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More Guidance from the CRA on Bitcoin Activities and Transactions

Following the recent IRS publication on the U.S. tax treatment of bitcoin activities and transactions, the CRA has issued further guidance on the Canadian tax issues arising in respect of the virtual currency.

In CRA Document No. 2014-052511E5 “Virtual Currencies (Bitcoins)” (March 28, 2014), the CRA was asked several questions about bitcoin activities and transactions (not all of the underlying facts are described in the technical interpretation, but we can infer what the taxpayer asked from the responses provided by the CRA).

Bitcoin Mining Business?

In respect of bitcoin “mining“, the CRA noted the difference between business and personal activities. In Stewart v. The Queen (2002 SCC 46) the Supreme Court of Canada stated that an activity may be commercial in nature if the taxpayer had a subjective intention to profit and there was evidence of business-like behaviour supporting such intention. Whether a particular activity is undertaken for profit is a question of fact that can only be determined on a case by case basis. The CRA stated that, in this case, the taxpayer appeared to be operating a bitcoin mining business.

If a taxpayer mines bitcoins in a commercial manner, the taxpayer’s income for the year will be determined with reference to the property in the taxpayer’s inventory at the end of the year. The rules for determining the value of inventory are described in section 10 of the Income Tax Act and Part XVIII of the Income Tax Regulations, and in most cases will be either (i) the value of the inventory at the end of the year at its cost or fair market value (whichever is lower) or (ii) the value of the inventory at the end of the year at its fair market value (this requires a determination of whether or not the business activity is an adventure or concern in the nature of trade). In certain cases, other methods of valuing inventory may be available (see Interpretation Bulletin IT-473R “Inventory Valuation” (December 21, 1998)).

Theft / Losses

The CRA also noted that a loss of trading assets (i.e., inventory or cash) through theft or embezzlement is normally deductible in computing income from a business if such losses are an inherent risk of the business and the loss is reasonably incidental to the business activities. The amount of the loss would be the cost of the property less any insurance proceeds. Stolen capital property may result in a capital loss (see Interpretation Bulletin IT-185R “Losses from Theft, Defalcation or Embezzlement” (March 9, 2001)). This is interesting, given the recent difficulties encountered by the Mt. Gox bitcoin exchange, which in February 2014 discovered a theft of more than 700,000 of its bitcoins.

Gifts / Other Income

The CRA added that a gift of a virtual currency would not be subject to income tax in the hands of the recipient (see Interpretation Bulletin IT-334R2 “Miscellaneous Receipts” (February 21, 1992)). However, where a taxpayer receives a voluntary payment from an employer or another person in connection with employment, the payment may be taxable as employment income under section 5 or as a taxable benefit under paragraph 6(1)(a) of the Income Tax Act. Further, voluntary payments received in connection with a business must be included in the taxpayer’s income from that business.

Barter Transactions

Finally, the CRA stated that, where one type of virtual currency is exchanged for another type of virtual currency, the value of the goods or services received by the taxpayer must be brought into the taxpayer’s income if they are business-related (see Interpretation Bulletin IT-490 “Barter Transactions” (July 5, 1982)).

The CRA suggested that Canadian taxpayers should review the CRA’s fact sheet, “What you should know about digital currency” (November 2013).

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More Guidance from the CRA on Bitcoin Activities and Transactions

IRS: Bitcoin Not a Currency for Tax Purposes

As expected, the U.S. Internal Revenue Service has provided some guidance on the U.S. tax treatment of Bitcoin.

In Notice 2014-21 (March 25, 2014), the IRS stated that Bitcoin is property and not currency for tax purposes.  According to the Notice, “general tax principles applicable to property transactions apply to transactions using virtual currency.”  Some of the U.S. tax implications of Bitcoin include the following: (1) taxpayers receiving Bitcoins as payment for goods or services must include in their gross income the fair market value of the Bitcoins; (2) taxpayers will have a gain or loss upon the exchange of Bitcoins for other property; and (3) taxpayers who “mine” Bitcoins must include the fair market value of the Bitcoins in their gross incomes.  The IRS also confirmed in its statement that employment wages paid in Bitcoins are taxable.

