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Canadian NFT Traders, Artists and Content Producers Can Fall Victim to a Tax Trap: If You Wish To Claim Input Tax Credits, You Must Have Proper Records

posted 1 year ago

Introduction: Canadian Businesses Dealing in Non-Fungible Tokens Must Maintain Certain ITC Records

Non-fungible tokens have become a popular new method for many musicians, artists, and content producers to monetize their work. A non-fungible token, also known as an NFT, is essentially a special kind of digital asset that uses blockchain technology to track ownership. Any digital content, such as a digitized image, song, poetry, or even this post, can be turned into an NFT. The underpinning blockchain enables the general public to trace ownership transfers and confirm who is in possession of a particular non-fungible token. As a consequence, an NFT enables the creation, sale, purchase, and ownership of distinctive digital objects.

Each non-fungible token has its own characteristics, unlike cryptocurrencies. For this reason, non-fungible tokens are referred to as such. Contrarily, cryptocurrency is fungible, meaning that exchanging one Bitcoin for another would provide the exact same result. But every NFT is unique, like a work of art. You don’t get the same item if you swap one for another. As a result, non-fungible tokens have drawn interest as a brand-new platform for the sale of digital artwork and music.

For independent NFT artists and NFT content producers in Canada, the revenue from producing and selling non-fungible tokens is their source of income. Accordingly, in line with paragraph 9(1) of the Canada Income Tax Act, self-employed Canadian NFT artists and Canadian NFT content producers are required to record their profits as business income.

Additionally, there may be GST/HST requirements associated with commercial NFT sales. The selling of commercial NFTs is still a taxable supply even if bitcoin trading is a financial service that is exempt from GST/HST. The purchase or sale of a “virtual payment instrument,” which is defined as a “property that is a digital representation of value, that functions as a medium of exchange, and that only exists at a digital address of a publicly distributed ledger,” is considered to be a “financial service” under the Excise Tax Act of Canada and is exempt from GST/HST obligations. Cryptocurrencies that are fungible, such as USD Coin (USDC), Ethereum, or Binance USD (BUSD), fit the criteria of a “virtual payment instrument” well. NFT art, however, does not. A non-fungible token does not “function as a medium of exchange” when it represents a work of art or piece of music since it is not a “digital representation of value.” Therefore, if a self-employed Canadian NFT artist or content creator earns $30,000 or more in gross income, they must register for a GST/HST number, charge GST/HST on non-fungible tokens sold in Canada, collect the GST/HST, and then pay it to the Canada Revenue Agency.

It is advantageous for Canadian NFT artists and content creators to register for GST/HST because they may then claim input tax credits (ITCs), which lower the net GST/HST owing to the Canada Revenue Agency. With the use of an input tax credit, a GST/HST registered firm can reduce the amount of GST/HST owing to the CRA by the sum of GST/HST paid to its own vendors.

The Excise Tax Act of Canada places strict crypto record-keeping obligations on registrants who request ITCs. It should come as no surprise that the Canada Revenue Agency uses its most aggressive tax auditing strategies when targeting groups that the CRA’s tax auditors believe are most likely to keep inaccurate records, such as those who produce, exchange, and sell non-fungible tokens or other blockchain-based assets. The GST/HST crypto tax auditors of the CRA will investigate a Canadian NFT artist’s or content creator’s ITC claims in order to determine when the taxpayer really got the supporting papers, in addition to whether or not the taxpayer has such documents on hand. Failure to maintain records in accordance with the Excise Tax Act results in the loss of all contested input tax credits for Canadian NFT artists, NFT content producers, and NFT dealers. As a result, when the CRA’s tax auditors are through, Canadian NFT artists, NFT content makers, and NFT dealers who regularly maintain inadequate records will find themselves with a sizable GST/HST penalty.

The ITC record-keeping obligations for GST/HST registrants conducting commercial sales of non-fungible tokens are examined in this article. The Excise Tax Act’s record-keeping requirements for input tax credits are covered in the section that follows a discussion of the GST/HST system in Canada. Finally, it offers professional crypto tax tips for Canadian NFT artists, NFT content makers, and NFT dealers from our team of knowledgeable Canadian NFT and crypto tax lawyers.

