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The Implications of Buying and Selling Collectible Trading Cards on Canadian Taxes – Magic: The Gathering

posted 2 months ago

Introduction: Unique Trading Card Sold by Canadian to Renowned Rapper Post Malone

“Magic: The Gathering,”™ a collectible trading card game (TCG) crafted by Wizards of the Coast, has evolved into one of the world’s premier TCGs since its inception in 1993. Boasting impressive statistics in both revenue, with annual card sales exceeding USD 1 billion, and player count, with over 35 million participants globally since 2018, the game stands out. Unlike traditional sports cards like hockey or baseball, Magic: The Gathering cards are specifically designed for strategic tabletop gameplay, featuring proprietary rulesets. Wizards of the Coast-sanctioned tournament circuits, such as Grand Prix, occasionally hosted in cities like Toronto, Montreal, and Ottawa, draw thousands of players and traders worldwide. These events offer major competitive play, lucrative side-events, and opportunities for casual friendly matches. The game has given rise to a sophisticated secondary market, facilitating the buying and selling of individual Magic: The Gathering cards, known as “singles.” This market allows players to acquire specific rare cards for their collections or construct more formidable and intriguing card decks. The intersection of collecting, trading, and playing Magic: The Gathering cards introduces a multitude of personal and profit-driven motivations for players. As we delve into the subject, it becomes evident that these complexities pose intricate challenges from the perspective of Canadian tax law.

In July 2023, Wizards of the Coast unveiled its latest card set, “Lord of the Rings: Tales of Middle Earth,”™ a comprehensive collection inspired by J.R.R. Tolkien’s renowned works. To generate excitement around the launch, Wizards of the Coast introduced a series of special-edition collector’s boosters featuring unique cards with alternate art. Additionally, these boosters contained a selection of distinctive serialized cards portraying some of Tolkien’s most celebrated characters and creations. Among these serialized cards was a one-of-a-kind copy of “The One Ring,” depicting the iconic ring of Sauron from the book series. This unique card was incorporated into the production sheets of the collector’s boosters, offering the chance for one fortunate player to discover it. The announcement of these collector’s boosters garnered widespread media attention, prompting major global card stores like Dave and Adams in the U.S.A. and Gremio de Dragones in Spain to publicly offer millions of dollars for The One Ring. As reported by CBC News, the fortunate individual who found The One Ring turned out to be a resident of Toronto, Ontario. In a noteworthy private sale, the card was eventually purchased by Austin Richard Post, renowned by his stage name “Post Malone,” for a staggering $2.64 million.

This noteworthy event offers a distinctive lens through which we can examine the intersection of Trading Card Games (TCGs) and Collectible Card Games (CCGs) with Canadian tax law. This article aims to delve into several fundamental principles that form the basis of income taxation in Canada within the realm of TCGs, including Magic: The Gathering. This exploration encompasses concepts like source theory income, windfall gains, and the crucial aspect of categorizing profits as either income or capital gains for Canadian tax purposes. While the narrative of this article revolves around the renowned discovery of The One Ring, our goal is to elucidate how these principles might have relevance to a broad spectrum of TCG/CCG players, enthusiasts, and collectors. The conclusion of this article will offer valuable tax tips related to maintaining records of trades and transactions, along with addressing frequently asked questions pertaining to Canadian tax law.

Assessing Whether Your Trading Card Ventures Could Lead to Taxable Income

The initial and pressing challenge in ascertaining the Canadian tax implications of acquiring and trading Magic: The Gathering cards stems from the definition of income for tax purposes. As per section 3 of the Canadian Income Tax Act, a taxpayer’s income explicitly encompasses all earnings derived from a productive “source” within or outside Canada. Section 3 enumerates various productive sources of income, which include:

  1. Office;
  2. Employment;
  3. Business; and
  4. Property

While section 3 enumerates specific productive sources, the definition of “income from all sources inside or outside of Canada” is not restricted to the mentioned examples. Income can still originate from other sources. Canadian tax courts have determined that an income source should possess one or more of the following characteristics:

  1. it occurs periodically;
  2. it entails an organized activity, effort, or pursuit on the taxpayer’s part (such as providing services, running a business, or selling property);
  3. it involves transactions within a marketplace;
  4. it results in an enforceable payment; and/or
  5. if it pertains to a business or property, there is a pursuit of profit.

Canadian tax courts have consistently upheld the perspective that if income doesn’t fit into a recognized productive source, it is not subject to taxation under the Income Tax Act. Generally, these courts have acknowledged that windfall gains, gifts, inheritance, strike pay for employees, and lottery winnings are not classified as “sources” for income tax purposes. This classification stems from the fact that broadly speaking, none of the mentioned receipts originate from a “productive” source of income. In essence, these are irregular and non-recurring amounts that a taxpayer might receive, not as a result of an organized effort to earn income but due to probabilities, irrational decision-making, or unforeseen circumstances.

