Tax Planning

Canadian Cryptocurrency Tax Planning: Transferring Cryptocurrency To A Naked Trustee Or Holding Cryptocurrency As A Naked Trustee – Canadian Tax Steerage From A Canadian Tax Lawyer – Tax

Introduction: Bare Trusts & Canadian Cryptocurrency
Users

The developments in blockchain technology bring about an
ever-increasing range of opportunities, arrangements, and
assets-smart contracts, cryptocurrency liquidity mining and yield
farming, and non-fungible tokens (NFT), to name a few. A bare-trust
agreement may offer yet another layer of flexibility for Canadian
cryptocurrency traders and blockchain investors.

This article is meant for cryptocurrency-savvy Canadians who may
benefit from settling a bare trust concerning their
blockchain-based assets and who seek to understand the notion of a
bare trust. This article discusses three key topics concerning a
bare-trust relationship-namely, its nature, its relevance for
Canadian tax purposes, and the indicia proving its existence. This
article concludes by offering pro tax tips from our top Canadian crypto tax lawyers to Canadian
cryptocurrency users who have created or who seek to create a bare
trust.

What is a Trust and What is a Bare Trust?

The trust concept finds its roots in equity, a body of law
developed in the English Court of Chancery and adopted by Canadian
courts. Equity distinguishes legal ownership from beneficial
ownership. A person legally owns a property if his or her
name is on title, yet the beneficial owner is “the
real owner of property even though it is in someone else’s
name.” (Csak v Aumon, [1990] 69 DLR (4th) 567 (Ont.
HCJ), at p. 570.)

A trust, then, is a relationship between a trustee, a
beneficiary, and a property. And it depends on the distinction
between beneficial and legal ownership: the trustee legally owns
the property; the beneficiary (unsurprisingly) beneficially owns
the property.

The trust’s creator (also known as the settlor) will often
burden the trustee with duties to maintain or manage the trust
property in the beneficiary’s favour. For instance, the settlor
might require that the trustee manage a large sum of money,
cryptocurrency, or non-fungible tokens for a child or disabled
beneficiary.

A bare trust, however, is a trust in
which the trustee has no obligations other than to deal with the
trust property in compliance with the beneficiary’s directions.
In other words, under a bare trust, the beneficiary retains
complete control over the trustee’s dealings with the trust
property.

As such, a bare trust is primarily an agency
relationship whereby the bare trustee holds title to property
as the beneficiary’s agent. An agency relationship
exists where parties agree that one person (the agent) shall act in
accordance with the directions of the other (the principal). Hence,
a bare trust arises when parties agree that one person (the bare
trustee) shall act in accordance with the directions of the other
(the beneficiary) with respect to a property (the trust property).
The trust property is, of course, the property over which the
beneficiary enjoys true ownership but to which the bare trustee
holds legal title.

How Is a Trust Taxed in Canada?

Although a trust is a relationship between entities and not
itself an entity, Canada’s Income Tax Act treats a
trust as a separate taxpayer. Subsection 104(2) of Canada’s
Income Tax Act deems a trust to be an individual for
income-tax purposes. This means that a trust must file a T3 trust
income-tax return each taxation year. It also means that the
settlement of a trust constitutes a disposition of the trust
property to the trust, and the settlor may thereby trigger capital-gains tax.

Moreover, if the trust itself earns income, it pays Canadian
income tax at the top marginal tax rate on the income remains in
the trust. The trust may claim a deduction for the income that it
pays to a beneficiary. The beneficiary accordingly pays tax on
amounts received from the trust.

A trust that qualifies as a graduated-rate estate (GRE)
doesn’t incur top-rate tax on its income; a GRE’s income is
taxed at progressive rates. A “graduated-rate estate”
basically refers to a deceased person’s estate during the 36
months after that person’s death.

