Bitcoin: A Canadian Taxation and Financial Reporting Perspective

Transcription

1 Bitcoin: A Canadian Taxation and Financial Reporting Perspective Eric Spano [email protected] (514) Introduction Given the lack of clarity with regards to the classification and treatment for both taxation and financial reporting purposes of the peer-to-peer electronic cash system known as Bitcoin, this report seeks to provide recommendations and guidelines that are consistent with the current rules and definitions of both Canadian Generally Accepted Accounting Principles (GAAP) as well as the Canadian Income Tax Act (ITA). In order to achieve this, the report will be divided into the following sections each with their own specific purpose: Part I: Virtual Currencies and the Bitcoin System will provide a brief historical and technical overview of the Bitcoin system in order to instill a fundamental base of knowledge that will prove to be useful in understanding what Bitcoins are, how they are created and how they can be transferred between users. Part II: Bitcoins in Canada will characterize the main users of Bitcoins in Canada as well as the activities in which they are used. Part III: Taxation of Bitcoins will consider the aforementioned users and activities in an attempt to provide recommendations for a tax treatment. Part IV: Financial Reporting of Bitcoins will look at the Bitcoin system from the perspective of businesses that produce financial statements in order to provide guidance for the classification and measurement of Bitcoins for businesses required to report under Canadian GAAP.

2 PART I: VIRTUAL CURRENCIES & THE BITCOIN SYSTEM WHAT ARE BITCOINS? WHERE DO BITCOINS COME FROM? HOW DO YOU USE BITCOINS? VIRTUAL CURRENCIES CONCLUSION PART II: BITCOINS IN CANADA MINERS TRADERS/INVESTORS MINING FUNDS RESELLERS EXCHANGES CONSUMERS & MERCHANTS CONCLUSION PART III: TAXATION OF BITCOINS CLASSIFICATION BITCOIN FACTS BITCOIN AS INTANGIBLE PERSONAL PROPERTY TYPES OF INCOME EMPLOYMENT INCOME BUSINESS INCOME PROPERTY INCOME CAPITAL GAINS & LOSSES TAXATION FOR MINERS CLASSIFICATION OF INCOME IMPLICATIONS CONCLUSION TAXATION FOR TRADERS/INVESTORS CLASSIFICATION OF INCOME DIRECT BITCOIN INVESTMENT CLASSIFICATION OF INCOME BITCOIN DERIVATIVES IMPLICATIONS DIRECT BITCOIN INVESTMENT IMPLICATIONS BITCOIN DERIVATIVES CONCLUSION TAXATION FOR RESELLERS CLASSIFICATION OF INCOME IMPLICATIONS CONCLUSION TAXATION FOR OTHER USERS

3 PART IV: FINANCIAL REPORTING OF BITCOINS TAXATION VS. FINANCIAL REPORTING CANADIAN FINANCIAL REPORTING ENVIRONMENT GOALS BITCOIN - A FINANCIAL REPORTING DEFINITION COMPANIES THAT WILL REPORT BITCOINS BITCOIN CLASSIFICATION IFRS BITCOINS HELD AS AN INVESTMENT BITCOINS HELD FOR IMMEDIATE RESALE BITCOIN CLASSIFICATION ASPE BITCOINS HELD AS AN INVESTMENT BITCOINS HELD FOR IMMEDIATE RESALE CONCLUSION BIBLIOGRAPHY

4 PART I: VIRTUAL CURRENCIES & THE BITCOIN SYSTEM WHAT ARE BITCOINS? The trouble with deciding how to treat Bitcoins is often related to a misconception of what they are and how they work. The Bitcoin system was created and designed by the enigmatic computer programmer Satoshi Nakamoto with the ultimate goal of providing a way for users to send electronic cash to each other without the need to go through a financial institution. Instead of relying on the use of credit cards or online payment processors such PayPal to make online transactions, the Bitcoin system uses a peer-to-peer network of computers to transfer Bitcoins between users and also to verify transactions without the need for a financial institution. Essentially, there is no such thing as a physical Bitcoin a Bitcoin is in fact just a chain of digital signatures stored in a file on your computer that you can transfer to other users as a means of payment or keep on your hard disk as a store of value. Bitcoins are different from fiat currencies (such as the Canadian dollar) because they are not issued or regulated by a central bank. They are more similar to commodities such as gold because their value is derived from their scarcity and difficulty to obtain. These concepts will become clearer shortly. For more information on digital signatures, asymmetric cryptography and cryptography on the Internet, IBM provides some excellent introductory guides that can be found in the Bibliography at the conclusion of the report (see MacTaggart). WHERE DO BITCOINS COME FROM? As mentioned, there is no central banking authority or government that issues Bitcoins and they aren t physical tangible goods, so where do they come from? They are actually created by ordinary computer users through a process called mining. In order to mine a Bitcoin, a user will run a software program on their computer that attempts to solve a very complex and time consuming mathematical algorithm. These users are known as miners in the Bitcoin community. When the algorithm is solved, something called a block is created which allows others to see that another user solved the algorithm and that the solution is valid. This user is then rewarded with 25 Bitcoins an amount that is set to decrease by 50% roughly every four years in order to prevent inflation. This reward is an incentive for a user to use the expensive amount computing power necessary to solve the algorithm. As more algorithms are solved, the difficulty increases and while in the beginning it was possible to solve an algorithm using just one computer, today the algorithms have reached such levels of complexity that users have to pool their computing power together and share the reward. Also, the Bitcoin system is setup in such a way that there is a 4

