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David Rotfleisch on Tax Traps for Canadian NFT Artists, Creators & Trades: Why Obtaining Proper Records is Necessary to Claim Input Tax Credits

posted 2 years ago

The Record-Keeping Requirements of Canadian Non-Fungible Businesses Dealings – An Introduction

Non-fungible tokens have become a popular new method for many musicians, artists, and content producers to monetize their work. NFTs, or non-fungible tokens, are essentially one-of-a-kind digital assets that use blockchain technology to track ownership. A digitized image, song, poem, or even this article itself can be turned into an NFT. The underlying blockchain enables the general public to trace ownership transfers and confirm who is in possession of a particular non-fungible token. As a result, an NFT enables the creation, sale, purchase, and ownership of distinctive digital objects.

Each non-fungible token carries distinct characteristics, unlike cryptocurrencies. Cryptocurrency is “non-fungible”, meaning that trading one Bitcoin for another gets you exactly the same thing; whereas each NFT is unique, like a work of art. One cannot be exchanged for another to provide the same result. Non-fungible tokens have therefore gained attention as a new medium for commercializing digitized art and music.

Profits from the creation and sale of non-fungible tokens are considered business income for self-employed NFT artists and NFT content creators in Canada. Therefore, in accordance with paragraph 9(1) of the Canada Income Tax Act, self-employed Canadian NFT artists and Canadian NFT content producers are required to report their earnings as business income.

Additionally, commercial NFT sales might result in GST/HST requirements. Commercial NFT sales remain a taxable supply (sale) even though a bitcoin trading business 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. Fungible cryptocurrency, such as Bitcoin, Tether, or Ethereum, fits the criteria of a “virtual payment instrument,” while NFT artwork does not. As a representation of a work of art or music, a non-fungible token does not serve as a “digital representation of value” or “function as a medium of exchange.” Therefore, if a self-employed Canadian NFT artist or content creator earns $30,000 or more in gross revenue, such artist or creator needs 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.

When a Canadian NFT artist or content creator registers for GST/HST, he or she has the opportunity to claim input tax credits (ITCs), which lower the net GST/HST due to the Canada Revenue Agency. With the use of an input tax credit, a GST/HST-registered business can reduce the amount of GST/HST owed to the CRA by the sum of GST/HST paid to its own vendors.

The Excise Tax Act of Canada places strict record-keeping obligations on registrants who make ITC claims. It should come as no surprise that the Canada Revenue Agency employs its most aggressive strategies when auditing organizations that the CRA’s crypto tax auditors believe are most likely to maintain incomplete records, organizations like those that produce, trade, and market non-fungible tokens or other blockchain-based assets. The GST/HST auditors of the CRA will examine a Canadian NFT artist’s or content creator’s ITC claims to determine not only if the taxpayer is in possession of supporting documentation but also when the taxpayer actually acquired that documentation. All disputed input tax credits shall be forfeited by Canadian NFT artists, NFT content producers, and NFT dealers who fail to comply with the Excise Tax Act’s record-keeping obligations. Therefore, after the CRA’s tax auditors are done, Canadian NFT artists, NFT content makers, and NFT dealers who frequently keep bad records will find themselves with a hefty GST/HST charge plus interest and potentially penalties.

This article looks at the ITC record-keeping requirements for GST/HST registered businesses selling non-fungible tokens commercially. In addition, it discusses the GST/HST system in Canada before covering the record-keeping requirements for input tax credits under the Excise Tax Act. Finally, it offers professional tax advice from our expert Canadian NFT-tax lawyers for Canadian NFT artists, NFT content makers, and NFT sellers.

GST/HST System in Canada: An Overview

Every “recipient of a taxable supply made in Canada,” as defined in Section 165 of the Excise Tax Act of Canada, is subject to GST/HST. The term “taxable supply” broadly refers to any commercial activity and includes the majority of business transactions, such as the sale of goods or services, barter exchanges, license or leasing agreements, etc., and in general non-technical parlance means any purchase.

Although GST/HST is charged to the individual who receives the property or service (the purchaser), the vendor is responsible for actually collecting the tax and remitting it to the Canada Revenue Agency. Particularly, any Canadian business that generates $30,000 or more in yearly global gross revenues must apply for a GST/HST number and start collecting the tax on its products and services. If you don’t, you could face tax fines with interest, and possible penalties and crypto tax evasion charges.

By claiming those sums as input tax credits, registered suppliers who are a part of the supply chain may recover the GST/HST they paid to their own company vendors. The GST/HST paid to retailers or other suppliers cannot, however, be recovered by the final consumer through input tax credits. The burden of the GST/HST is therefore typically only borne by the final customer. Businesses charge GST/HST on sales but only pay the difference to the Canada Revenue Agency since they receive a full input tax credit for the GST/HST they paid on their own purchases.

