Crypto Tax Trap For Canadian Emigrants: When You Leave And Cease To Be A Canadian Tax Resident, Your Cryptocurrency Portfolio May Be Subject To Departure Tax

Introduction – Departure Tax for Canadian Emigrants with Cryptocurrency

When a taxpayer ceases to be a Canadian tax resident, paragraph 128.1(4)(b) of Canada's Income Tax Act deems the taxpayer to have disposed of almost all property (including cryptocurrency, non-fungible tokens, and other digital assets) at fair market value. This deemed disposition may give rise to a capital gain, commonly known as "departure tax". By means of departure tax, Canadian taxpayers must pay income tax on any gains that accrued on investments that taxpayers held during the time that they resided in Canada. This includes gains that've accrued on cryptocurrency such as Bitcoin (BTC), Bitcoin Cash (BHC), Litecoin (LTC), Ethereum (ETH), Chainlink (LINK), Dash, Zcash (ZEC), and Ripple (XRP).

Yet Canada's Income Tax Act exempts certain properties from the deemed disposition. Canadian real property, for instance, is exempt from the deemed disposition (and therefore not subject to departure tax). Another example of an exempt property is inventory in a business carried on through a permanent establishment in Canada.

Thus, in most cases, a Canadian emigrant who owns cryptocurrency will incur departure tax on that cryptocurrency portfolio. But if those cryptocurrency holdings constitute inventory in a cryptocurrency-trading business, those crypto assets may be exempt from the deemed disposition and the resulting departure tax.

This article discusses the circumstances under which a Canadian emigrant's cryptocurrency will qualify for the departure-tax exemption. This article first gives an overview of the notion of Canadian tax residence. It then discusses the deemed-disposition rule under paragraph 128.1(4)(b) of Canada's Income Tax Act and the inventory exemption under subparagraph 128.1(4)(b)(ii). This article concludes by offering pro crypto tax tips from our top certified specialist in taxation Canadian cryptocurrency tax lawyer to Canadian cryptocurrency traders and investors.

The Notion of Canadian Tax Residence & Its Significance

Subsection 2(1) and section 3 of Canada's Income Tax Act require a Canadian tax resident to pay Canadian tax on worldwide income.

In contrast, subsection 2(3) of Canada's Income Tax Act obliges a Canadian non-resident to pay tax only on Canadian-sourced income—in particular, income from: (1) employment in Canada; (2) carrying on a business in Canada; and (3) disposing of a taxable Canadian property. So, your status as a Canadian resident for income-tax purposes determines the extent to which Canada may tax your income.

Canadian tax residents come in two forms: factual residents and deemed residents. In addition, Canada's Income Tax Act may deem you to be a non-resident if the provisions in a tax treaty dictate that you're a tax resident of Canada's treaty partner.

Factual residence is also known as common-law residence. This is because the doctrine comes from the judicial decisions making up Canada's common law. The Canada's Income Tax Act uses the terms "resident" and "ordinarily resident" but defines neither. So, the responsibility of defining residence falls upon Canadian courts—namely, the Tax Court of Canada, the Federal Court of Appeal, and the Supreme Court of Canada.

The Supreme Court of Canada has defined a taxpayer's residence variously as: "the place where in the settled routine of his life he regularly, normally or customarily lives"; and "the degree to which a person in mind and fact settles into or maintains or centralizes his ordinary mode of living.": Thomson v Minister of National Revenue, [1946] SCR 209, at paras 50 and 71.

Further, courts are quick to observe that your particular circumstances determine whether you're a factual resident in Canada. When rendering a decision about an individual's residence status, a court (and by extension, the Canada Revenue Agency) may examine any of the following factors (and then some):

Past and present life habits;
Regularity and length of visits in the jurisdiction asserting residence;
Ties within that jurisdiction;
Ties elsewhere; or
The permanence or purposes of a stay abroad.

The required analysis, then, calls for comprehensive examination of the individual's circumstances. This is also why the common-law test has been labelled "factual residence."

A deemed resident is an individual who Canada's Income Tax Act stipulates is a Canadian tax resident. Paragraph 250(1)(a) of Canada's Income Tax Act deems a person to have been a Canadian resident throughout the year if that person "sojourned" in Canada for 183 days or more in a year. You sojourn if you visit. So, unlike a factual resident, a sojourner need not have a "settled routine" in Canada, nor does a sojourner "customarily live" in Canada. In other words, even if you're not a factual resident in Canada, your mere physical presence in Canada for just over half a year will brand you a Canadian tax resident.