5 maximum of 21 million Bitcoins that can be created through this mining process. The value of Bitcoins is derived from the fact that there is a limited supply and that they are difficult, time consuming and costly to create. HOW DO YOU USE BITCOINS? To recap, it is now clear that Bitcoins are chains of digital signatures that are created by solving complex algorithms and subsequently stored on a computer. This reiterates the fact that Bitcoins can be created by anybody (not a central authority) and don t need to go through a financial institution (because they re stored on a computer and transferred directly between users). But where do you keep your Bitcoins? How can you give them to and receive them from other users? Before getting into that, three important concepts must be explained: wallets and addresses and the blockchain. When you decide to start using Bitcoins, you must create a wallet, which can be done by either installing specialized Bitcoin software on your computer (such as MultiBit or BitcoinQT among others) or by creating one online (using websites such as InstaWallet.org). Once your wallet is created, you can generate addresses to store within the wallet these addresses are used to store, send and receive Bitcoins. While a wallet is simply the software that contains one or more addresses, an address itself is a complex string of letters and numbers that looks like this: 1PeizMg76Cf96nUQrYg8xuoZWLQozU5zGW An analogy to think of is as follows: your wallet is like a bank, and your address is like a bank account. One bank can contain many bank accounts, just like one wallet can contain many addresses. Taking this concept one step further, if you have money in a bank account, you can transfer it to someone else s bank account to give them money. This is how Bitcoins are transferred. Addresses are secured in a wallet through the use of cryptographic keys, much like how bank accounts are secured with PIN numbers. The cryptographic properties of Bitcoins are fascinating, but an in depth understanding is not required for our purposes. Finally, the blockchain is the ledger that shows all of the transactions that have occurred between every address in the Bitcoin system. Using the bank example, the blockchain is the equivalent of the banks ledger that stores all of the daily transactions. Unlike a bank ledger however, the blockchain is publicly viewable by anyone. This means that anyone can see which transactions are taking place by simply looking at the blockchain (by visiting the BlockChain.info website). It is because all of the transactions can be publicly viewed that Bitcoins are considered to be only somewhat anonymous while all transactions are publicly displayed, nobody really knows whom the addresses actually belong to. Unlike 5

6 bank accounts, no name or registration is associated to create an address or wallet. This provides some level of anonymity, but it is not foolproof. Now that we know what wallets, addresses and the blockchain are, here is an example of a Bitcoin transaction between two users, A and B: User A wants to send 10 Bitcoins to User B, and so User B provides User A with his address. User A opens up his computer to access his wallet, and then transfers the 10 Bitcoins from his own address to the address that User B provided him with. This transaction is then immediately posted and viewable in the blockchain. The transaction is not 100% complete at this point however. Before continuing with the example, I would like to bring something to your attention. When you spend a $20 bill, it is impossible for you to spend the same bill more than one time because once you have spent it the first time, it is physically removed from your possession. Now since Bitcoins are not actually tangible like a $20 bill and instead are just data in a computer file, what s stopping someone from copying their Bitcoins and spending the same ones more than once? This dilemma is why the transaction in the previous example wasn t yet complete. Where we last left off, the transaction was posted and viewable in the Bitcoin system s ledger, the blockchain. At this point however, the transaction is considered to be unconfirmed, and User B cannot yet spend them. How does a transaction become confirmed? I would like you to think about those Bitcoin miners from earlier. Remember those complex algorithms that they were solving in order to earn Bitcoins as a reward? Those weren t just random algorithms with no purpose whenever Bitcoins are sent from one address to another they are sent in the form of an algorithm. Miners compete against each other by solving the algorithms of these unconfirmed transactions. The algorithms are designed so that out of all the miners in the world, only one can solve it successfully. Once it has been solved, the transaction will be 100% confirmed and the miner will receive his 25 Bitcoins, and the user receiving the Bitcoins is fully in possession of them. As mentioned before, the miner also creates something called a block, which is a mathematical proof. If a user tries to spend the same Bitcoins more than once, it won t be possible because miners will be able to publicly see that the same algorithm has already been solved and they ll just skip past it, thus never allowing that transaction to be completed. Going back to our example, once the algorithm representing User A s transaction with User B is solved by a miner, the transaction will be considered as confirmed and thus fully complete and the miner who solved it will receive a reward of 25 Bitcoins. This also makes Bitcoin transactions irreversible, in that once you send Bitcoins to a user, it is impossible to reverse that transaction and retrieve your Bitcoins. 6