A trust must also realize all accrued capital gains for
income-tax purposes every 21 years. Subsection 104(4) of
Canada’s Income Tax Act deems a trust to have disposed
of all capital property at fair market value every 21 years. (For
spousal trusts, alter ego trusts, and joint
spousal trusts, this deeming rule doesn’t apply during the
lifetime of the qualifying beneficiary. Instead, the deemed
disposition occurs upon that beneficiary’s death, and, if the
trust continues, every 21 years thereafter.)

How Is a Bare Trust Taxed in Canada?

Canada’s income-tax law ignores the bare trustee. Although
subsection 104(2) of Canada’s Income Tax Act deems a
trust to be an individual for income-tax purposes, this deeming
rule doesn’t apply to “an arrangement under which the
trust can reasonably be considered to act as agent for all the
beneficiaries under the trust with respect to all dealings with all
of the trust’s property” (see: subsection 104(1)). As a
result, if a person retains beneficial ownership of cryptocurrency,
non-fungible tokens, or other blockchain assets while transferring
legal title to a bare trustee-e.g., by transferring the assets to
the bare trustee’s wallet-the transaction does not constitute a
disposition for income-tax purposes, and the settlor does not
thereby trigger capital-gains tax.

Subsection 104(1) also deems a bare trust to not be a trust for
income-tax purposes. For that reason, a bare trust needn’t file
a T3 trust income-tax return. In addition, a bare trust isn’t
subject to the 21-year deeming rule under subsection 104(4) of
Canada’s Income Tax Act. So, the bare trust isn’t
forced to realize all accrued capital gains for income-tax purposes
every 21 years.

And if, in accordance with the beneficiary’s directions, the
bare trustee sells some or all of those blockchain assets to a
third party, the transaction is taxed as though the beneficiary had
dealt directly with the third party. That is, the beneficiary must
report the resulting gain or loss as income. (The resulting gain or
loss will be reported either on capital account or on income
account, depending on the facts surrounding the transaction.)

The same is true for the foreign-reporting rule requiring a
Canadian-resident person to file a T1135 form if that person owns “specified
foreign property” with a total cost exceeding $100,000.
Cryptocurrency, NFTs, and other blockchain-based assets are
“intangible property,” and, because they exist on
decentralized digital platforms, they’re “situated,
deposited or held outside Canada.” As such, they typically
meet the definition of “specified foreign property.” Although the
bare trustee holds legal title to the digital assets by means of
the bare trustee’s wallet, those digital assets truly belong to
the bare trust’s beneficiary. If the beneficiary’s total
cost for those cryptocurrency, non-fungible tokens, and other
blockchain assets exceeds $100,000, the beneficiary must file a
T1135 form disclosing those assets.

For the most part, a bare trust’s GST/HST treatment reflects
its income-tax treatment. That is, courts will generally ignore a
bare trust when applying the provisions of Canada’s Excise
Tax Act. This is relevant to Canadians who create, sell, and
trade non-fungible tokens. Commercial sales of non-fungible tokens
might bring about GST/HST obligations because commercial NFT sales
qualify as a taxable supply under the Excise Tax Act. Thus, if you engage
in commercial NFT sales through a bare trust in which you’re
the beneficiary, you may need to register for GST/HST and to
charge, collect, and remit GST/HST on your NFT sales in Canada.

There are exceptions to the Canadian tax treatment of a
bare-trust relationship. For example, a bare trustee isn’t
ignored for the purposes of the GST/HST New Housing Rebate (see:
The Queen v Cheema, 2018 FCA 45). Thus, while Canadian tax
law typically ignores bare trusts, this treatment isn’t
universal. The lesson is that, before entering a bare-trust
relationship, you must first confirm that the bare trust will
indeed bring about the desired tax consequences in your particular
circumstances. For tax guidance concerning bare trusts, speak to
one of our expert Canadian tax lawyers in Toronto today.

How Do You Determine Whether a Bare Trust has been
Created?