A deemed non-resident, by contrast, is an individual who Canada's Income Tax Act stipulates is not a tax resident of Canada. Canada has numerous bilateral tax conventions or tax agreements with other countries. These conventions or agreements are commonly known as tax treaties. Tax treaties contain provisions aimed at preventing double taxation and combating tax evasion. Notably, Canada's tax treaties usually contain a tie-breaker clause that settles the issue of a person's country of tax residence where both countries' domestic tax laws claim jurisdiction to tax the person's worldwide income on the basis of domicile, residence, place of management, or any other similar criterion. To this end, subsection 250(5) of Canada's Income Tax Act deems a person to be a non-resident of Canada if a tax treaty proclaims that the person is a tax resident of Canada's treaty partner. Subsection 250(5) assures consistency between domestic cryptocurrency tax law in Canada and Canada's tax treaties.

Deemed Disposition & Departure Tax: Paragraph 128.1(4)(b) of Canada's Income Tax Act

This deemed disposition will cause the emigrating taxpayer to realize a taxable capital gain if the fair market value (at the time that the taxpayer ceased to be a Canadian tax resident) of the targeted property exceeds the taxpayer's tax cost (or ACB) for that property.

In most cases, this deemed-disposition rule will catch cryptocurrency such as Bitcoin (BTC), Bitcoin Cash (BHC), Litecoin (LTC), Ethereum (ETH), Chainlink (LINK), Dash, Zcash (ZEC), and Ripple (XRP). As a result, a Canadian emigrant who owns cryptocurrency will typically incur departure tax on that cryptocurrency portfolio.

This departure tax essentially allows the Canada Revenue Agency to treat the targeted property as though the taxpayer had sold it at fair market value upon leaving Canada. The emigrating taxpayer must report the departure tax on the Canadian income-tax return for the tax year in which the taxpayer ceased to be a Canadian tax resident.

Inventory Exemption: Subparagraph 128.1(4)(b)(ii) of Canada's Income Tax Act

Canada's Income Tax Act exempts certain properties from the deemed disposition underlying the departure tax. One category of exempt property is "property described in the inventory of a business carried on by the [emigrating] taxpayer through a 'permanent establishment' in Canada at the particular time."

Thus, an emigrating taxpayer's cryptocurrency may be exempt from the deemed disposition (and thus not subject to departure tax) if the following two conditions are satisfied:

The cryptocurrency qualifies as business inventory (e.g., inventory in a cryptocurrency-trading business); and
The emigrating taxpayer carried on that business through a "'permanent establishment' in Canada at the particular time."

The following two sections will examine each condition in turn.

Condition 1: Is Your Cryptocurrency Inventory? Trading vs. Investing

Canada's Income Tax Act recognizes only two broad sorts of property for tax purposes:

capital property, which creates a capital gain or loss upon disposition; and
inventory, which figures into the computation of business income.

The type of income that the property generates upon sale (capital gains or business income) determines whether that property is a capital property or inventory. In other words, one starts by determining the nature of the income and then characterizes the property, not the other way around. Hence, your profits from a cryptocurrency transaction will be treated as either (i) business income or (ii) a capital gain, and, if they are characterized as business income, your cryptocurrency units constitute inventory.

The income/capital distinction also comes with other important tax implications. The full amount of business or property income is taxable, while only one-half of a capital gain is taxable. On the flip side, while only one-half of capital losses are deductible, one may fully deduct losses and expenses associated with business or investment activity.

Some cryptocurrency transactions straddle the line between income and capital. Canadian courts have indeed churned out a large body of case law wrestling with the ambiguity between investing, which produces a capital gain or loss, and trading, which results in business income or expenses. Courts assess a wide range of factors when deciding whether to characterize a transaction's gains or losses as on an account of capital or income. Applied to cryptocurrency transactions, these factors may include:

transaction frequency—e.g., a history of extensive buying and selling of cryptocurrency or of a quick turnover of cryptocurrency units might suggest a business;
length of ownership—e.g., brief periods of holding the cryptocurrency indicate business dealings, not capital investing;
knowledge of cryptocurrency markets—e.g., increased knowledge of or experience with cryptocurrency markets favours a business characterization;
relationship to the taxpayer's other work—e.g., if cryptocurrency transactions (or similar dealings) form a part of a taxpayer's employment other business, it points toward business;
time spent—e.g., a greater likelihood of characterization as a business if a substantial part of the taxpayer's time is spent studying cryptocurrency markets and investigating potential purchases;
financing—e.g., leveraged cryptocurrency transactions indicate a business; and
advertising—e.g., increased likelihood of business characterization if the taxpayer has advertised or otherwise made it known that he deals in cryptocurrency.

