The Financial Consumer Agency of Canada, [FCAC], an independent agency of the Government of Canada, in a communique to the public affirmed the usage of cryptocurrencies for regular purchases and for trades on cryptocurrencies exchanges. However, it emphasized that cryptocurrencies are not a “legal tender”, i.e. officially issued fiat currencies.
Additionally, FCAC warned the public of the risks associated with the usage of cryptocurrencies. Mainly, that they offer fewer protections, deposits are not insured, they are high-risk investments, that they have higher exposure to fraudulent actions and that the transactions are irreversible.
Regardless of such warning, no specific law was issued to address the cryptocurrency’s realm. That is not surprising as most countries are yet to issue laws specific to the blockchain and cryptocurrencies.
This new innovative area, the Distributed Ledge Technology and all its applications, and the potential it brings is yet to fully unfold. Thus, legislatures are most likely balancing between allowing entrepreneurs the needed space to grasp the full potential of the technology and protecting the general public and consumers from the risks associated with the innovation process. The standing senate committee on banking, trade, and commerce stated this in its report “digital currency: you can’t flip this coin!”
That being said, several existing laws remain applicable to cryptocurrencies in Canada.
Securities Law regulates ICOs
Securities are governed by provincial and territorial acts. Yet, the Canadian Securities Administrators (CSA) brought the rules closer together.
Securities are typically defined to include any investment contract (e.g. Ontario, and British Columbia). This is similar to the approach the USA undertakes. Even the test applied by the Supreme Court of Canada in Pacific coin to examine the existence of an investment contract is almost identical to the Howey test applied by the US Supreme Court as the Supreme Court of Canada cited the Howey case in its ruling.
Under Pacific Coin, an investment contract exists when there is:
- An investment of money
- in a common enterprise
- with the expectation of profit
- that comes significantly from the efforts of others.
Accordingly, if a coin or token is deemed to be an investment contract, in Ontario for example, then Securities’ regulations will apply to the coin offering. In fact, in August 2017 the CSA published CSA Staff Notice 46-307 “Cryptocurrency Offerings” which outlines how securities law requirements may apply to initial coin offerings (ICOs), initial token offerings (ITOs), cryptocurrency investment funds and the cryptocurrency exchanges trading these products.
In its press release, the CSA states that “[t]he notice describes the factors CSA staff consider in assessing whether prospectus, registration and marketplace requirements apply. It also outlines how the [CSA Regulatory Sandbox] can help Fintech businesses contemplating such offerings and summarizes key issues that businesses should be prepared to discuss with CSA staff.”
The prospectus requirement can be exempted under Section 2.3 of National Instrument 45-106 Prospectus Exemptions (NI 45-106) if the coins are being sold to investors who qualify as “accredited investors” as defined under securities laws or based on an offering memorandum prospectus exemption for retail investors who do not qualify as accredited investors.
The registration is required for completing trade in securities for business purposes. Actually, the CSA found the following factors as important considerations for whether a person or company is trading in securities for a business purpose:
- “Soliciting a broad base of investors, including retail investors;
- Using the internet, including public websites and discussion boards, to reach a large number of potential investors;
- Attending public events, including conferences and meetups, to actively advertise the sale of the coins/tokens; and
- Raising a significant amount of capital from a large number of investors.”
As for the market place requirement, the CSA stated that:
A cryptocurrency exchange that offers cryptocurrencies that are securities must determine whether it is a marketplace. Marketplaces are required to comply with the rules governing exchanges or alternative trading systems. If an exchange is doing business in a jurisdiction of Canada, it must apply to that jurisdiction’s securities regulatory authority for recognition or an exemption from recognition. To date, no cryptocurrency exchange has been recognized in any jurisdiction of Canada or exempted from recognition.
Tax Laws apply to cryptocurrencies
FCAC stated in its above-mentioned report that Canadian tax laws apply to cryptocurrencies transactions. Furthermore, CRA, [Canadian Revenue Agency] issued a Guide for cryptocurrency users and tax professionals where it started by stating that it
generally treats cryptocurrency as a commodity for purposes of the Income Tax Act.
This means that taxation will be applied based on how the person or business interacts with the crypto realm.
Thus, if a person uses cryptocurrencies to purchase products, for example, the rules of barter transactions would apply.
However, if the person is trading in cryptocurrencies, then any gains or losses will be taxed as income or capital. According to lawyers from the law firm Gowling WLG,
Where a taxpayer does not engage in the business of trading in cryptocurrency […] any gain or loss generated from the disposition of cryptocurrency should be treated as on account of capital. However, where a taxpayer engages in the business of trading or investing in cryptocurrency, gains or losses therefrom should be treated as being on account of income.
Concerning mining cryptocurrencies, the CRA Views 2014-0525191E5 stated that the taxpayer’s end-year inventory value is the determining factor on whether the mining activity will be treated as a taxable business or non-taxable hobby.
Anti-Money Laundering regulations will apply to cryptocurrencies
A few decades ago, the world started paying more attention to fighting criminals who disguise illegal proceeds through legitimate businesses and transaction. Thus, was the evolvement of Anti-Money Laundering (AML) regulations. Those measures were expanded later on to include fighting terrorism.
Money laundering is a federal crime in Canada under Section 462.31 of the criminal code. Furthermore, certain obligations are imposed on financial institutions and certain businesses under the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA). Those obligations include compliance, assessment, ongoing monitoring, and reporting.
FINTRAC [Financial Transactions and Reports Analysis Centre of Canada] is responsible for the compliance and enforcement of the PCMLTFA on a federal level.
When it comes to the crypto realm, the PCMLTFA does not apply in its current version. The government has introduced amendments to the PCMLTFA that would render its scope applicable to virtual/crypto securities. Those amendments obtained the royal assent on June 2014 but are yet to enter into force.
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Disclaimer: This is an article, not a legal opinion nor legal advice.