As with a conventional express trust, a bare trust must exhibit
the so-called three certainties: (1) certainty of intention, (2)
certainty of subject, and (3) certainty of object. The
certainty-of-intention requirement deals with the settlor’s
intention to create a trust, and this requirement demands that the
settlor demonstrate an intention to create a trust by obligating
the trustee to hold a property for the beneficiary’s benefit.
The certainty-of-subject requirement deals with the property that
the settlor intends to put in trust, and it demands three things.
First, the settlor must own the property-at least beneficially-that
the settlor intends to put in trust. Second, the trust property
must be ascertainable when the trust comes into existence. Third,
each beneficiary’s entitlement to the trust property must be
sufficiently defined. Finally, the certainty-of-object requirement
deals with the trust’s beneficiary or beneficiaries. Under this
requirement, it must be possible to ascertain each beneficiary (if
the trust is a fixed trust) or to determine the beneficiary status
of a given individual (if the trust is a discretionary trust).

But the principles of agency law also prove relevant in a
bare-trust relationship. This is because a bare trust is
essentially a principal-agent relationship in which the agent holds
legal title to property that the principal beneficially owns.
Hence, the principles that discern whether parties have entered an
agency relationship also bear upon whether parties have created a
bare trust.

An agency relationship may emerge in one of two ways: First, it
may arise by agreement between the principal and agent. Their
agreement may be express, or it may be implied by the conduct or
situation of the parties. Second, an agency relationship may
retrospectively emerge by the principal’s subsequent
ratification of acts done on his behalf.

The essential ingredients of an agency relationship are that (i)
the principal and agent must both consent, (ii) the principal has
given the agent the authority to affect the principal’s legal
position, and (iii) the principal retains control over the
agent’s actions. The parties need not have reduced their agency
agreement to writing. If no written agency agreement exists, the
parties’ conduct determines whether they intended to create an
agency relationship.

The key feature is the level of control that the alleged
principal exerts over the alleged agent. Notably, in an agency
relationship, the principal retains beneficial ownership of any
property subject to that relationship. Hence, when an agency
relationship calls for the agent to acquire the principal’s
property, a bare trust potentially arises: If the agent acquires
the principal’s property with the sole responsibility of
carrying out the principal’s instructions, the agent holds that
property as a bare trustee while the principal enjoys the
rights associated with beneficial ownership-that is, the rights to
use, possess, dispose of, earn income from, and destroy the
property. If, on the other hand, the alleged agent need not accept
the principal’s instructions on dealing in the property, or if
the alleged agent has significant independent power, discretion,
responsibility over the property, he is neither an agent nor a bare
trustee.

Therefore, when parties haven’t recorded their agreement in
a written legal instrument, a number of factors speak to whether
the parties have created a bare trust with respect to a property.
Relevant questions will include the following (amongst others):

  • Does the purported bare trustee deal in the alleged trust
    property without the purported beneficiary’s direction or
    permission?
  • Does the purported bare trustee derive any personal benefit
    from the alleged trust property?

This determination calls for a detailed analysis of the
parties’ arrangement in light of the principles governing
agency and bare-trust relationships. So, if you want to create a
bare trust concerning your cryptocurrency, non-fungible tokens, or
other blockchain assets, or if you seek to confirm whether you hold
these assets as a bare trustee, please consult one of our
experienced Canadian tax lawyers.

Pro Tax Tips: Tax-Planning Opportunities Involving Crypto-Based
Bare Trusts & The Importance of a Written Bare-Trust
Agreement

A bare trust affords the flexibility of holding cryptocurrency,
non-fungible tokens, or other digital assets in a wallet or
exchange account under another person’s or entity’s name
while preserving the tax treatment that correctly reflects your
true ownership of those digital assets.