Ultimately, the taxpayer's motive or intent at the time of acquiring the cryptocurrency is the most important criterion that courts consider when determining whether the transaction produced a capital gain or business income. Still, to discern a taxpayer's intention, courts will focus on the objective factors surrounding both the purchase and the sale of the cryptocurrency. In other words, courts will determine a taxpayer's intent by evaluating the factors listed above.

In sum: This multi-factored test determines not only whether your cryptocurrency transactions generate business income but also whether your cryptocurrency units comprise inventory.

Condition 2: Do You Carry on business through a Canadian "Permanent Establishment" and "at the Particular Time"?

Even if the emigrating taxpayer's cryptocurrency qualified as inventory in a cryptocurrency-trading business, that cryptocurrency will still trigger departure tax unless the emigrating taxpayer carried on that business through a "permanent establishment in Canada" and did so "at the particular time."

A "permanent establishment" for individuals is defined in the Income Tax Regulations under subsection 2600(2). It essentially refers to a fixed place of business (i.e., a brick-and-mortar location) where the individual carries on his or her business. As a result, the emigrating taxpayer's cryptocurrency will qualify for the inventory exemption only if the emigrating taxpayer carries on the cryptocurrency-trading business through a brick-and-mortar location in Canada.

What's more, the inventory exemption under subparagraph 128.1(4)(b)(ii) contains a timing test. To qualify for the exemption, the property must relate to a business carried on through a Canadian permanent establishment "at the particular time." The phrase "at a particular time" is defined within subsection 128.1(4) of Canada's Income Tax Act. It refers to the time that the taxpayer ceases to be a resident.

Thus, the inventory exemption applies only if the emigrating taxpayer maintains a Canadian permanent establishment (i.e., a Canadian brick-and-mortar location) at the time that the taxpayer ceased to be a Canadian tax resident. This may occur, for example, where the emigrating taxpayer has employees or agents who continue the cryptocurrency-trading operations from a fixed place of business within Canada.

If, on the other hand, the emigrating taxpayer is the only person operating the cryptocurrency-trading business, the taxpayer's cryptocurrency will typically fail to qualify for the inventory exemption.

This is because most emigrating taxpayers (especially those that cease to be Canadian tax residents) generally don't maintain a brick-and-mortar location in Canada at the time that they leave. So, when they cease to be Canadian tax residents, they won't have a permanent establishment in Canada. Therefore, even if we assumed that the cryptocurrency qualified as inventory in a cryptocurrency trading business, the inventory exemption wouldn't apply because the cryptocurrency failed to satisfy the timing test in subparagraph 128.1(4)(b)(ii).

Pro Tax Tips: Emigration Tax Planning for Canadians who Own Cryptocurrency, NFTs & Other Digital Assets

When a taxpayer ceases to be a Canadian tax resident, paragraph 128.1(4)(b) of Canada's Income Tax Act triggers a fair-market-value disposition of almost all that taxpayer's property including cryptocurrency, non-fungible tokens, and other digital assets. This departure tax may lead to a hefty tax bill for emigrating Canadians who own cryptocurrency, NFTs, and other digital assets.

But you can avoid departure tax on your cryptocurrency, NFTs, and digital assets if those assets qualified as inventory in a business that you continued to operate through a Canadian permanent establishment at the time that you ceased to be a Canadian tax resident.

As discussed in the previous sections, this departure-tax exemption requires (1) your cryptocurrency to qualify as business inventory, (2) the business to be carried on through a Canadian permanent establishment, and (3) the Canadian permanent establishment to exist at the time that you ceased to be a Canadian tax resident. To determine whether you qualify for this departure-tax exemption, consult one of our knowledgeable Canadian crypto-tax lawyers today.