The GST/HST System in Canada: An Overview

GST/HST is levied on “every receiver of a taxable supply made in Canada,” according to Section 165 of the Excise Tax Act of Canada. The term “taxable supply” broadly refers to any trading activities and includes the majority of business transactions, such as the sale of products or services, barter exchanges, license or leasing agreements, etc.

The individual who creates the supply, or the seller, is responsible for actually collecting the tax and repatriating it to the Canada Revenue Agency, although the GST/HST is imposed on the person who receives the good or service (the purchaser). A Canadian company must apply for a GST/HST registration and start collecting the tax on its products and services if its yearly global gross revenues reach $30,000 or more. If this isn’t done, there may be tax fines, interest charges, and legal action for tax evasion related to cryptocurrencies.

Authorized suppliers who are part of the supply chain may claim input tax credits for the GST/HST they paid to their own commercial vendors in order to recuperate those costs. The GST/HST that was paid to merchants or other suppliers cannot, however, be recuperated by the final consumer due to a lack of eligibility for input tax credits. As a result, the ultimate customer is typically the only one obligated to pay GST / HST. As a result of receiving a full input tax credit for the GST/HST they paid on their own purchases, businesses only pay the difference to the Canada Revenue Agency when they collect the GST/HST from customers.

Numerous companies are excluded from the requirement to pay GST/HST under the Excise Tax Act. An illustration of a “small supplier” is a Canadian company with yearly gross revenues of less than $30,000. Furthermore, a small supplier is not required to register for GST/HST and is thus not required to collect it, according to clause 240(1)(a) of the Excise Tax Act. (This excludes commercial ride-sharing services like Lyft and Uber as well as taxi businesses. Regardless of the amount of gross yearly revenue they generate, taxi drivers and commercial ride-share drivers are required to register for GST and HST.)

Another illustration of a company that is exempt from the requirement to charge or collect GST/HST is a financial services company. The Excise Tax Act’s definition of a “financial service” encompasses a variety of transactions using a “financial instrument,” including those involving stocks, insurance policies, valuable metals, commodities options, etc. A “virtual payment instrument” is described as “property that is a digital representation of value, that serves as a medium of exchange, and that only exists at a digital address of a publicly distributed ledger” by the Canadian Parliament, which expanded the definition of “financial instrument” to include this term in June 2021.

A virtual payment instrument is one that is fungible, such as a cryptocurrency like Binance USD (BUSD), USD Coin (USDC), or Cardano (ADA). As a result of its eligibility as a financial services firm, bitcoin trading is free from GST/HST.

However, non-fungible tokens are not covered by the concept of a virtual payment instrument. A “digital representation of value” is not typically found in NFT artwork, which instead frequently consists of a digital representation of a work of art or piece of music. It might be argued that it doesn’t “serve as a medium of trade” because of this. Therefore, despite the fact that a cryptocurrency trading firm is eligible to receive financial services that are GST/HST-exempt, commercial NFT sales are nevertheless considered taxable supplies under the Excise Tax Act of Canada.

For GST/HST-registered NFT artists, NFT content creators, and NFT dealers, there are requirements for claiming input tax credits, or ITCs.

A registered supplier that has paid GST/HST to one or more of its own business suppliers is eligible to claim those payments as input tax credits, which lowers the supplier’s net GST/HST obligation to the Canada Revenue Agency. As a result, if a GST/HST-registered NFT artist or content producer paid GST/HST to business vendors, they are eligible to claim those sums as input tax credits. The GST/HST due on commercial rent, the GST/HST payable on professional fees provided by Canadian crypto tax lawyers or accountants, the GST/HST due on internet-service costs, and the GST/HST payable on mobile phone fees are a few examples of monies claimable as ITCs (to the extent that the internet use and cell-phone use were business related).

Nevertheless, in order to be eligible for the ITC claim itself, a GST/HST registrant must fulfill specific requirements. For instance, the business seller, who must also be registered for GST/HST, must have been a GST/HST registrant throughout the reporting period in which the GST/HST was paid to or became due to them. Furthermore, the GST/HST must have been due on a business expenditure in order for the registrant to claim an input tax credit (as opposed to a personal expense).

Additionally, a company also has to provide “taxable supplies” (make sales) in order to be eligible for ITCs. This term covers taxable goods and services as well as zero-rated supply (such as exports), but it does not include exempt goods and services. In other words, if a company solely manufactures exempt supplies, it cannot claim ITCs. For instance, a company that trades cryptocurrencies and qualifies as a supplier of financial services free from GST/HST is not allowed to collect input tax credits. Health care, education, and long-term housing rent are more instances of excluded supplies.