This often proves useful to Canadian taxpayers who want to
incorporate a cryptocurrency-trading business. By operating a cryptocurrency-trading business through a
Canadian-controlled private corporation (CCPC), a Canadian
cryptocurrency trader not only gains access to the small-business
deduction (SBD) tax rate but also reaps the benefits of
tax-deferral opportunities. Section 85 of the Income Tax
Act allows a tax-deferred rollover of cryptocurrency,
non-fungible tokens, or other blockchain assets to the corporation
at cost, thereby deferring personal tax on any accrued, unrealized
gains. But as a matter of convenience, after incorporating the
cryptocurrency-trading business, the business owner might prefer to
avoid transferring title to the cryptocurrency wallets or exchange
accounts under the owner’s name. This can be accomplished by
means of a bare-trust agreement whereby the owner continues to hold
legal title to these assets solely for the benefit of the
crypto-trading corporation. For tax purposes, the corporation will
be treated as if it dealt directly with the crypto assets in the
wallet or exchange account. (For more information on incorporating
a cryptocurrency-trading business, see our article about the Canadian tax benefits of operating your
cryptocurrency-trading business or NFT-sales business as a
CCPC.)

Another common scenario arises when a Canadian taxpayer wants to
invest in cryptocurrency, non-fungible tokens, or other digital
assets, and the taxpayer asks a more crypto-experienced friend or
relative to make the purchase on the taxpayer’s behalf. The
friend or relative will then purchase the digital assets using the
taxpayer’s money and hold the asset as a bare trustee for the
taxpayer’s benefit. In accordance with the bare-trust
relationship, although the bare trustee holds legal title to the
digital assets, the resulting tax responsibilities fall solely on
the taxpayer who beneficially owns the digital assets underlying
the bare trust.

As mentioned above, the creation of a bare trust does not
require a written agreement. The parties’ conduct is what
determines whether they intended to create a bare trust. Still, if
parties intend to create a bare trust, they should execute a
written bare-trust agreement. Likewise, parties who have already
entered an oral bare-trust agreement should memorialize their
pre-existing bare-trust relationship by executing a written
bare-trust agreement. Although the bare-trust agreement is itself
distinct from the document recording that agreement, the Canada
Revenue Agency will likely dispute the existence of a bare trust
without documentary evidence.

If you plan on entering a bare-trust agreement concerning
digital assets or if you want to confirm whether a crypto-related
arrangement qualifies as a bare trust, consult with one of our
knowledgeable Canadian NFT-tax and crypto-tax lawyers today. Not
only can our expert Canadian tax lawyers provide tax guidance about
crypto-planning opportunities involving bare trusts, but they can
also draft a bare-trust agreement containing the clauses that you
require for your blockchain-related arrangement.

Frequently Asked Questions

Question: What is a bare trust? And what’s its
significance for tax purposes?

Answer: A bare trust is a trust in
which the trustee has no obligations other than to deal with the
trust property in compliance with the beneficiary’s directions.
In other words, under a bare trust, the beneficiary retains
complete control over the trustee’s dealings with the trust
property. As such, a bare trust is primarily an agency
relationship whereby the bare trustee holds title to property
as the beneficiary’s agent. Canada’s tax laws typically
ignore a bare trust. For example, if a person retains beneficial
ownership of cryptocurrency, non-fungible tokens, or other
blockchain assets while transferring legal title to a bare
trustee-e.g., by transferring the assets to the bare trustee’s
wallet-the transaction does not constitute a disposition for
income-tax purposes, and the settlor does not thereby trigger
capital-gains tax. Likewise, the bare trust’s income is taxed
as though the beneficiary had earned that income directly. Also, a
bare trust needn’t file a T3 trust income-tax return.

Question: I transferred various cryptocurrency and
non-fungible tokens to my friend. How do I determine whether I have
created a bare trust? What happens if this transfer doesn’t
qualify as a bare trust?

Answer: If you in fact didn’t create a bare
trust when transferring the cryptocurrency and NFTs to your friend,
then you have disposed of those digital assets at fair market
value, which means that you may incur capital-gains tax.

As with a conventional express trust, a bare trust must exhibit
the so-called three certainties:

  • certainty of intention: You must have intended to
    create a bare trust.
  • certainty of subject: You must have owned the
    cryptocurrency and non-fungible tokens that you settled into the
    bare trust, the bare trust property must be ascertainable when the
    trust came into existence, and your beneficial entitlement to the
    trust property must be sufficiently defined.
  • certainty of object: It must be possible to ascertain
    that you were the beneficiary.