In addition, even if your cryptocurrency presently doesn't qualify for a departure-tax exemption, you may be able to reorganize your affairs before leaving Canada so that you reduce or avoid departure tax on your cryptocurrency holdings. You might, for example, satisfy the inventory exemption by hiring employees or agents who will continue operating the cryptocurrency-trading business from a fixed place of business within Canada after you've left Canada. But if you go this route, your business income will remain taxable in Canada. So, you'll need to consider whether the tax savings from avoiding departure tax will justify the tax costs and compliance costs resulting from continued operations within Canada.

The good news is that Canadian cryptocurrency traders and investors can avoid tax-planning blunders through early engagement of a Canadian crypto-tax lawyer. Our Certified Specialist in Taxation Canadian crypto-tax lawyer has assisted numerous Canadian cryptocurrency traders and investors with emigration crypto tax planning, thereby allowing them to reduce or avoid departure tax relating to cryptocurrency, NFTs, and other digital assets. Speak with one of our skilled Canadian crypto-tax lawyers today.

Frequently Asked Questions

What is departure tax?

When a taxpayer becomes a Canadian non-resident for tax purposes, paragraph 128.1(4)(b) of Canada's Income Tax Act deems that taxpayer to have disposed of certain types of properties at fair market value. This deemed disposition will cause the emigrating taxpayer to realize a taxable capital gain if the fair market value (at the time that the taxpayer ceased to be a Canadian tax resident) of the targeted property exceeds the taxpayer's tax cost (or ACB) for that property.

The tax liability relating to this deemed disposition is often called "departure tax." This departure tax essentially allows the Canada Revenue Agency to treat the targeted property as though the taxpayer had sold it at fair market value upon leaving Canada. The emigrating taxpayer must report the departure tax on the Canadian income-tax return for the tax year in which the taxpayer ceased to be a Canadian tax resident.

Does departure tax apply to cryptocurrency?

Generally, yes. In most cases, departure tax applies to cryptocurrency such as Bitcoin (BTC), Bitcoin Cash (BHC), Litecoin (LTC), Ethereum (ETH), Chainlink (LINK), Dash, Zcash (ZEC), and Ripple (XRP). As a result, a Canadian emigrant who owns cryptocurrency at the time of emigration will typically incur departure tax on that cryptocurrency portfolio.

I've heard that cryptocurrency, NFTs, and other digital assets may sometimes be exempt from departure tax. Is this correct?

Yes. Canada's Income Tax Act exempts certain properties from the deemed disposition underlying the departure tax. One category of exempt property is "property described in the inventory of a business carried on by the [emigrating] taxpayer through a 'permanent establishment' in Canada at the particular time."

Thus, an emigrating taxpayer's cryptocurrency may be exempt from the deemed disposition (and thus not subject to departure tax) if the following two conditions are satisfied:

The cryptocurrency qualifies as business inventory (e.g., inventory in a cryptocurrency-trading business); and
The emigrating taxpayer carried on that business through a "'permanent establishment' in Canada at the particular time."

To determine whether you qualify for this departure-tax exemption, consult one of our knowledgeable Canadian crypto-tax lawyers today.

Is it possible to rearrange my affairs so that I can reduce or avoid departure tax on my cryptocurrency holdings?

Yes, you may be able to reorganize your affairs before leaving Canada so that you may reduce or avoid the departure tax that would otherwise apply on your cryptocurrency holdings. We recommend that you begin the tax-planning process as early as possible by contacting a competent Canadian crypto-tax lawyer. You might, for example, satisfy the inventory exemption in subparagrap128.1(4)(b)(ii) of Canada's Income Tax Act by hiring employees or agents who will continue operating the cryptocurrency-trading business from a fixed place of business within Canada after you've left Canada. But if you go this route, your business income will remain taxable in Canada. So, you'll need to consider whether the tax savings from avoiding departure tax will justify the tax costs and compliance costs resulting from continued operations within Canada.

The good news is that Canadian cryptocurrency traders and investors can avoid tax-planning blunders through early engagement of a Canadian crypto-tax lawyer. Our Certified Specialist in Taxation Canadian crypto-tax lawyer has assisted numerous Canadian cryptocurrency traders and investors with emigration tax planning, thereby allowing them to reduce or avoid departure tax relating to cryptocurrency, NFTs, and other digital assets. Speak with one of our skilled Canadian crypto-tax lawyers today.

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