7 VIRTUAL CURRENCIES In essence, Bitcoin is a virtual currency, which has been defined by the European Central Bank (ECB) as a type of unregulated, digital money, which is issued and usually controlled by its developers, and used and accepted among the members of a specific virtual community. Within this definition of virtual currencies, the ECB goes a step further and classifies them into three different types. Bitcoin is classified by the ECB as a Type 3 virtual currency, indicating that it is a virtual currency with bidirectional flow, which essentially means that a user can both buy and sell the virtual currency with a real, fiat currency such as Canadian dollars. This is unlike some other virtual currencies where the user can only acquire it but cannot re-sell it or convert it for a real, fiat currency video games that use in-game currencies come to mind. As we can see based on the ECB s claims, Bitcoin is easily classified as a virtual currency. CONCLUSION As we can see, the nature of the Bitcoin system and Bitcoin transactions are very complex and it must be stressed that this is a rudimentary introduction to what Bitcoins are and how they work. While the advanced technical details of Bitcoins are beyond the scope of this report, several things are abundantly clear. Firstly, Bitcoins are purely digital and do not exist in any tangible or physical capacity. Unless of course, you write down your wallet address this would be a physical representation of a Bitcoin. Secondly, there is no need for a central bank or financial institution to monitor or regulate Bitcoin transactions since Bitcoins are created by its users at a predetermined rate and the transactions are also verified by those same users using a proof-based algorithm system. This evidently creates regulatory challenges, but that is not the concern of this report. For our taxation and financial reporting purposes however, the explanations and examples in Part I will be sufficient and useful in classifying and defining Bitcoins within the current regulatory environment in Canada. 7

8 PART II: BITCOINS IN CANADA Now that the concepts of what Bitcoins are and how they work are much clearer, we can take a look at what Canadians are doing with Bitcoins. We will classify users of Bitcoins into five distinct groups: Miners, Traders/Investors, Resellers, Exchanges and Consumers. MINERS As mentioned in Part I, Bitcoins are created through the collective computing power of miners. Since the difficulty level of the algorithms is high, miners prefer to pool their computing power together in order to earn as many Bitcoins as possible as quickly as they can. The downside of this of course is that the rewards for solving algorithms need to be shared amongst all of the users in the pool and as such the returns are lower but more frequent than if a user were to mine Bitcoins on their own. There are new devices being introduced very shortly by companies such as Butterfly Labs that promise to solve algorithms at lightning fast speeds due to their advanced computing power and low energy consumption, which may increase the number of individual miners in Canada. Regardless of whether or not miners act alone or in groups, once they receive their rewarded Bitcoins they have several options. At this point, they can hold on to the Bitcoins in hopes that the value will continue to increase, sell their Bitcoins through an exchange, a reseller or other Bitcoin enthusiasts or finally they can buy goods online in exchange for their Bitcoins. It is important to note that no matter what the market value of Bitcoins is, miners receive the same 25 Bitcoin reward and their only costs are those incurred to solve the algorithm (which mainly include computer hardware and electricity expenses) There are several large mining pools in Canada, however one of the most popular is the Havelock Investment Mining Fund. This is an interesting concept because it allows users to simply invest in the Funds existing mining operations without actually having to contribute any computing power of their own and still earn dividends from the Fund on a monthly basis. We will take a more detailed look at mining funds in Parts III and IV. TRADERS/INVESTORS The next group of Bitcoin users in Canada that we will discuss is the traders/investors. These users are primarily interested in Bitcoins as an investment vehicle and are very similar in nature to individuals who invest foreign currencies, commodities and equity securities. Their goal to acquire Bitcoins when they believe the market rates to be low and thus Bitcoins to be 8

9 undervalued and then sell the Bitcoins for a profit once the market value reaches their desired target level. These traders use many similar forms of technical analysis used by equity traders and they acquire and dispose of their Bitcoins using various sources including miners, resellers and exchanges. Bitcoin traders/investors may invest directly in Bitcoins, or in Bitcoin derivative investments such as mining funds or Bitcoin futures/options. MINING FUNDS Some Bitcoin miners will not be satisfied with a simple mining operation and will have aspirations of expansion and growth in order to generate as many Bitcoins as possible. These miners will create what are known as Mining Funds funds that allow anybody to invest in and earn dividends once Bitcoins are mined. Essentially how Mining Funds work are as follows: 1) A Bitcoin miner creates a Mining Fund and sells Units to investors 2) Units will entitle investors to a quarterly dividend from the Mining Fund 3) The Mining Fund manager can do whatever he sees fit with the invested funds in order to generate a return (invest in mining equipment, sell Bitcoins, etc.) The key aspect to Mining Funds is that all business is transacted in Bitcoins. An investor must buy a Unit with Bitcoins, and will receive Bitcoins as dividends. The Fund manager will only report Bitcoin holdings. A tricky aspect with Mining Funds is that when you invest in a Unit, there is no implied or otherwise contractual ownership of the actual mining operation or company. As an investor, you are simply investing your Bitcoins in good faith, assuming positive intent and that the integrity of the Mining Fund is reputable. You will have no say in any investment decisions related to your invested Bitcoins. This is unlike investing in shares of a public company because investors in Mining Funds have zero rights once the funds have been invested. Since no actual Canadian dollars are transacted or used in Mining Funds, there are no reporting requirements for the Funds under Canadian legislation and since no rights are being transferred to investors, technically Mining Funds are not acting as a securities broker and can avoid regulation. This opens the door for a lot of nefarious behavior to be committed by those managing Mining Funds. The possibility for Ponzi schemes and other methods of defrauding investors is high, which could ultimately destroy the credibility of Bitcoin itself. 9