For TCG players like Magic: The Gathering enthusiasts, this rule holds particular relevance. For instance, if a taxpayer engages in an organized tournament and achieves a high standing, earning non-cash prizes like packs or cards, or even a substantial cash prize, the tax treatment depends on the taxpayer’s classification. If the taxpayer is deemed a hobbyist, these prizes may not be considered taxable income upon receipt (although the taxpayer might have taxable income if he or she decides to later sell those non-cash prizes, a point addressed later in this article). On the other hand, if the activity is viewed as a business, the cash earnings could be characterized as business income and any non-cash prizes might be seen as property income. The determination of whether tournament winnings constitute a source of income often comes up in contexts like poker, where it is widely acknowledged that skilled players can significantly enhance their chances of winning and profiting.

Establishing whether a taxpayer’s activities qualify as a taxable source of income or if they are of a personal nature and therefore do not constitute a source of income was delineated by the Supreme Court of Canada in Stewart v Canada, 2002 SCC 46. The Stewart test consists of two components that must be addressed sequentially to ascertain whether a taxpayer’s activities amount to a source of business income or property income, a matter explored in detail in this article:

  1. Was the taxpayer’s activity conducted to make a profit, or was it a personal pursuit?
  2. If the activity was not of a personal nature, was the origin of the income attributable to a business or property?

Criterion 1: Is the Taxpayer’s Endeavor Conducted with the Intent of Generating Profit?

In the initial part of the examination, it must be determined whether the taxpayer engaged in the activity primarily to achieve profit or if it was a personal pursuit. The key factor in making this determination is whether the activity was conducted in a manner that can be deemed “commercial.” Even if the activities initially appear to be personal, if there is substantial evidence indicating a commercial nature, they may be deemed profit-oriented and constitute a source of income.

Whether a venture is conducted in a commercial manner hinges on the taxpayer’s subjective intentions, supported by objective factors reflecting the true intentions. Therefore, the taxpayer must primarily aim for profit in a specific activity and must execute that activity following recognized business standards. Canadian courts have identified several objective criteria relevant to this assessment, such as (i) the taxpayer’s recent profits and losses, (ii) the level of training the taxpayer possesses regarding the activity, (iii) the intended approach to the activity, and (iv) the potential of the taxpayer’s venture to generate a profit.

Test 2: If the Venture is Undertaken in Pursuit of Profit, is it Business or Property Income?

The second aspect of the test delves into how to classify gains or losses when the taxpayer’s activities, motivated by a predominant intention to earn a profit, are not of a personal nature. As discussed earlier, if a hobby transforms into a business activity, immediate tax implications may arise. In situations where a taxpayer receives and later disposes of cards for cash or in exchange for other cards, there could be an income inclusion, especially when the taxpayer opens a valuable card from a randomized booster pack or receives a non-cash prize for tournament placement. The resulting gain or loss from such a sale or commercial activity will need to be reported either as income from a business or income from property.

The Income Tax Act distinguishes between two primary types of property for income tax purposes:

  1. Capital property, the sale of which leads to a capital gain or loss (including personal-use property or listed personal property, as further discussed below); and
  2. Inventory, the sale of which results in business income or loss.

The nature of income generated upon selling a property determines whether it qualifies as capital property or inventory, influencing the subsequent tax treatment of gains or losses. The distinction between capital and income has been a subject of extensive litigation in Canadian tax courts. Various factors are considered in making this determination, including:

  • Frequency of transactions – a higher frequency of buying and selling trading cards may suggest a business;
  • Length of possession – keeping trading cards for short periods leans towards commercial activities rather than capital investments;
  • Knowledge of trading card markets – more knowledge or expertise in trading card markets favors a business categorization.
  • Connection to the taxpayer’s other work – if trading card activities are part of the taxpayer’s employment or other business, it indicates a business.
  • Amount of time dedicated – a significant portion of the taxpayer’s time spent on research, analysis, or active management suggests a business.
  • Leveraged financial backing – leveraged trading card transactions signal a business.
  • Promotion or marketing efforts – if the taxpayer promotes trading card activities as a business, it is more likely to be characterized as such.

Ultimately, the primary factor that courts consider when determining whether a property’s disposition leads to a capital gain or business income is the taxpayer’s intent at the time of purchase. The Tax Court of Canada and the Canada Revenue Agency analyze the objective circumstances surrounding both the acquisition and sale of the property to ascertain the taxpayer’s purpose. This holds true even in cases involving the acquisition and sale of a single property, often referred to as “an adventure or concern in the nature of trade.”