This guidance from the IRS accords with the positions taken by tax authorities in other jurisdictions.

Commentators have considered the tax implications of Bitcoin in Canada both before and after the CRA released its most recent guidance in CRA Document No. 2013-0514701I7 “Bitcoins” (December 23, 2013).

The Canadian government has taken the position that Bitcoin is not legal tender. The Canada Revenue Agency has stated that, when addressing the Canadian tax treatment of Bitcoin, taxpayers must look to the rules surrounding barter transactions and must consider whether income or capital treatment arises on Bitcoin trading (i.e., speculating on the changes in the value of Bitcoins).

While Bitcoin currency exchanges encounter uncertainty (or fail entirely), and Bitcoin prices continue to fluctuate, the global tax implications of Bitcoin are becoming clearer.

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IRS: Bitcoin Not a Currency for Tax Purposes

Federal Court of Appeal dismisses taxpayer’s appeal in Morguard: Trial judge made no error in concluding that a “break fee” was income

The Federal Court of Appeal has dismissed the taxpayer’s appeal in Morguard Corporation v The Queen.

(See our previous posts on the case here, here and here.)

Justice Sharlow wrote for the panel which also included Justice Evans and Justice Stratas.  She agreed with the reasoning of the trial judge that Ikea Ltd. v. Canada is indeed the leading case on the characterization of extraordinary or unusual receipts in the business context, and found that his application of the principles stated by the Supreme Court of Canada in Ikea was correct. The court noted that Ikea was not based on a particular factual finding, but “involved consideration of a number of factors, including the commercial purpose of the payment and its relationship to the business operations of the recipient.”

The Court of Appeal found that the trial judge made no error in concluding, on the facts of the case, that the break fee received by Morguard as the result of a failed takeover bid was income and not capital. The appeal was dismissed with costs.

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Federal Court of Appeal dismisses taxpayer’s appeal in Morguard: Trial judge made no error in concluding that a “break fee” was income

Federal Court of Appeal hears argument on whether “break fees” are income (Morguard)

Is a “break fee” received in return for withdrawing from a takeover bid a capital receipt or an income receipt?

That was the issue before a panel of the Federal Court of Appeal (“FCA”) on November 20, 2012 in Morguard Corporation v. The Queen on appeal from a decision of the Tax Court of Canada. The panel consisted of Justice Evans, Justice Sharlow and Justice Stratas. At the conclusion of the hearing, judgment was reserved.

For the facts of the case and our analysis of the trial decision, see here. For a brief review of the issues raised in the factum filed by each party in the FCA, see here.

Arguments of the Taxpayer

Counsel for the appellant argued the trial judge had made an “error of law” in determining that Acktion Corporation (“Acktion”) was “essentially in the business of doing acquisitions and takeovers” (Acktion was the name under which Morguard Corporation (“Morguard”) operated during the period at issue). Counsel argued that Acktion was a holding company and that it had sought the takeover to increase its capital holdings. The standard of review for an error of law is “correctness”.

The panel asked counsel whether there was any error of law. Justice Stratas asked whether the issue was really a factual one, for which the standard of review is much higher, namely, “palpable and overriding error”.

Counsel argued that it is settled law that a corporation cannot conduct a “business” of acquiring capital assets. Accordingly, counsel argued that the trial judge erred in concluding that Acktion had done so. In support of this proposition, counsel cited the 1978 FCA decision in Neonex International Ltd. v The Queen (78 DTC 6339). 

It was not clear whether the panel agreed with counsel on this point, as their other questions focused on whether the Supreme Court of Canada (“SCC”) decision in Ikea Ltd. v. Canada ([1998] 1 SCR 196) had displaced Neonex by instituting a “modern approach” that supports an organic assessment of the circumstances around the receipt.