There are additional strict record-keeping obligations under the Excise Tax Act of Canada. A registrant is not permitted to claim an input tax credit under the terms of paragraph 169(4)(a) of the Act “unless, before filing the return for which the credit is claimed, the registrant has obtained sufficient evidence in such form containing such information as will enable the amount of the input tax credit to be determined, including any such information which may be prescribed.” It’s noteworthy that the clause mandates that the registrant have documented proof “before filing” the GST/HST return that claims the ITC. To put it another way, the registrant must not only get the records needed to support the ITC but must also do so before ever attempting to submit the claim.

The particular documents that a registrant must acquire to verify its input tax credits are laid forth in the Input Tax Credit Information (GST/HST) Regulations. The following data must typically be obtained by registrants:

  • The name of the vendor that billed the GST/HST used to calculate the input tax credit;
  • The whole sum paid to or outstanding from that provider;
  • The quantity of GST/HST that has been paid to or is still owed to that supplier (in other words, the supporting document should show GST/HST as a distinct line item);
  • The date when the GST/HST was paid or became due;
  • The GST/HST registration number of the supplier;
  • The conditions of the payment; and
  • a sufficient description of each supplier, or each commodity or service, to allow for identification.

Typically, this information may be found on contracts, receipts, and invoices, all of which the registrant requesting the ITC should save.

However, the information described above is not included on credit card statements, bank account statements, or cancelled checks. They could mention that a payment was made, but they don’t say if the payment included GST or HST. Therefore, invoices, receipts, and contracts are eventually required as additional documentation for GST/HST-registered NFT artists, content producers, or dealers to provide with their credit card bills, bank account statements, and cancelled checks.

Verifying Your Suppliers to Protect Yourself from Tax Evasion & Defending Your ITC Claims in a GST/HST Audit by CRA – Professional Tax Advice

Because there are inadequate supporting documentation, the GST/HST auditors at the Canada Revenue Agency often reject ITCs. Additionally, CRA tax auditors are more likely to examine businesses in sectors where players are known for keeping shoddy records, which is usually the case with individuals who develop, exchange, and sell non-fungible tokens and other blockchain-based assets. A GST/HST registrant engaged in commercial sales of non-fungible tokens would forfeit all contested input tax credits and may be hit with a hefty GST/HST charge if the record-keeping requirements of the Excise Tax Act are not met (plus, interest and potential gross-negligence penalties).

NFT artists, NFT content producers, and NFT dealers that are GST/HST registered should typically get paperwork that include all of the following details to support their input-tax credit claims:

  • The name of the provider that billed the GST/HST that is the basis for the ITC;
  • The whole sum paid to or yet owed to the provider;
  • The sum of GST/HST already paid to or yet owed to the provider;
  • Date on which the GST/HST was paid or became due;
  • The GST/HST registration number of the supplier;
  • The conditions of the payment; and
  • An adequate explanation to distinguish each supply

The NFT artist, content provider, or dealer who is GST/HST registered should also make sure the supplier has a current GST/HST registration number. If you cannot provide a legitimate GST/HST registration number for your supplier, the CRA’s tax auditors will refuse your ITCs, even if you can demonstrate that you really paid the GST/HST to that source. The fact that your supplier may have wrongfully charged you for GST/HST is likely to be taken advantage of by the CRA and the courts, because equity doesn’t apply in Canadian cryptocurrency tax issues.

Therefore, before paying your supplier any sum that you plan to claim as an input tax credit and in order to safeguard yourself from crypto tax fraud, you should verify the legitimacy of the GST/HST registration number. You can verify a supplier’s GST/HST registration number by utilizing the GST/HST registry search on the Canadian government’s website (https://www.canada.ca/en/revenue-agency/services/e-services/e-services-businesses/confirming-a-gst-hst-account-number.html). A record demonstrating your search of the GST/HST register maintained by the CRA should also be kept (e.g., taking a screenshot capturing the search result and the date upon which you performed the search).

Our knowledgeable Canadian NFT and crypto tax lawyers can provide guidance to Canadian NFT artists, NFT content producers, and NFT dealers on how to safeguard their companies from GST/HST fraud and how to make sure that their claims for input tax credits withstand scrutiny from the GST/HST auditors of the Canada Revenue Agency.

