Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: 1) Assuming the Deposited Tokens and Receipt Tokens are held by the taxpayer on account of capital, do either of the following transactions result in a disposition for the taxpayer as defined in subsection 248(1) of the Act?
a) When the taxpayer deposits the Deposited Tokens into a liquidity pool on the XXXXXXXXXX platform; and
b) When the Receipt Tokens are sold or redeemed for the Deposited Tokens.
2) Assuming the Deposited Tokens and Receipt Tokens are held by the taxpayer on account of income in a business and have increased in value since their respective acquisitions by the taxpayer, should the taxpayer recognize income in the year relating to the following transactions?
a) When the taxpayer deposits the Deposited Tokens into a liquidity pool on the XXXXXXXXXX platform; and
b) When the Receipt Tokens are sold or redeemed for the Deposited Tokens.
3) Are the crypto-asset rewards received as consideration for depositing the Deposited Tokens on the XXXXXXXXXX platform included in the taxpayer’s income under sections 3 and 9 of the Act?
Position: 1) Question of fact: a) yes; b) yes.
2) a) Yes; b) yes.
3) Question of fact: yes.
Reasons: 1) Common law meaning of disposition, and none of the exclusions in the definition of “disposition” in subsection 248(1) apply.
2) General principles, and as stated in interpretation bulletin IT-490, a barter transaction results in income or expense.
3) Consistent with jurisprudence.
Élisabeth Daigneault Income Tax Rulings Directorate
Senior Programs Officer Joyce Fung, CPA, CA
Stakeholder Affairs and Technical Support Section
Digital Compliance and Audit Support Division
Compliance Programs Branch 2023-097307
March 20, 2024
Dear Ms. Daigneault:
Re: Crypto-asset transactions with a decentralized finance platform
This is in reply to your request sent on May 5, 2023 and revised on December 21, 2023, regarding the application of the Income Tax Act (hereinafter the “Act”) with respect to certain crypto-asset transactions entered into by an individual taxpayer with XXXXXXXXXX, (the “Platform”), a decentralized finance (“DeFi”) platform.
Unless otherwise noted, all statutory references herein are references to the Act.
Facts
Our understanding of the relevant facts is as follows (the facts are simplified for the purpose of this document):
1. The Platform is a “decentralized crypto liquidity aggregator” that aims to provide crypto-asset liquidity for DeFi applications.
2. The XXXXXXXXXX system relies on two types of crypto-assets native to the XXXXXXXXXX protocol:
a. XXXXXXXXXX (“Rtokens”) are only issued to liquidity providers (described below), in an automatic process as a “receipt token” for crypto-asset deposits made on the Platform. In a sense, these tokens represent a claim against the XXXXXXXXXX protocol. Rtokens are issued and redeemable on a 1:1 basis, and as such, the value of each Rtoken should normally reflect the value of the underlying crypto-asset. Rtokens are destroyed, or “burned”, when they are redeemed for their underlying crypto-assets.
b. XXXXXXXXXX (“Nativetoken”) is issued to both liquidity providers and liquidity directors (also described below) as a reward for their contributions to the Platform. Nativetoken allows a user of the platform to act as a liquidity director, and to participate in the governance of the Platform.
3. There are two main roles on the Platform, which are not mutually exclusive:
a. Liquidity providers deposit crypto-assets into the Platform’s “liquidity pool” of that crypto-asset type and receive redeemable Rtokens to evidence the deposit. As liquidity providers receive Nativetoken as a reward for providing liquidity (or if they separately acquire Nativetoken), they can also become liquidity directors. Liquidity providers that do not also take on the role of a liquidity director cannot influence or control how crypto-assets deposited with the Platform are used.
b. Liquidity directors can vote on where they want liquidity in the Platform to be allocated (i.e., which type of crypto-asset to deploy to which other DeFi application). The voting power given to a liquidity director is based on their pro rata portion of “staked” Nativetoken (i.e., Nativetoken locked by a smart contract and used as collateral to ensure the owner acts in a manner beneficial to the protocol). The liquidity directors’ collective votes have an impact on the liquidity providers’ liquidity rewards rates.