The Excise Tax Act exempts a number of types of companies from the requirement to collect GST/HST. According to paragraph 240(1)(a) of the Excise Tax Act, a “small supplier” is, for instance, a Canadian business with gross annual sales of less than $30,000. Additionally, small suppliers are exempt from GST/HST registration and collection requirements. (A taxi driver or employee of a commercial ride-sharing service, such as Uber or Sidecar, must register for GST/HST regardless of the amount of gross annual revenue the individual generates.)

Another example of a business that is exempt from GST/HST requirements is a financial services business. The Excise Tax Act’s definition of a “financial service” encompasses a variety of transactions involving a “financial instrument,” including those involving securities, insurance policies, precious metals, commodities options, etc. Fungible cryptocurrency, such as Bitcoin (BTC), Ethereum (ETH), or Binance Coin (BNB), falls squarely within the definition of a virtual payment instrument, which is defined by the Canadian Parliament as “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.” As a result of its eligibility as a financial services business, bitcoin trading is exempt from GST/HST.

However, non-fungible tokens are not included in the concept of virtual payment instrument. NFT artwork, for example, is frequently a digital representation of a piece of art or music, rather than a “digital representation of value,” and thus does not “function as a medium of exchange.” Therefore, despite the fact that a cryptocurrency trading business is a taxable supply of financial services free from GST/HST, commercial NFT sales are nonetheless subject to the Excise Tax Act of Canada.

Claim Input Tax Credits: GST/HST-Registered NFT Artists, NFT Content Creators, & NFT Dealers’ ITC Requirements

A registered supplier that has paid GST/HST to one or more of its own business vendors 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 creator paid GST/HST to business vendors, that payor is eligible to claim those sums as input tax credits. A few examples of amounts that can be claimed as ITCs are the GST/HST due on commercial rent, the GST/HST due on professional services rendered by Canadian crypto-tax lawyers or accountants, the GST/HST due on internet service fees, and the GST/HST due on mobile phone fees (to the extent that the use of the internet and mobile devices was related to business).

However, in order to be eligible for the ITC claim itself, a GST/HST registrant must fulfill specific requirements. For instance, the business vendor must also be a registered GST/HST payer and the registrant must have been registered during the reporting period in which the GST/HST was paid to or became due from the vendor. Additionally, if the GST/HST was charged on a business expense, the registrant cannot claim an input tax credit (as opposed to a personal expense).

The words “taxable supplies” cover taxable sales and services, zero-rated supplies (such as exports), but excludes exempt supplies, and a business cannot claim ITCs unless it makes such supplies (sales). In other words, a business cannot claim ITCs if all of its supplies are exempt. For instance, a company that trades cryptocurrencies and qualifies as a supply of financial services free from GST/HST is not permitted to claim input tax credits. Long-term residential rent, health care, and educational services are additional instances of exempt supplies.

Strict record-keeping obligations are also imposed by the Excise Tax Act of Canada. The Tax Act’s paragraph 169(4)(a) states that a registrant cannot claim an input tax credit “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 as may be prescribed.” Or, to put it another way, the registrant must both get the records needed to support the ITC and do so before even attempting to do so.

The precise records that a registrant must gather to verify its input tax credits are laid forth in the Input Tax Credit Information (GST/HST) Regulations. A registrant typically has to gather the following data:

  • The supplier’s name who charged the GST/HST that is the basis for the input tax credit;
  • The full sum paid to or due to that supplier;
  • Amount of GST/HST paid or due to that provider (i.e., GST/HST should be shown as a separate line item in the supporting document);
  • The date that the GST/HST was paid or became due;
  • GST/HST registration number of the supplier;
  • Payment terms; and
  • Sufficient description to identify whether each supply is a service or good.

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

Cancelled cheques, bank account records, and credit card transactions do not, however, contain the information specified above. They might say that a payment was made, but they don’t say whether it was GST/HST-inclusive. Therefore, credit card transactions, bank account statements, and cancelled cheques must eventually be supported by invoices, receipts, and contracts from GST/HST-registered NFT artists, content creators, or dealers.

Pro Tax Tips for Input Tax Credits: Protect Yourself from Tax Fraud and Defend Your ITC Claims in CRA’s GST/HST Audit by Verifying Your Suppliers

The GST/HST auditors at the Canada Revenue Agency often reject ITCs due to a lack of supporting documentation. Additionally, CRA tax inspectors routinely investigate businesses in sectors where record-keeping is notoriously bad, as is commonly the case with individuals who produce, trade, and sell non-fungible tokens and other blockchain-based assets. A GST/HST registrant selling non-fungible tokens commercially who does not comply with the Excise Tax Act’s record-keeping obligations would forfeit all contested input tax credits and may be hit with a hefty GST/HST charge (plus, interest and potential gross-negligence penalties).