In a general sense, categorizing proceeds from a transaction as capital gains is more advantageous for a taxpayer compared to receiving business income, as only half of the capital gains are considered taxable income. The determination of whether a Canadian taxpayer’s trading card activities should be classified as a business or as an investment is a highly fact-specific analysis, relying significantly on the taxpayer’s intentions at the time of acquiring the trading cards and whether they were obtained with the purpose of trading.

The incident involving The One Ring offers an appropriate context to delve deeper into this rule. In the case of The One Ring, the card was swiftly sold after its discovery, resulting in a substantial profit. The individual who sold the card had obtained it from a series of randomized collector’s boosters, specifically marketed and sold by Wizards of the Coast to serious collectors and resellers who were well aware of the potential monetary value of the cards they could uncover. These factors strongly lean towards characterizing the sale of The One Ring as an adventure or concern in the nature of trade. If the taxpayer’s knowledge of trading card markets is limited, or if there is other objective evidence indicating the intention to hold the acquired cards for a significantly longer period than the few months The One Ring was held, these factors could support a characterization of the sale as on capital account, resulting in more favorable tax treatment.

Since a taxpayer’s business income is fully taxable, while only half of capital gains are treated as taxable income, broadly speaking, characterizing proceeds from a transaction as capital gains is more advantageous for a taxpayer than receiving business income. These tax rules are intricate and nuanced, contingent on the unique circumstances of each taxpayer. Therefore, a definitive determination would require a more thorough analysis. This case underscores the advantages of consulting with an expert Toronto tax lawyer to explore potential tax implications when buying and selling cards for a collection, avoiding the risk of violating Canadian tax rules and ensuring accurate income reporting. For active TCG/CCG traders or players with substantial earnings and trades, seeking advice from a Canadian tax lawyer is crucial to navigate individual circumstances and ensure compliance with the law.

Rules Regarding Personal-Use Property Might Potentially Exempt Hobbyists from Reporting Requirements

Surprisingly, numerous trades may be subject to taxation under Canadian law, even if the intention was not to operate a trading business or generate substantial profit. Despite this, the Canadian tax system does offer some relief. The Income Tax Act’s personal-use-property rules create an opportunity for hobbyists to potentially sidestep tax obligations related to their trades, particularly when dealing with property treated as capital property.

The Canadian Income Tax Act defines “personal use property” (“PUP”) as any property owned by a taxpayer primarily used for personal enjoyment or use by the taxpayer or someone related to them. This category encompasses various items, including vehicles, furniture, personal effects, and collectibles such as trading cards. Regarding personal-use property, the Income Tax Act stipulates that the proceeds from disposing of such property will be the greater of $1,000 (the “floor”) and the actual proceeds received by the taxpayer. Similarly, the adjusted cost base of personal-use property is deemed to be the greater of $1,000 and the actual adjusted cost base. Consequently, if a taxpayer disposes of personal-use property with an adjusted cost base and proceeds both below $1,000, the proceeds for tax purposes will be nil, and no taxable income will arise from the disposition.

It is crucial to understand that losses related to personal-use property are not deductible for tax purposes, except when those losses arise from the sale of “listed personal property” (“LPP”). Listed personal property, as defined in the Income Tax Act, includes a taxpayer’s personal-use property that encompasses prints, etchings, drawings, paintings, sculptures, works of art, jewelry, rare folios, manuscripts, books, stamps, and coins. Losses incurred from the disposition of listed personal property may be deducted when calculating net gains from the sale of other listed personal property, and they can be carried back across the seven taxation years preceding the year in which the losses occurred.

Notably, the enumerated list in the Income Tax Act does not explicitly cover trading cards, making it unlikely for trading cards to qualify as listed personal property. Consequently, losses from the sale of trading cards, considered personal-use property rather than inventory of a business, are likely not deductible against proceeds from the sale of other personal-use property. Canadian trading card players and enthusiasts should familiarize themselves with the PUP/LPP rules under the Income Tax Act to ensure accurate reporting of any sale exceeding the specified floors on the annual tax return. Seeking advice from a reputable Canadian tax lawyer is advisable in the case of significant profits to ensure compliance with all applicable Canadian tax laws.