10 RESELLERS Resellers of Bitcoins in Canada provide an easy and quick way for individuals to purchase and sell Bitcoins. Resellers are generally small businesses that operate websites with posted rates to buy or sell Bitcoins that are slightly different from actual market rates on larger exchanges in order to incentivize buyers. Bitcoin resellers buy Bitcoins directly from their customers, which mean that they take full ownership and possession of the Bitcoins. They subsequently find other individuals to sell them to, advertising online and usually using a website to process the transactions. As we will see next, the tax implications vary depending on the type of user. EXCHANGES All over the world, Bitcoin exchanges are the most popular and widely used way for users to acquire Bitcoins, and this is no different in Canada. Exchanges allow users to buy and sell Bitcoins with ease, while usually requiring registration and collecting some personal information for verification purposes (whereas resellers don t usually require as much information to transact). Bitcoin exchanges work in the same way that regular currency exchanges do: buyers and sellers register accounts with the exchange and then either deposit Canadian dollars or Bitcoins to their account. Once the funds are in their account, they are held by the exchange on behalf of the user until the user decides to sell or buy Bitcoins. At this point, they will post an offer and the deal will be completed when another buyer or seller agrees on the rate being asked. The most popular Canadian Bitcoin exchange is the Canadian Virtual Exchange (cavirtex.ca) CONSUMERS & MERCHANTS Most casual Bitcoin users will fall into this category. Bitcoin consumers are those users who have no interest in mining their own but are still interested in the technology behind it and the advantages that it provides. These consumers acquire Bitcoins for short-term purposes and in smaller amounts usually as a very liquid, short-term investment or even using them to purchase various goods and services online perhaps to buy some products on the increasingly popular BitMit.com, or gamble on one of the many online casinos that accept Bitcoins (SatoshiDice.com and Infiniti Poker to name a few), or better yet to pay for webhosting on Wordpress.com. As an increasing number of online merchants and service providers begin to accept Bitcoins as a form of payment, it can be expected that the number of Bitcoin consumers will increase as well. 10

11 As for these merchants, a business does not have to solely accept Bitcoins to be considered a Bitcoin merchant. In fact, the goal of Bitcoins is to be integrated into the economy such that business will accept them alongside regular Canadian dollars. CONCLUSION As we can see, there are various users of Bitcoins in Canada with several different purposes. The situations are similar all across the world, and if the growth in popularity of Bitcoins continues to increase we may begin to see even more types of users and new, varied uses for Bitcoins as well. 11

12 PART III: TAXATION OF BITCOINS CLASSIFICATION The difficulty with determining what taxes are owed to the government related to various Bitcoin transactions stems from the fact that while Bitcoins are often described as a virtual currency, current Canadian tax legislation offers no guidance for virtual currencies. This raises the question of whether Bitcoins could be classified as money or monetary instruments like other foreign currencies. Since the Canadian Income Tax Act (ITA) offers no definition of monetary instruments, we turn to the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA), specifically Memorandum D , which defines monetary instruments as: The following instruments in bearer form or in such other form as title to them passes on delivery, namely, a securities, including stocks, bonds, debentures and treasury bills; and (b) negotiable instruments, including bank drafts, cheques, promissory notes, travellers cheques and money orders, other than warehouse receipts or bills of lading. For greater certainty, this definition does not apply to securities or negotiable instruments that bear restrictive endorsements or a stamp for the purposes of clearing or are made payable to a named person and have not been endorsed Based on all that we have learned so far, Bitcoins do not fall within this definition of monetary instruments. Also, the Canadian government has issued no official statement on Bitcoins and has not yet recognized virtual currencies as being equivalent to foreign fiat currencies. Based on these facts, it can be said that under current Canadian legislation Bitcoins are not legally considered to be money nor are they monetary instruments and are not viewed in the same light as foreign fiat currencies. Given all that we have learned about Bitcoins in Parts I & 2, it is indisputable that Bitcoins are digital in form and share many similar characteristics to commodities such as gold in that their value stems from their scarcity and the difficulty to acquire them. It can therefore be argued that Bitcoins are in fact more similar to a digital commodity or digital good than they are to monetary instruments. 12