4. Rewards for deposits accrue to the crypto-asset wallet where the Rtokens are held.
5. Rtokens are transferable, along with the ability to claim the underlying deposited assets and earn rewards for the deposited assets.
6. Nativetoken are also transferable. Through decentralized exchanges (“DEXs”) such as SushiSwap and UniSwap, it is possible to exchange Nativetoken for other crypto-assets.
7. If there is a shortage of an asset type on the Platform, a “bailout mechanism” is activated, which is designed to minimize the liquidity providers’ risk of investment loss.
Taxpayer’s transactions
8. The taxpayer is an individual resident in Canada for tax purposes, and is a resident of the province of XXXXXXXXXX.
9. In XXXXXXXXXX, the taxpayer deposited XXXXXXXXXX (“XLP”) and XXXXXXXXXX (“YLP”) crypto-assets (collectively, the “Deposited Tokens”) into liquidity pools on the Platform, in exchange for which the taxpayer received XXXXXXXXXX (“1LP”) and XXXXXXXXXX (“2LP”) tokens, respectively, on a 1:1 basis (collectively, the “Receipt Tokens”).
10. In XXXXXXXXXX, the taxpayer redeemed 1LP and 2LP for XLP and YLP. As discussed above, the 1LP and 2LP tokens were burned upon the redemptions. Based on the timeline of the Platform, the taxpayer exited from the platform during its “yield farming” phase and before liquidity deployment began on XXXXXXXXXX.
11. For the duration that his XLP and YLP crypto-assets were deposited with the Platform, the taxpayer received rewards in the form of Nativetoken (“Rewards”). Based on the timing and type of assets deposited, the taxpayer should have accrued daily Nativetoken rewards based on his proportion of XLP and YLP tokens staked in each of the respective pools.
12. It is assumed that any Nativetoken rewards accrued by the taxpayer should only have related to his deposits of the Deposited Tokens, and not to any governance or voting activities.
13. At the times of the redemptions, the market values of XLP and YLP had increased compared to their respective values at the time that they were originally deposited into the Platform.
14. The taxpayer has not filed any elections regarding his crypto-assets with respect to the XXXXXXXXXX taxation year, including an election under section 10.1, if applicable.
Issues
You have asked for our opinion on the following issues:
1. Assuming the Deposited Tokens and Receipt Tokens are held by the taxpayer on account of capital, do either of the following transactions result in a disposition for the taxpayer as defined in subsection 248(1) of the Act?
a. When the taxpayer deposits the Deposited Tokens into a liquidity pool on the Platform; and
b. When the Receipt Tokens are sold or redeemed for crypto-assets of the same type as the Deposited Tokens.
2. Assuming the Deposited Tokens and Receipt Tokens are held by the taxpayer on account of income in a business and have increased in value since their respective acquisitions by the taxpayer, should the taxpayer recognize income in the year relating to the following transactions?
a. When the taxpayer deposits the Deposited Tokens into a liquidity pool on the Platform; and
b. When the Receipt Tokens are sold or redeemed for crypto-assets of the same type as the Deposited Tokens.
3. Should the Rewards received as consideration for depositing the Deposited Tokens on the Platform (referred to by the Platform as yield farming or liquidity mining) be included in the taxpayer’s income under sections 3 and 9 of the Act?
The facts and information provided with respect to the taxpayer’s file do not allow us to conclusively determine the exact legal nature of the transactions in which he was engaged. Despite this, it is our view that the facts and information provided by the taxpayer are sufficient for the CRA to provide the comments below. It is important to note, however, that given the large variety of arrangements and mechanisms that exist in the DeFi area, these comments may only apply to the situation described above.
