Last month saw Canada’s first-ever Bitcoin Expo, with more than 300 enthusiasts attending the Toronto event. The core of the Bitcoin community is made up of cryptologists, hackers and other denizens of the tech world.
Still, virtual currencies seem poised to enter the mainstream, so governments and regulators have been paying more attention. Does Bitcoin have a place in the world of financial products and services for retail investors?
Virtual currencies exist in between technology and investment products. They’re neither money nor securities, and for now are generally unregulated.
Unregulated products, particularly ones with eye-popping price volatility, often attract a lot of press—as well as people with more greed than sense. In response, securities regulators are issuing warnings directed at investors and their advisors.
Quebec’s Autorité des marchés financiers (AMF) put out a consumer alert in February warning that virtual currencies aren’t covered by government deposit insurance or any industry compensation fund. It also cautioned about a heightened risk of fraud. The OSC’s Office of the Investor has also posted a warning and invited readers to report any violations of securities law involving currencies.
In the U.S., the SEC’s Office of Investor Education and Advocacy has linked virtual currencies to Ponzi schemes and investment fraud. FINRA has also issued a fraud warning, and cites the “significant risk” associated with speculative investment in virtual currencies.
Regulators consider Bitcoin and other virtual currencies more like commodities than securities. Consider that, under current regulations, futures and options contracts to exchange value based on commodities can be derivatives or securities. For instance, a futures contract on a physical commodity, such as oil or orange juice concentrate, is a derivative. And a scheme that promises to provide a return from investments in commodities can be considered to be an investment contract, which is a security. But transacting in the commodity itself is not trading in a security. So, buying and selling Bitcoin or other virtual currencies via ATM, for instance, does not trigger securities legislation.
But, if you were to offer to invest a client’s money in Bitcoin and take some form of compensation, that could be considered an investment contract and subject you to securities laws.
Read: Inside Bitcoin trading
Another regulator interested in virtual currency transactions is FINTRAC, which administers and enforces Canada’s anti-money laundering (AML) rules.The agency also oversees Money Service Businesses (MSBs). These are primarily remittance services, such as Western Union; foreign exchange services; and dealers in foreign currencies.
FINTRAC’s stated that, under current law, it has no jurisdiction over transactions in virtual currencies because these currencies are not legal tender. You can’t, for example, pay your taxes in Bitcoin. So, virtual currencies are considered property rather than money.
But this year’s federal budget announced proposals that would make dealers in Bitcoin and other virtual currencies MSBs. Once this becomes law, businesses exchanging Bitcoin for loonies and vice versa will be treated by FINTRAC as if they were exchanging loonies for euros, and will therefore be subject to the AML regime that applies to all MSBs.
For all the recent turmoil and negative press involving Bitcoin, it’s unlikely virtual currencies will prove a passing fad. And as they move into the mainstream, more questions will arise. For example, if Bitcoin is a commodity rather than a security, then an exchange (like the departed Mt. Gox) will not be subject to supervision by securities regulators, since it by definition cannot be a securities exchange.
Advisors are prohibited from conducting business that isn’t securities-related, subject to limited exceptions. MFDA members may, for instance, sell deposit instruments off-book, even though deposits aren’t securities. Since Bitcoins aren’t securities, yet aren’t carved out of the prohibition against non-securities business, advisors generally won’t be able to offer them to clients or deal in them as intermediaries.
And, given dire warnings from regulators, advisors will need some intestinal fortitude to venture, however cautiously, into the world of virtual currencies.
Even so, exploring Bitcoin and other virtual currencies may well reward those who do. Such currencies, and the platforms on which they operate, are significant technological advances, and are likely here to stay.
How CRA taxes Bitcoins
In November 2013, Canada Revenue Agency issued a fact sheet reminding taxpayers of reporting requirements when using digital currencies, often called cryptocurrency.
Here’s how it works.
We’re required to calculate and report taxes in Canadian dollars. Where business or investments have been transacted in other currencies, there must be a conversion back into Canadian dollars. With traditional currencies, there are published exchange rates with other central banks to facilitate this process. Though there are online exchanges that will quote digital currencies in Canadian dollars, these are not directly recognized for tax purposes.
Instead, CRA considers these types of transactions to fall under barter rules. The value of the exchange is fair market value in Canadian dollars, on the same basis as if cash was the consideration. Apart from being used in exchange for goods and services, digital currencies can also be bought and sold as commodities.
Depending on who is involved and how the transaction is carried out, the tax treatment may be as: current income or expenses; acquisition or disposition of capital property; eligible capital property (goodwill); personal-use property; or inventory.
– Doug Carroll, JD, LLM (Tax), CFP, TEP, is vice-president, Tax and Estate Planning, Invesco Canada.
Susan Han is associate counsel in the Business Law Group of Miller Thomson in Toronto. firstname.lastname@example.org
Originally published in Advisor's Edge Report
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