13 BITCOIN FACTS For Canadian taxation purposes, we can therefore ascertain the following to be true: Bitcoins are digital (intangible) in nature Bitcoins can be transferred between individuals without the approval or authorization of a central authority Bitcoins are created by the computing power of individuals Bitcoins can be sold for fiat currency or bartered for goods and services Bitcoins are used as an asset for various types of derivatives Based on the above facts (herein referred to as the Bitcoin Facts), one could logically and arguable conclude that Bitcoins are best classified under current Canadian legislation as a digital good/commodity. If Bitcoins are in fact a digital good/commodity, they would be considered as property. Property is defined in subsection 123(1) of the Excise Tax Act as: Any property, whether real or personal, movable or immovable, tangible or intangible, corporeal or incorporeal, and includes a right or interest of any kind, a share and a chose in action, but does not include money Property is similarly defined in subsection 248(1) of the Income Tax Act as: Property of any kind whatever whether real or personal, immovable or movable, tangible or intangible, or corporeal or incorporeal As we can see, both definitions are very similar and based on the aforementioned Bitcoin Facts, it is clear that Bitcoins should be classified as property for taxation purposes. Bitcoins are the property of the person who mines/creates them, or the person who holds the wallet that contains that address in which the Bitcoins are stored it can therefore be said that the owner of that wallet has a right to the Bitcoins. However, these definitions are vague, so we look to the Canada Customs and Revenue Agency (CCRA) for more guidance. BITCOIN AS INTANGIBLE PERSONAL PROPERTY GST/HST Technical Information Bulletin B-090 published in July 2002 attempts to take the classification of property a step further, outlining the CCRA s interpretation of legislation and definitions related to digital commerce and therefore digital goods, such as Bitcoins. The Bulletin states that a supply made by electronic means is characterized as either a supply of intangible personal 13

14 property or a supply of a service. They indicate that key factors that indicate that a supply made by electronic means is one of intangible personal property are: a right in a product or a right to use a product for personal or commercial purposes is provided, such as: intellectual property or a right to use intellectual property (e.g., a copyright); or rights of a temporary nature (e.g., a right to view, access or use a product while on-line); a product is provided that has already been created or developed, or is already in existence; a product is created or developed for a specific customer, but the supplier retains ownership of the product; and a right to make a copy of a digitized product is provided Once again, we can see that Bitcoins satisfy the criteria of intangible personal property because there is an inherent right in Bitcoin ownership that implies that they can be used for personal or commercial purposes, and furthermore because Bitcoins have already been created and developed once they are in someone s possession. Based on the aforementioned criteria and definitions, it is my recommendation that Bitcoins be regarded as digital goods, or intangible personal property for taxation purposes since it satisfies all the criteria for this classification under current legislation and does not fit into the definition of money or monetary instrument despite being considered as a virtual currency and sharing some characteristics with tangible, fiat currencies. Operating under this assumption, we will now look at how the various users of Bitcoins mentioned in Part II would be affected by this definition. It must be noted that the goal of this report is to provide a preliminary guidance for Bitcoin taxation reporting in Canada given current legislation. As such, we will be focusing solely on determining what amounts related to Bitcoin activity individuals and businesses must include in their reported income. This is Division B Income in the ITA, more commonly referred to as Net Income for Tax Purposes or Net Income. Any related deductions or further tax implications are beyond the scope of this report. TYPES OF INCOME Before continuing, we will need to identify the possible types of Bitcoin income that can be recognized for taxation purposes by each of the different Bitcoin users 14

15 in Canada. The ITA states that there are four basic types of income: Employment Income, Business Income, Property Income and Capital Gains & Losses. EMPLOYMENT INCOME According to ITA 5(1), Employment Income is a taxpayer s income for a taxation year from an office or employment is the salary, wages and other remuneration, including gratuities, received by the taxpayer in the year. BUSINESS INCOME ITA 9 indicates that a taxpayer s business income is his profit from a business. Abstract No. 124 from the CICA s Emerging Issues Committee defines as a business as a self-sustaining integrated set of activities and assets conducted and managed for the purpose of providing a return to investors. A business consists of (a) inputs, (b) processes applied to those inputs, and (c) resulting outputs that are used to generate revenues. In a less detailed example, ITA 248(1) defines a business as a profession, calling, trade, manufacture or undertaking of any kind whatever [...] and an adventure or concern in the nature of trade. PROPERTY INCOME There is no definition in the ITA for Property Income, however we can think of it as being the return on invested capital in situations where little or no effort is required by the investor to produce the return. Examples would include collecting rent, interest, dividend payments and royalties. CAPITAL GAINS & LOSSES CRA Guide for Capital Gains T4037 defines Capital Gains as arising when you sell, or are considered to have sold, a capital property for more than the total of its adjusted cost base and the outlays and expenses incurred to sell the property and therefore a Capital Loss arises when you sell, or are considered to have sold, a capital property for less than the total of its adjusted cost base and the outlays and expenses incurred to sell the property. The guide also defines Capital Property as depreciable property, and any property which, if sold, would result in a capital gain or a capital loss. You usually buy it for investment purposes or to earn income. It does not include the trading of assets of a business, such as inventory. 15