CRA response to question 1
For the purposes of the Act, the definition of “disposition” in subsection 248(1) is not exhaustive. As such, in addition to the specific inclusions and exclusions listed in the definition in subsection 248(1), the common law concept of a disposition generally applies.
In document 2014-0525191E5, the CRA has previously taken the position that an exchange of one type of virtual currency for another would trigger a disposition for income tax purposes.
Based on the limited facts available, we are of the view that the taxpayer’s deposit of the Deposited Tokens into a liquidity pool on the Platform, and sale or redemption of the Receipt Tokens for the Deposited Tokens, are dispositions of the Deposited Tokens and Receipt Tokens, respectively, under subsection 248(1) of the Act.
CRA response to question 2
The question of whether the taxpayer realizes a profit or loss in the year a crypto-asset is exchanged or sold is dependent on how profit is calculated in accordance with the Act.
“Profit” is not defined in the Act but has been considered by the courts. In Canderel v. R., [1998] 1 S.C.R. 147, the Supreme Court of Canada laid out principles for determining profit. In particular, the court determined that any method that can provide an accurate picture of the taxpayer’s profit for the given year can be employed, as long as it is not inconsistent with the provisions of the Act, rules of law (i.e., case law), and well-accepted business principles.
One such method is the “realization principle”. While it is not a rule of law, it has historically been a well-accepted general principle and is consistent with the longstanding approach of the CRA with respect to barter transactions, as outlined in paragraphs 3 and 4 of interpretation bulletin IT-490, Barter Transactions:
3. A barter transaction is effected when any two persons agree to a reciprocal exchange of goods or services and carry out that exchange usually without using money. […]
4. The Department takes the view that barter transactions are within the purview of the Income Tax Act. Such transactions can therefore result in income or expense as contemplated by sections 3 and 9 thereof or can result in the acquisition or disposition of capital property, eligible capital property, personal-use property or inventory, depending upon the circumstances of the persons who are bartering and the nature of that which is bartered, on the same basis as if cash was the consideration.
In our view, and consistent with the aforementioned document 2014-0525191E5, a deposit of the Deposited Tokens, redemption of the Receipt Tokens, and sale of the Receipt Tokens for goods constitute barter transactions in accordance with interpretation bulletin IT-490. As such, the taxpayer should recognize income in the year in which each such transaction took place.
Similarly, if the taxpayer sold the Receipt Tokens in exchange for money, the realization principle should typically apply such that the transaction is a taxable event and, again, should result in the recognition of income by the taxpayer for the year.
CRA response to question 3
The Supreme Court of Canada in Stewart v. Canada, 2002 SCC 46, established a two-stage approach to determine whether a taxpayer’s activities constitute a source of business or property income: (i) Is the taxpayer’s activity undertaken in pursuit of profit, or is it a personal endeavour? (ii) If it is not a personal endeavour, is the source of income a business or property? Where the nature of an activity is clearly commercial, the taxpayer’s pursuit of profit is established.
Although it is not clear based on the limited facts submitted whether the Rewards received by the taxpayer should constitute income from property or from a business, we are of the view that such Rewards do constitute profit of the taxpayer that are subject to tax under sections 3 and 9 of the Act. Indeed, the nature of the activities described appears to be commercial. As such, the Rewards should be included in the computation of the taxpayer’s income.
For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency’s electronic library. After a 90-day waiting period, a severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. You may request an extension of this 90-day period. The severing process removes all content that is not subject to disclosure, including information that could reveal the identity of the taxpayer. The taxpayer may ask for a version that has been severed using the Privacy Act criteria, which does not remove taxpayer identity. You can request this by e-mailing us at: ITRACCESSG@cra-arc.gc.ca. A copy will be sent to you for delivery to the taxpayer.
We trust our comments will be of assistance.
Yours truly,
Charles Dumas
Section Manager
for Division Director
Specialty Tax Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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