Introduction
As decentralized finance (DeFi) grows in popularity, Canadian taxpayers involved in yield farming face increased scrutiny from the Canada Revenue Agency (CRA). Yield farming, which involves staking or lending cryptocurrency in exchange for rewards, is considered taxable income, and the CRA has ramped up its efforts to audit cryptocurrency activities.
In this article, we explore the key considerations for auditing yield farming income in Canada and how to ensure compliance.
Why Yield Farming Attracts CRA Audits
Yield farming transactions are decentralized, often involving multiple platforms and anonymous participants. The CRA views these transactions as complex and high-risk for underreporting or tax evasion. Yield farming rewards are considered income and must be reported at their fair market value in Canadian dollars at the time of receipt. Failure to accurately report yield farming income can result in audits, penalties, and interest on unpaid taxes.
Key Areas of Focus During a CRA Audit
- Accurate Reporting of Yield Farming Rewards
The CRA will focus on whether the taxpayer has accurately reported the fair market value of all yield farming rewards. Rewards must be converted into Canadian dollars using the exchange rate at the time of receipt. Yield farmers who fail to report these amounts may face significant penalties. - Classification of Income
One of the first things the CRA will assess during an audit is whether the yield farming income has been classified correctly. Frequent yield farming transactions may be classified as business income, subjecting the entire reward to taxation. Passive yield farming, however, may be classified as capital gains, in which only 50% of the gain is taxable. - Deductible Expenses
Yield farmers can deduct certain expenses if their activities are classified as business income. During an audit, the CRA will verify whether expenses such as gas fees, transaction fees, and legal fees have been correctly claimed and documented. The CRA will also assess whether these expenses are directly related to the generation of yield farming income. - Record-Keeping
Proper record-keeping is essential to passing a CRA audit. Yield farmers must keep detailed records of all transactions, including:- The date of the transaction.
- The fair market value of the rewards in Canadian dollars.
- Any transaction or gas fees incurred. Incomplete or inaccurate records can result in penalties and reassessments during an audit.
- Foreign Yield Farming Activities
If yield farming occurs on foreign platforms, Canadian taxpayers must report their worldwide income. The CRA may also scrutinize whether foreign asset reporting requirements have been met, such as filing Form T1135 if foreign holdings exceed CAD 100,000.
How to Prepare for a CRA Audit
- Use Crypto Tax Software: Tools like CoinTracking or Koinly can help track yield farming income and expenses, ensuring accurate reporting.
- Maintain Backup Documentation: Ensure that all yield farming transactions are backed up with supporting documentation, such as screenshots of transactions, wallet addresses, and exchange rate data.
- Consult a Tax Professional: If you receive a notice of audit, it’s best to work with a tax professional experienced in cryptocurrency audits to ensure you provide accurate information and address any issues.
Conclusion
With the CRA increasing its focus on cryptocurrency activities, Canadian yield farmers must ensure they accurately report their income and maintain detailed records to avoid penalties during an audit. Proper classification of income, diligent record-keeping, and professional guidance can help taxpayers stay compliant and navigate CRA audits successfully.
If you have any questions or require further assistance, our team of accountants at Tax Partners Oshawa can help you.
Please contact us by email at [email protected] or by phone at 905-448-2241 for a FREE initial consultation appointment.
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