16 We will reference these types of income when discussing the tax effects for each of the different Bitcoin users. TAXATION FOR MINERS CLASSIFICATION OF INCOME Bitcoins cannot come into existence until a Bitcoin miner has effectively mined them and receives them as a reward for processing and confirming Bitcoin transactions. The Bitcoins are created using computers, and the miner will then hold the Bitcoins for resale or use them in a form of barter transaction. An individual acting as a Bitcoin miner would then find himself facing the following situations: 1) An individual acquires a computer for the purposes of generating Bitcoins 2) As a direct result of the use of his computer to solve algorithms, the individual receives Bitcoins 3) The individual sells these Bitcoins for Canadian dollars 4) The individual trades these Bitcoins for other goods or services First and foremost, we will need to determine what type of income a miner is generating. Given that mining Bitcoins integrates a self-sustaining set of activities consisting of inputs (a computer, electricity), processes applied to those inputs (Bitcoin mining software) and outputs (Bitcoins), it is quite clear that any revenues generated through Bitcoin mining should be considered as Business Income. This is the case regardless of whether an individual has established a registered business (partnership, incorporation, etc.) or is operating simply as a sole proprietor. Now, while we will not necessarily focus on GST/HST implications, it is important to note that according to the CRA s GST/HST Memoranda Series from May 1999, if an individual is generating less than $30,000 in revenues from his Bitcoin mining operation, he will be considered as a Small Supplier and not required to register for GST/HST purposes. If revenues are $30,000 or greater, registration will be required and GST/HST remittance and collection is mandatory. IMPLICATIONS Now that we know Bitcoin mining income should be classified as Business Income, we can look at the implications. We will reference the four situations mentioned earlier to see how this classification will impact various mining activities. 16

17 Starting a Mining Operation When an individual starts a mining operation, he will likely acquire a computer or other similar type of computer equipment to conduct his mining activities. As such, the acquisition property to be used directly in mining Bitcoins would be considered as the acquisition of property used in business. è Any income generated by this property is considered as Business Income è When this property is disposed of, there will be a Capital Gain or Capital Loss Mining & Earning Bitcoins After acquiring the necessary computer equipment to generate Bitcoins, and individual will install certain software and begin solving algorithms to generate Bitcoins. Various expenses will be incurred at this point, namely electricity and other utility expenses. These expenses will directly offset and reduce any income generated by the mining business. Once the miner receives the Bitcoins, a significant issue arises at this stage, are the Bitcoins recognized as income? Or is income only recognized when they are sold or traded? From a practical standpoint, when a miner earns Bitcoins and receives possession of them in his wallet address, his main objective is to resell them at a profit. As such, upon earning and receiving the Bitcoins, a miner should recognize no income. At this stage in the process, he is holding the Bitcoins as property for resale at a profit and no income is generated while held. The cost of these Bitcoins held for resale will be their market value at the date they were received and earned by the miner. è When a miner receives Bitcoins, no income is recognized è Bitcoins will be recorded as Property Acquired for Resale at a Profit with a cost equal to their market value at the date of receipt Selling Bitcoins for Dollars Now after a miner has received some Bitcoins, he may be inclined to sell them in order to recover his initial costs and make a profit. When the Bitcoins are sold for Canadian dollars, the miner is earning Business Income and the profit earned will be the difference between the amount received for the Bitcoins and the cost that was recorded on the date that the miner earned the Bitcoins. This profit will be fully taxable as Business Income. è When a miner sells Bitcoins for Canadian dollars, Business Income is earned 17

18 è Profit = Sale Price of Bitcoins less Original Cost of Bitcoins è Any other expenses related to generating the Bitcoins will be deducted as expenses as well Bartering Bitcoins for Other Goods & Services If a miner decides to trade his Bitcoins for other goods or services, we will refer to Interpretation Bulletin IT-490 Barter Transactions for guidance. The relevant information is as follows: In the case of goods bartered by a taxpayer for either goods or services, the value of those goods must similarly be brough into the taxpayer s income if they are business-related In this case, if a Bitcoin miner decides to trade his Bitcoins for any good or service, the value of that good or service will need to be recognized as Business Income. This income inclusion will be offset by the original cost of the Bitcoins, meaning that in essence a Bitcoin sale for Canadian dollars or bartering Bitcoins will have the same taxation effect for Bitcoin miners. è When a miner traders Bitcoins for other goods or services, Business Income is earned è Profit = Value of Goods/Services Received less Original Cost of Bitcoins è Any other expenses related to generating the Bitcoins will be deducted as expenses as well CONCLUSION Bitcoin mining is considered to be a business activity, therefore any related income should be classified as Business Income Any property used to generate Bitcoins can be disposed of for a Capital Gain/Loss When a Bitcoin miner receives Bitcoins, there are no immediate taxation implications since they are considered as Property Acquired for Resale at a Profit o However the market value of Bitcoins received must be noted at the date of acquisition, as this will be the cost of the Bitcoins When a Bitcoin miner sells or barters his earned Bitcoins, Business Income will be recognized 18