But the principles of agency law also prove relevant
in a bare-trust relationship. This is because a bare trust is
essentially a principal-agent relationship in which the agent holds
legal title to property that the principal beneficially owns.
Hence, the principles that discern whether parties have entered an
agency relationship also bear upon whether parties have created a
bare trust. The essential ingredients of an agency relationship are
that (i) the principal and agent must both consent, (ii) the
principal has given the agent the authority to affect the
principal’s legal position, and (iii) the principal retains
control over the agent’s actions. If no written agency
agreement exists, the parties’ conduct determines whether they
intended to create an agency relationship.

In short, the bare-trust determination calls for a detailed
analysis of your arrangement in light of the principles governing
agency and bare-trust relationships. So, to confirm whether you
created a bare trust, please consult one of our experienced
Canadian tax lawyers.

Question: Is it necessary to have a written bare-trust
agreement?

Answer: The creation of a bare trust does not
require a written agreement. The parties’ conduct is what
determines whether they intended to create a bare trust. Still, if
parties intend to create a bare trust, they should execute a
written bare-trust agreement. Likewise, parties who have already
entered an oral bare-trust agreement should memorialize their
pre-existing bare-trust relationship by executing a written
bare-trust agreement. Although the bare-trust agreement is itself
distinct from the document recording that agreement, the Canada
Revenue Agency will likely dispute the existence of a bare trust
without documentary evidence. Our expert Canadian tax lawyers can
draft a bare-trust agreement containing the clauses that you
require for your specific circumstances.

Question: I am the beneficiary of a bare trust
containing cryptocurrency and non-fungible tokens. Do I need to
file a T1135 Form?

Answer: For income-tax purposes, the bare
trustee is ignored, and the beneficiary of a bare trust is treated
the same as a person who holds the property without an
intermediary. Generally, you must file a T1135 form for each tax
year in which the following three conditions applied: (1) you were
a Canadian tax resident; (2) you held “specified foreign
property” during the year; and (3) your aggregate tax cost for
the “specified foreign property” exceeded $100,000 (in
Canadian currency) at any point during the year. Cryptocurrency,
NFTs, and other blockchain-based assets are “intangible
property,” and, because they exist on decentralized digital
platforms, they’re “situated, deposited or held outside
Canada.” As such, they typically meet the definition of
“specified foreign property.” Therefore, although the
bare trustee holds legal title to your cryptocurrency and
non-fungible tokens by means of the bare trustee’s wallet, you
may need to file a T1135 form reporting those blockchain assets if their
total cost exceeds $100,000. That said, “specified foreign
property” excludes “property that is used or held
exclusively in the course of carrying on an active business.”
This includes inventory. So, if you operated a
cryptocurrency/NFT-trading business, the cryptocurrency and NFTs
that you held as inventory don’t qualify as “specified
foreign property.” This might apply to the cryptocurrency and
NFTs in your bare trust. So, to confirm whether you must file a
T1135 form with your income-tax return, speak to a knowledgeable
Canadian tax lawyer.

Question: I hold cryptocurrency and non-fungible tokens
as a bare trustee for a family member. Do I need to file a T1135
Form?

Answer: The definition of “specified
foreign property” arguably includes the bare trustee’s
legal title. Under paragraph (h) of the definition, “specified
foreign property” includes “an interest in [.] any
property [.] that is specified foreign property.” This might
capture the legal title that the bare trustee holds in the digital
assets comprising the bare trust. Still, the bare trustee holds
merely vacuous legal title to the digital assets, so the bare
trustee’s cost for that interest should be nominal. As a
result, even if bare legal title to digital assets meets the
definition of “specified foreign property,” the bare
trustee will likely fail to meet the $100,000-cost requirement.
Canadian tax statutes are exceedingly complex. If you hold any
asset, including cryptocurrency or non-fungible tokens, as a bare
trustee, consult with our Certified Specialist in Taxation
crypto-tax lawyer for advice on your Canadian tax-reporting
obligations.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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