Tax Pro Tip: Exercise Caution in Classifying Personal-Use Property as a Set for Taxation Purposes

The $1,000 floor rule for personal-use property provides a significant exemption for the majority of Canadian taxpayers. This rule allows a taxpayer to benefit from the exemption for each transaction involving the disposition of personal-use property to multiple arm’s-length parties, as long as the property retains its status as personal-use property and does not transition into inventory of a business. Nevertheless, the rules are less lenient when it comes to situations where taxpayers attempt to exploit the $1,000 floor rule intentionally to shield proceeds from taxation.

The Income Tax Act includes provisions that limit the multiple uses of the $1,000 floor rule when properties originally part of a set or series are separately disposed of to the same purchaser or multiple non-arm’s length purchasers. This situation may arise when a single purchaser or group of purchasers agrees to buy your TGC card collection or a set of rare TGC cards through several transactions, each with proceeds not exceeding $1,000. In such cases, these transactions are treated as a single personal-use property for the purposes of the $1,000 floor rule, potentially subjecting the proceeds of disposition to significant taxation.

The characteristics that determine whether personal-use-property belongs to a “set” are not explicitly defined by the Income Tax Act. Whether a specific CCG collection or group of items qualifies as a “set” is a case-specific question, and there is no singular decisive factor. While there is limited case law on this definition, the CRA has shared its perspectives on the matter. Although the CRA’s views do not carry the force of law, Canadian courts have acknowledged them as essential tools for interpreting and applying Canada’s tax laws to other taxpayers. A “set” is not established merely because two properties are similar. However, if the combined value of two or more properties, when sold together, exceeds the sum of their individual values, this may suggest the existence of a set. Additionally, if two or more properties are typically disposed of together rather than individually, it may indicate the presence of a set.

This implies that a collection of CCG cards may not inherently meet the criteria of a “set” under these rules. However, there is still a risk that a set of collectible cards sold as a group could qualify as a set, depending on the specific circumstances. Considering the substantial potential value of collectible cards, the associated tax risk can be significant. If you plan to sell or auction your TCG/CCG collections or any other collectibles or cards, we highly recommend consulting with a top Canadian tax lawyer to mitigate potential tax pitfalls and explore any available tax planning options.

Frequently Asked Questions (FAQs):

At what point does an activity constitute a “source” of income for Canadian tax purposes?

Section 3 of the Canadian Income Tax Act explicitly includes a taxpayer’s income derived from any productive “source” inside or outside Canada, encompassing income from an office, employment, business, or property. Canadian tax courts generally reject windfall gains, gifts, inheritance, strike pay for employees, and lottery winnings as “sources” for income tax purposes, as they do not emanate from a “productive” source of income. These receipts are irregular and non-recurring, lacking an organized effort to earn income. Whether another receipt constitutes a source of income involves a fact-specific analysis based on the commercial nature of the activity and its pursuit of profit.

When selling TGC/CCG trading cards in Canada, are the proceeds considered income from a business or property, and what are the associated tax implications of such sales?

Determining whether the profit or loss from the disposition of trading cards should be categorized as capital (arising from the sale of property) or income (stemming from a business) relies on various factors, including: (1) the frequency of transactions involving trading cards; (2) the duration of ownership; (3) the taxpayer’s comprehension of trading card marketplaces; (4) the connection between trading activities and the taxpayer’s other employment; (5) the time invested in trading cards; (6) whether the taxpayer utilizes leveraged debt for purchases and sales; and (7) whether the taxpayer promotes these trading activities as a business. Ultimately, the taxpayer’s intention at the time of acquiring TCG/CCG trading cards is the paramount factor considered by courts in determining whether any disposition results in a capital gain or fully taxable business income.

What defines personal-use-property (“PUP”) and listed personal property (“LPP”)?

The Canadian Income Tax Act defines “personal use property” (“PUP”) as any property owned by a taxpayer primarily used for personal enjoyment by the taxpayer or someone related to them. This category encompasses various items such as vehicles, furniture, personal effects, and collectibles like trading cards. Listed personal property under the Income Tax Act includes specific items like (a) prints, etchings, drawings, paintings, sculptures, and works of art; (b) jewelry; (c) rare folio, manuscripts, or books; (d) stamps; and (e) coins. The Act establishes a floor rule of $1,000 for the proceeds of disposition and adjusted cost base of personal-use-property or listed personal property that a taxpayer disposes of. If both are less than $1,000, the proceeds of disposition for tax purposes are treated as nil. However, only losses resulting from the disposition of listed personal property are deductible, and they can only offset net gains from the disposition of other listed personal property.

Disclaimer:

“This article just provides broad information. It is only up to date as of the posting date. It has not been updated and may be out of date. It does not give legal advice and should not be relied on. Every tax scenario is unique to its circumstances and will differ from the instances described in the articles. If you have specific legal questions, you should seek the advice of a Canadian tax lawyer.”

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