19 TAXATION FOR TRADERS/INVESTORS The taxation situation for traders is a bit trickier. Bitcoin Traders/Investors will either invest in Bitcoins directly, or in Bitcoin derivative investments such as Mining Funds or other Bitcoin Funds on the MPex Bitcoin Securities Exchange. We will analyze these two scenarios separately, as the classification of income under each scenario will vary. We will begin by classifying the income earned by traders/investors who invest directly in Bitcoins CLASSIFICATION OF INCOME DIRECT BITCOIN INVESTMENT An individual acting as a trader/investor directly in Bitcoins will face the following situations: 1) An individual acquires Bitcoins for investment/trading purposes 2) An individual holds these Bitcoins until a target price/value is reached 3) An individual sells his Bitcoins for a profit Firstly, it is quite clear that a disposition of property is occurring when an individual sells his Bitcoins. When earning a gain on the disposition of property, there are two possibilities for taxation: the first possibility is that the gain is considered to be a capital gain and only half the amount will be taxable. The second possibility is that the gain will be considered as business income and will therefore be fully taxable. This classification applies to the gains on the sale of Bitcoins but how do we know whether the gain is half or fully taxable? This is one of the most hotly litigated issues in Canadian tax courts when it comes to classifying gains or losses on equity investments. Generally, people will claim that their gains are capital in nature and only half taxable, however this is not an easy position to defend. The CCRA has outlined the following factors to consider and has demonstrated in many court cases over the last decade that the presence of several factors will result in the gains being classified as business income. It must be noted that the factors apply to securities, however the same notions apply to investments in Bitcoins as well. The factors are as follows: Frequent and extensive buying and selling of securities, Short periods of ownership, If you have some knowledge or experience in the industry you are investing, If you spend a lot of time studying the markets and securities, Your buys and sells of securities form part of your regular business, You use margin or debt to finance your purchases, You advertise yourself as an investment broker, 19

20 Your purchases appear to be speculative or the securities do not pay dividends While not all of these criteria apply to Bitcoin traders, most of them can be used as a reliable guide in classifying gains on the disposition of Bitcoins. If a Bitcoin trader meets some of the aforementioned criteria, their gains and losses will be considered as business income and fully taxable. If for some reason the above criteria don t apply, then they would be eligible to treat Bitcoin gains as capital gains, which would lead to favorable tax treatment this is unlikely however. CLASSIFICATION OF INCOME BITCOIN DERIVATIVES What happens if an investor decides to invest in a Bitcoin derivative investment? Currently, the most popular form of Bitcoin derivative in Canada comes in the form of a Mining Fund, which was discussed earlier in Part II. Since Mining Funds in Canada only accept investments in the form of Bitcoins and dividends are paid in Bitcoins, the question of how to account for Mining Fund related transactions is difficult to answer. An investor in a Mining Fund will encounter several situations: 1) An individual decides to invest in a Unit of a Mining Fund, acquiring the Unit with Bitcoins 2) The investor receives a dividend in the form of Bitcoins 3) The investor sells his Unit to another investor for Bitcoins 4) The investor sells his Unit to another investor for Canadian dollars In this case, the taxable situations involve the receipt of dividends and the disposal of the Unit. Upon receipt of a dividend, the investor will gain possession of intangible personal property in the form of Bitcoins. If we look at the types of income defined at the beginning of Part III, we determined that dividends received are considered to be Property Income and this will apply to Bitcoins received as well. Upon disposal of a Unit for Bitcoins or for Canadian dollars, an individual will receive a compensation for his Unit and there will be a gain recognized as the difference between the initial outlay for this Unit and the compensation received for the disposal of this Unit. The gain will either be a Capital Gain or Business Income depending on the same criteria mentioned in the previous section. 20

21 IMPLICATIONS DIRECT BITCOIN INVESTMENT Assuming that an investor has acquired and subsequently disposed of Bitcoins for a gain, there will be important tax implications. Using the situations mentioned above, we will analyze the implications. Acquiring Bitcoins When an investor acquires Bitcoins, the cost at which he acquires them is very important as this amount, plus any transaction fees, will be the cost base for the investment. The cost base will need to be adjusted each time Bitcoins are acquired or disposed of. There are no taxation implications for acquiring Bitcoins. è Record and adjust cost base Disposing of Bitcoins Business Income When an investor meets the criteria mentioned earlier, their gains will be treated as Business Income. This means that any profit earned on the disposal of Bitcoin holdings will be fully taxable. è Profit earned on Bitcoins is fully taxable Disposing of Bitcoins Capital Gains When an investor doesn t meet the criteria mentioned earlier, their gains will be treated as Capital Gains. This means that any profit earned on the disposal of Bitcoin holdings will be half-taxable. è Profit earned on Bitcoins is only half-taxable IMPLICATIONS BITCOIN DERIVATIVES Assuming that an investor has invested in a Unit of a Bitcoin Mining Fund, several taxable situations will occur and we will analyze the implications of those situations below. 21

22 Investment in a Unit When an individual invests Bitcoins in a Mining Fund Unit, the market value of the Bitcoins invested to acquire that Unit must be recorded as this will be the cost base of the investment. Any subsequent purchases or disposals of units will require an adjustment to the cost base. No immediate tax implications. è Record and adjust cost base Receipt of a Dividend When an individual receives a dividend as a result of investing in a Unit, this income would be considered as Property Income. As soon as the dividend in Bitcoins is received, the market value of Bitcoins at that date will need to be recorded as the equivalent amount in Canadian dollars will need to be recorded immediately as Property Income. At this date, the value of the Bitcoins will be used as the cost base for Bitcoins, and the Bitcoins received as a dividend will then be considered as a Direct Investment in Bitcoins and treated as such. è Market value of Bitcoins received as dividend is immediately recorded as Property Income è Bitcoins will subsequently be treated as a Direct Investment in Bitcoins and the value of the dividend will be the cost base of the Bitcoins Disposal of a Unit When an investor decides to sell his Unit of a Mining Fund, he can do so in exchange for dollars, Bitcoins or through a barter transaction. When the Unit is disposed of, a profit will be earned and that profit will be taxed based on the criteria mentioned earlier as either a Capital Gain or Business Income. è Profit on disposal of Unit is the compensation received less the original cost of the Unit è Profit will be taxable as Business Income or Capital Gain depending on criteria CONCLUSION Income earned by direct Bitcoin investment can either be classified as Business Income or Capital Gain depending on CRA factors 22