GST/HST-registered NFT artists, NFT content creators, and NFT dealers should typically get documents providing all of the following details to support their input-tax credit claims:

  • The supplier’s name who charged the GST/HST that is the basis for the input tax credit;
  • The full sum paid to or due to that supplier;
  • Amount of GST/HST paid or due to that provider (i.e., GST/HST should be shown as a separate line item in the supporting document);
  • The date that the GST/HST was paid or became due;
  • GST/HST registration number of the supplier;
  • Payment terms; and
  • Sufficient description to identify each supply.

The supplier’s current GST/HST registration number should also be verified by the GST/HST-registered NFT artist, content creator, or dealer. Even if you can demonstrate that you did, in fact, pay GST/HST to your supplier, the tax auditors at the CRA will reject your ITCs if you cannot provide a legitimate GST/HST registration number for your supplier. Since Canadian tax disputes are not subject to the principles of equity, the CRA and the courts are not likely to be sympathetic to the possibility that your supplier may have wrongfully charged you for GST/HST. 

Therefore, before paying your supplier any sum that you want to claim as an input tax credit, you should verify that their GST/HST registration number is valid in order to safeguard yourself against tax fraud. By using 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), you can verify a supplier’s GST/HST registration number. Keep a note of your search of the GST/HST registry maintained by the CRA, like taking a screenshot of the search result and the date of the search).

For Canadian NFT artists, NFT dealers, and NFT creators seeking advice on how to protect their businesses against GST/HST fraud, and ensure that Canada Revenue Agency cannot question their input-tax-credit claims, our expert Canadian NFT-tax lawyers can absolutely help.

The FAQs

Question: I work as a self-employed Canadian NFT artist, creating and selling non-fungible tokens to other Canadians. Commercial NFT sales, so I’ve heard, are exempt from GST/HST. Is that accurate?

Answer: No. Commercial NFT sales remain a taxable supply even though a cryptocurrency trading business 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 definition covers cryptocurrency that is fungible, but excludes non-fungible tokens like NFT artwork. Therefore, if earning $30,000 or more in gross revenue, a self-employed Canadian NFT artist or content creator must register for a GST/HST number, charge GST/HST on non-fungible tokens sold in Canada, collect that GST/HST, and pay that GST/HST to the Canada Revenue Agency.

Question: What is input tax credit all about?

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 ITC amount is basically equivalent to the GST/HST that the supplier paid on its own inputs (i.e., on its own business expenses).

Question: I’m a self-employed Canadian who runs a bitcoin trading business that is GST/HST registered. Is it possible for me to claim input tax credits?

Answer: No, it is not. Unless it makes “taxable supplies,” which include taxable sales and services as well as zero-rated supplies (for example, exports), but excludes exempt supplies, a business cannot claim ITCs. In other words, if a business solely makes exempt supplies, it cannot claim ITCs. A bitcoin trading company is a GST/HST-free supply of financial services. As a result, input tax credits are not available.

Question: I’m a Canadian self-employed business owner who runs a GST/HST-registered NFT trading operation. Are input tax credits available to me?

Answer: Yes, but only if you meet every requirement. The GST/HST must first have been paid to your vendor within the crypto reporting period in which you were registered for GST/HST. Second, you were required to pay GST/HST on a business expense in order to be eligible for an input tax credit (as opposed to a personal expense). Third, before submitting the GST/HST return in which you claim those ITCs, you must collect documentation proof substantiating your ITCs. NFT artists, NFT content creators, and NFT dealers that are GST/HST registered should typically get documents that include all of the following details to support their input-tax credit claims:

  • The supplier’s name who charged the GST/HST that is the basis for the input tax credit;
  • The full sum paid to or due to that supplier;
  • Amount of GST/HST paid or due to that provider (i.e., GST/HST should be shown as a separate line item in the supporting document);
  • The date that the GST/HST was paid or became due;
  • GST/HST registration number of the supplier;
  • Payment terms; and
  • Sufficient description to identify whether each supply is a service or good.

Contracts, receipts, and invoices are typically the sources of this data. Contact a crypto lawyer in Canada right away to find out if your blockchain-based business is eligible for input tax credits.

Question: I am aware that in order to be eligible for input tax credits, I must obtain specific supporting documentation. I usually write cheques or use credit cards to pay my business’s suppliers. Can I submit cancelled cheques, bank account statements, and credit card bills as proof for my ITC claims?

Answer: You must (at a minimum) present proof that your seller charged you GST/HST in order to satisfy the supporting-document requirements. Your credit card statements, bank account statements, and voided cheques won’t contain this information. Although cancelled cheques, bank account statements, and credit card statements may show that you made a payment, they cannot tell you whether the payment included GST/HST. As a result, your ITCs will not be supported by credit card statements, bank account statements, or cancelled cheques alone. In the end, you’ll need to add additional papers, such as invoices, receipts, and contracts, to the credit card statements, bank account statements, and cancelled cheques. Consult one of our knowledgeable Canadian crypto-tax lawyers right away for suggestions 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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