In order to demonstrate that the cryptocurrency fraudsters moved your cryptocurrency assets to unapproved wallets, you want to think about engaging a private investigator to do a forensic blockchain-tracing investigation. The Canadian Reserve Bank (CRA) states that you should consult a knowledgeable Canadian crypto-tax lawyer to carefully go over the terms of service offered by the cryptocurrency exchange platform where you kept your cryptocurrency holdings. These agreements frequently contain provisions that allow an experienced Canadian crypto-tax lawyer to determine whether you actually held the underlying cryptocurrency or only had a contractual right to enforce against the exchange. You may make sure that the complex intricacies of your cryptocurrency assets are thoroughly reviewed and comprehended by getting in touch with one of our knowledgeable Canadian crypto-tax lawyers. With specific guidance to protect your interests and guarantee adherence to Canadian cryptocurrency tax rules, our team of exceptionally qualified experts is prepared to help you navigate the complexity of cryptocurrency taxes audit. For professional help managing your cryptocurrency holdings sensibly and successfully, don’t hesitate to get in touch with us right now.

Frequently Asked Questions

I invest in cryptocurrencies as a Canadian, and the platform I used to hold all of my holdings went bankrupt recently. Consequently, I am unable to access my cryptocurrency. For income-tax purposes, can I deduct the ensuing loss?

Depending on the terms of service of the cryptocurrency exchange, you may be eligible to claim a tax deduction. The Canada Revenue Agency made a distinction between the following two arrangements in response to inquiries concerning cryptocurrency maintained through centralized cryptocurrency-exchange platforms during the November 2023 APFF roundtable:

1. A plan whereby the cryptocurrency exchange acts as a custodian for the taxpayer, holding the cryptocurrency in the taxpayer’s exchange account; and
2. Another plan whereby the taxpayer is granted the ability to withdraw a certain amount of cryptocurrency (i.e., the balance on the taxpayer’s exchange account) and the cryptocurrency is owned by the cryptocurrency exchange.

As per the first plan, the cryptocurrency in the taxpayer’s exchange account is owned by the taxpayer and not by the exchange. In terms of the cryptocurrency it keeps in wallets specified for clients, the cryptocurrency exchange just serves as a custodian. In the second scenario, on the other hand, the cryptocurrency is owned by the exchange and not the taxpayer.

According to the Canada Revenue Agency (CRA), any loss incurred—whether as a result of fraud, financial mismanagement, or bankruptcy—is deemed to have been suffered by the exchange, not the taxpayer, if the terms of service of a crypto exchange establish that the exchange owns the deposited crypto assets while the taxpayer holds only a contractual claim for payment. From this vantage point, the taxpayer’s position is seen as restricted to contractual entitlement rather than outright ownership of the assets, emphasizing the difference between ownership and contractual rights. According to the CRA’s interpretation, the exchange company has the primary liability for losses instead of the taxpayer.

The taxpayer still has the right to a claim even if the cryptocurrency exchange loses the specific crypto assets that are connected to it. As a result, depending on the circumstances, the taxpayer may not be eligible for an immediate tax deduction for the cryptocurrency loss. The contractual entitlement endures in spite of the destruction of the digital assets. Therefore, the taxpayer’s eligibility for a tax deduction may be delayed until the claim is settled or the loss is shown through the proper legal processes. This emphasizes how crucial it is to use legal channels to prove the loss and successfully file claims for deductions under the tax laws.

Alternatively, the terms of service of the cryptocurrency exchange can stipulate that the exchange keeps the cryptocurrency that has been deposited as a custodian for the advantage of the taxpayer. The CRA accepted that a loss of such cryptocurrency constituted a loss incurred by the taxpayer. Therefore, during the tax year in which the taxpayer’s cryptocurrency was lost by the crypto exchange, the taxpayer would be qualified to claim the cryptocurrency loss as a tax deduction.

Per the CRA’s viewpoint, you ought to consult a knowledgeable Canadian lawyer specializing in crypto-tax matters to carefully review the terms of service of the cryptocurrency exchange where you kept your cryptocurrency holdings. It is usually possible for an experienced Canadian crypto-tax lawyer to determine whether you actually owned the underlying cryptocurrency or if you just had a contractual claim against the cryptocurrency exchange by looking through the terms of service provided by the exchange. Consult with one of our knowledgeable Canadian lawyers specializing in crypto taxation right now.

I was duped by an investment in cryptocurrencies that I thought was trustworthy at first. If I want to make a claim for that loss, which records should I keep?

When a taxpayer has lost access to more relevant documents, the Canada Revenue Agency has suggested that it may accept the following types of evidence to support their claim of right to a crypto-scam loss during the November 2023 APFF roundtable:

• Public documents pertaining to fraud or insolvency on the cryptocurrency platform;
• Documentation verifying the creation of an account;
• Any agreements that may have been executed between the taxpayer and the cryptocurrency platform;
• The taxpayer’s pleadings from any crypto-recovery proceedings;
• A copy of any claim submitted to the bankruptcy trustee of the cryptocurrency platform;
• Evidence of the taxpayer’s previously declared cryptocurrency-related income or losses;
• Evidence that the taxpayer’s cryptocurrency was not disposed of before the crypto platform filed for bankruptcy;
• Exact estimates of the loss that was claimed;
• Any documentation pertaining to reimbursement or recovery; and
• Evidence that the taxpayer did not transfer the taxpayer’s claim to the trustee for the crypto platform’s bankruptcy.

To reduce the possibility of data loss when using a cryptocurrency exchange, transaction records must be regularly exported. Offsite or cloud storage solutions are an effective option for document and file backup, since they provide resilience against unanticipated events. Moreover, careful evidence collection becomes necessary in cases when someone is duped into believing that fraudulent schemes posing as genuine cryptocurrency investments. This means assembling a significant amount of evidence to support the investment venture’s claimed validity and to calculate losses incurred.

All types of financial data, including wire transfer documents, images of transactions with the fake platform, and bank account or cryptocurrency exchange statements detailing funds sent to the fraudulent organization, are considered acceptable forms of evidence. To strengthen one’s case even more, one can file police complaints and save email exchanges or screenshots of correspondence with the offenders.

Using a private investigator proficient in forensic blockchain-tracing methods is a wise decision when dealing with complex fraud situations. These experts are capable of carrying out comprehensive investigations to track the flow of cryptocurrency assets that have been stolen, maybe revealing payments from an unknown wallet that the thieves planned to make.

Keeping thorough records and looking into forensic matters help police catch and punish cryptocurrency fraudsters in addition to verifying statements. In the wake of fraudulent cryptocurrency transactions, individuals can improve their chances of justice and restoration by carefully preserving evidence and making use of professional services.

To sum up, taking proactive steps like routine data exports, thorough documentation, and the strategic use of investigative skills are critical to managing the risks associated with cryptocurrency transactions and effectively thwarting fraudulent schemes.

If you would like a CRA tax auditor to accept your crypto-loss claim, you must provide extensive supporting documents. If you come into a really challenging auditor, it is recommended that you consult with one of our expert Canadian crypto-tax lawyers. With their knowledge, you can be confident that your rights will be upheld and your claims will be appropriately considered throughout the audit process. In order to handle any complications and conflicts and eventually enable a more flawless resolution with the tax authorities, effective recordkeeping and knowledgeable legal assistance are essential.

DISCLAIMER: The information contained in this article is only general. Only the posting date makes it current. It can be outdated because it hasn’t been updated. It should not be trusted and does not provide legal advice. Every tax case is different from the examples given in the article since it is specific to its own set of circumstances. Consult a Canadian tax lawyer if you have any particular legal issues.