FREQUENTLY ASKED QUESTIONS

Question: I’m a self-employed Canadian NFT artist, and my field of work is producing and disseminating non-fungible tokens among other Canadians. Commercial NFT sales, according to what I’ve heard, are free from GST and HST. Is that correct?

Answer: No. Commercial NFT sales remain a taxable supply even if a bitcoin trading firm is a supply of financial services that is exempt from GST/HST.

The purchase or sale of a “virtual payment instrument,” which is defined as a “property that is a digital representation of value, that functions as a medium of exchange, and that only exists at a digital address of a publicly distributed ledger,” is considered to be a “financial service” under the Excise Tax Act of Canada and is exempt from GST/HST obligations.

This concept encompasses fungible cryptocurrencies but excludes non-fungible tokens, such as NFT artwork. A non-fungible token does not “function as a medium of exchange” when it represents a work of art or piece of music since it is not a “digital representation of value.” Therefore, if a self-employed Canadian NFT artist or content creator earns $30,000 or more in gross income, they are required to register for a GST/HST number, charge GST/HST on non-fungible tokens sold in Canada, collect the GST/HST, and then pay it to the Canada Revenue Agency.

Question: What does an input tax credit mean?

Answer: An input tax credit, often known as an ITC, is a credit that a GST/HST-registered supplier may use to lower the net GST/HST that the provider must pay to the Canada Revenue Agency. The GST/HST that the supplier paid on its own inputs is effectively offset by the amount of the ITC (i.e., on its own business expenses).

Question: I’m a self-employed Canadian who runs a cryptocurrency trading company that is GST/HST registered. Do I qualify for input tax credits?

Answer: No. ITCs cannot be claimed by a company until “taxable supplies” are made. This term covers taxable goods and services as well as zero-rated supply (such as exports), but it does not include exempt goods and services. In other respects, if a company solely manufactures exempt supplies, it cannot claim ITCs. A cryptocurrency trading firm is considered a financial service supplier exempt from GST/HST. Therefore, it is not eligible for input tax credits.

Question: I’m a self-employed Canadian who runs an NFT trading company that is GST/HST registered. Do I qualify for input tax credits?

Answer: A resounding yes, but only if you meet every need. First, the GST/HST must have been paid to your supplier or become owing within the crypto tax reporting period when you were registered for GST/HST. Second, a GST/HST payment must have been made on a business expenditure before you may claim an input tax credit (as opposed to a personal expense). Third, before submitting the GST/HST return in which you claim the ITCs, you must get documentation proof substantiating the ITCs. Most of the time, GST/HST-registered NFT artists, NFT content producers, and NFT dealers should acquire documentation including all of the following information to support their input-tax credit claims.

  • The name of the vendor that billed the GST/HST used to compute the input tax credit;
  • The entire sum paid to or still due from that provider;
  • The amount of GST/HST that has been paid to or is still owed to that supplier (in other   words, the supporting document should show GST/HST as a distinct line item);
  • The day the GST/HST was paid or became due;
  • The conditions of the payment, the GST/HST registration number of the provider, and
  • A sufficient description of each supplier, or each commodity or service, to allow for identification.

The common source of this information will be contracts, receipts, and invoices. Please get in touch with one of our knowledgeable Canadian NFT-tax lawyers to find out if your blockchain-based business qualifies for input tax credits.

Question: I am aware that I need to acquire specific supporting documentation in order to be eligible for input tax credits. Usually, I use a check or a credit card to pay my business’s suppliers. Can I use my credit card bills, bank account statements, and canceled checks as proof of my ITC claims?

Answer: You must (at a bare minimum) provide proof that your supplier charged you GST/HST in order to meet the supporting-document criteria. Your credit card, bank account, and canceled check statements won’t show this information.

Even while credit card bills, bank account statements, and canceled checks could show that you made a payment, they cannot tell you if the payment included GST/HST. Therefore, statements from credit cards, bank accounts, and canceled checks on their own will not be sufficient to substantiate your ITCs.

Finally, you must provide other documentation, such as invoices, receipts, and contracts, in addition to credit card statements, bank account statements, and canceled checks. Consult one of our knowledgeable Canadian crypto-tax lawyers right away for guidance on how to make sure that your ITC claims withstand the scrutiny of the GST/HST auditors from the Canada Revenue Agency.

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