Counsel argued the break fee was received in the pursuit of a capital acquisition and that, according to the modern approach, it should be characterised as a capital receipt. Counsel stressed that the expert evidence adduced at trial by both parties was that break fees are intended to support the acquisition of capital by deterring other bidders or to compensate for the various costs incurred in a failed takeover bid.

The panel sought clarification of the appellant’s position that there should be no tax liability arising from the receipt of the break fee. In its written submissions, the appellant argued that the break fee should not be taxed as a capital gain because there were no proceeds of disposition. Justice Sharlow noted that, according to this theory, the break fee could only be characterized either as income or a non-taxable capital gain.

Arguments of the Crown

Counsel for the Crown had to answer fewer questions from the panel. Counsel argued that the characterization of an “unusual receipt” such as a break fee requires a factual determination (relying on the SCC’s decision in Ikea on this point), which the Tax Court had made in this case.

Justice Evans asked about the distinction between conducting a real estate business that acquires companies as capital and being a real estate company in the business of acquisitions and takeovers. Counsel argued that, instead of acquiring real estate directly, Acktion’s business strategy was to acquire businesses that already owned real estate. Counsel further submitted that the corporate information distributed to its shareholders described the corporation as a real estate company and not as a holding company.

Justice Sharlow questioned the Crown’s reliance on the commercial description of Acktion’s business, noting that the technical distinction between income and capital is a legal distinction that would not generally be expected to appear in a commercial context. In response, counsel argued that Acktion treated the takeover bid as part of its regular business. After losing its takeover bid, Acktion negotiated a higher price for its remaining “toehold” in the company, then took the break fee and the proceeds of disposition of its shares and immediately sought to purchase another business. Counsel argued this course of conduct shows that Acktion considered the negotiation of break fees to be part of its real estate business.

In response to the appellant’s position that the break fee was a non-taxable capital gain, counsel submitted that the trial judge was correct in applying the factors set out by the FCA in Canada v. Cranswick ([1982] CTC 69) to determine whether a payment was a windfall. In this respect, the break fee was the product of an enforceable claim negotiated by the Appellant according to common practices in takeover bids and, thus, could not be characterised as a windfall.

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The panel reserved judgment. We will report on the judgment when it is released.

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Federal Court of Appeal hears argument on whether “break fees” are income (Morguard)

Supreme Court of Canada declines to hear an appeal on whether an expenditure in the course of a corporate reorganization was on capital or income account

Earlier today, the Supreme Court of Canada (The Chief Justice, Justice Rothstein and Justice Moldaver) dismissed an application for leave to appeal by Imperial Tobacco dealing with the classic distinction between deductible corporate expenditures on income account and non-deductible corporate expenditures on capital account. 

In brief, the taxpayer made a payment to extinguish an employee stock option plan (suggesting that the payment was made on income account) but made the payment during the course of a corporate reorganization (suggesting that the payment was made on capital account). 

The taxpayer’s argument for deductibility was supported by the Tax Court decision in Shoppers Drug Mart Limited v. The Queen (dealing with the very same transaction) while the Crown’s argument for non-deductibility was supported by the earlier Federal Court of Appeal decision in Kaiser Petroleum Ltd. v. The Queen.  

Both the Tax Court of Canada and Federal Court of Appeal followed the reasoning of the Federal Court of Appeal in Kaiser and sided with the Crown, holding that the payment was on capital account.  The decision of the Federal Court of Appeal is now final and binding.

For a brief description of the reasoning of the Federal Court of Appeal, see our earlier blog post.

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Supreme Court of Canada declines to hear an appeal on whether an expenditure in the course of a corporate reorganization was on capital or income account

Morguard Corporation v. The Queen – When will a “break fee” be considered income?

In Morguard Corporation v. The Queen, 2012 TCC 55, Justice Boyle of the Tax Court of Canada considered whether a “break fee” received by a predecessor of the Appellant (for the purposes of this discussion, the “Appellant”) in respect of its unsuccessful attempted acquisition of a public corporation, was received on account of income or capital (there was also a procedural issue that will not be discussed in this post).  Based on the approach set out in Ikea Ltd. v. Canada, [1988] 1 SCR 196, 98 DTC 6092, affirming 96 DTC 6526 (FCA) and 94 DTC 1112 (TCC), Justice Boyle concluded that, on the facts, a break fee such as the one received by the Appellant was taxable on account of income because the negotiation and inclusion of break fees in the Appellant’s acquisition agreements was an integral part of its commercial business operations and activities. 

The relevant facts in this case are quite simple. In early 1997, the Appellant commenced implementation of its business strategy of assembling direct or indirect ownership of, or controlling positions in, real estate companies.  As a result of this business strategy, the Appellant acquired large/controlling interests in a number of real estate companies. 

In 1998, the Appellant acquired 19.2% of Acanthus Real Estate Corporation (“Acanthus”).  In June 2000, the Appellant made a hostile take-over bid for all of the remaining shares in Acanthus at a purchase price of $8.00, thereby increasing its position to 19.9%.  Following negotiations between Acanthus and the Appellant, the parties entered into a pre-acquisition agreement in order to give support and deal protection to the Appellant and the bid.  Pursuant to this pre-acquisition agreement, it was agreed that the Appellant would acquire all the outstanding shares of Acanthus at a purchase price of $8.25 per share and that Acanthus would, inter alia, pay a break fee of $4.7 million to the Appellant if a better bid was received and accepted by Acanthus.

On June 29, 2000, Acanthus received an unsolicited bid from a third-party (the “Third-Party”) for all of the outstanding shares of Acanthus at a purchase price of $8.75.  Attempting to thwart the Third-Party bid, the Appellant increased its bid to $9.00 per share on July 2, 2000.  At that time, the Appellant and Acanthus entered into an amending agreement (the “Amending Agreement”) to the original pre-acquisition agreement, pursuant to which a superior offer from a third-party would need to be for at least $9.30 per share and the break fee was increased to $7.7 million. 

Ultimately, Acanthus accepted an offer from the Third-Party for $9.40 and the Appellant chose not to match the offer.  Consequently, the Amending Agreement was terminated and Acanthus paid the Appellant the $7.7 million break fee.  In addition to the $7.7 million break fee (the “Break Fee”), the Appellant realised a gain of $4.8 million on the sale of its shares of Acanthus.

The Appellant argued that the Break Fee was a capital receipt and therefore should not be taxable because it was not received in respect of a disposition of property (i.e. no property was actually disposed of).  Critical to the Appellant’s argument was, the fact that (a) the Break Fee was received in relation to the acquisition of shares of Acanthus, which was a capital investment, and (b) the receipt of the Break Fee was the only time the Appellant had ever received a break fee in attempting to implement its real estate company acquisition strategy. 

After dismissing the Appellant’s “windfall” argument, Justice Boyle noted that Ikea is the leading modern case on the characterization of extraordinary or unusual receipts in the business context.  In that case, the taxpayer sought to assemble long-term leaseholds from which to operate its business.  In doing so, the taxpayer received a “tenant inducement payment” which it treated on capital account because the payment was received in respect of a long-term lease, which is capital in nature.  All levels of court found that the receipt was on income account because the leaseholds were necessary to the business of the taxpayer and they were a necessary incident to the conduct of the taxpayer’s business.  Consequently, the capital purpose (assembling long-term leaseholds) was not the relevant link to be considered. 

Citing the reasons for Judgment in the Tax Court of Canada in Ikea, Justice Boyle noted, at paragraph 43, that Justice Bowman was correct in finding “that the payment was clearly received and inextricably linked to [the taxpayer’s] ordinary business operations, and further that no question of linkage to a capital purpose could even be seriously entertained.”  In this case, Justice Boyle found that break fees were expected incidents of the Appellant’s business strategy of entering into acquisition agreements with real estate corporations, regardless of how unusual the receipt of such a payment may be and, therefore, the Break Fee was an amount received in the course of the Appellant’s business and commercial activities.  Consequently, the receipt of the Break Fee by the Appellant was on account of income.

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Morguard Corporation v. The Queen – When will a “break fee” be considered income?