23 Dividends earned by a Mining Fund will be considered as Property Income upon receipt Gain on disposition of Mining Fund Units will be considered as either Business Income or Capital Gain depending on the same CRA factors outlined for direct Bitcoin investments TAXATION FOR RESELLERS CLASSIFICATION OF INCOME Since resellers are in the business of buying and selling Bitcoins, they are clearly engaging in the trade of Bitcoins and as such as conducting a business. Further analysis of this classification is not required. With regards to GST/HST, the same applies to resellers as it does for Miners a business with revenues of less than $30,000 is not required to collect or remit GST/HST. However once revenues are $30,000+, Bitcoin resellers will be required to collect and remit GST/HST on their purchases and acquisitions of Bitcoins. Using input tax credits, this difficult situation is alleviated since GST/HST doesn t actually have to be collected a reseller can simply record all of the GST/HST that would be owed to the government as a result of its Bitcoin purchases and offset that with the amount that it should be collecting on its sale of Bitcoins. The difference will be owed and remitted to the CRA. IMPLICATIONS There are two major activities for a Bitcoin reseller - buying and selling Bitcoins. We will analyze the implications of each situation below. Buying Bitcoins When a reseller purchases Bitcoins from a customer or supplier, he will be acquiring the Bitcoins by immediately paying with Canadian dollars for those Bitcoins. GST/HST issues aside, there is no taxable event in this transaction for the reseller however the cost of the Bitcoins acquired will be important in determining the profits of the business. The cost of the Bitcoins won t be the market rate in this case, however it will be the amount that the reseller paid for the Bitcoins. At this point, the Bitcoins are considered as Property Acquired for Resale at a Profit. è No tax implications, however cost of Bitcoins must be noted è Bitcoins recorded as Property Acquired for Resale at a Profit 23

24 Selling Bitcoins When a reseller sells Bitcoins, he is earning a profit on the difference between what he paid for the Bitcoins. This profit will be included in Business Income and can be offset by the cost of the Bitcoins as well as any business related expenses. è Profit earned on sale of Bitcoins is Business Income è Can be offset by expenses and cost of acquiring Bitcoins CONCLUSION Income earned by Bitcoin resellers is Business Income Cost of buying Bitcoins for resale is a direct business expense to be deducted from Business Income o Other deductions include normal business expenses TAXATION FOR OTHER USERS Bitcoin exchanges hold Bitcoins in escrow for their clients and as such there would be no tax implications directly related to Bitcoins. Futhermore, consumers would merely have to pay taxes on purchased Bitcoins and would have nothing to report in income. Merchants accepting Bitcoins will not have to worry about taxation issues, as the use of Bitcoin payment processors will result in the receipt of Canadian dollars from sales of goods or services for Bitcoins. Merchants not using payment-processing services will treat Bitcoin transactions the same way that Bitcoin miners treat barter transactions. 24

25 PART IV: FINANCIAL REPORTING OF BITCOINS TAXATION VS. FINANCIAL REPORTING In Canada there exists a bit of a paradox with regards to operating a business businesses will generally have different amounts of Net Income for tax purposes than they will report on their financial statements. This is not due to any type of accounting manipulation or fraud; rather it is a result of the different goals of taxation and financial reporting. Items are recognized differently for tax purposes than they are for financial statement purposes because different situations will have different relevance. For example, at the end of each year if you have a holding of Bitcoins that you haven t yet sold, there would be no tax implication as a result of simply holding on to those Bitcoins and your Net Income would remain unaffected. On the flipside, adjustments would be required for financial reporting purposes to ensure that the value of the Bitcoins that you haven t yet sold at the end of the year is correct any adjustments made to the value of the Bitcoins would either increase or reduce your Net Income for the year. Because of these differences in relevance of information, an additional section covering financial reporting issues related to Bitcoins is required for a complete understanding of how Bitcoins can be integrated into the Canadian regulatory and reporting framework. CANADIAN FINANCIAL REPORTING ENVIRONMENT In Canada, businesses are required to prepare financial statements following the guidelines created by the Canandian Institute of Chartered Accountants (CICA). The CICA has created a Handbook that businesses can refer to when preparing financial statements to ensure that they comply with the relevant standards and requirements. There are several parts of this Handbook, two of which are of importance in our analysis of Bitcoin financial reporting. These two parts are: Part I International Financial Reporting Standards Part II Accounting Standards for Private Enterprises In Canada, the type of business you own will determine which of the two parts will be used in guiding you while you prepare your financial statements. Part I contains all the relevant information for compliance with International Financial Reporting Standards (IFRS), which is the required standard for all Canadian companies that are publicly traded. Part II contains the Accounting Standards for Private Enterprises (ASPE), which as you may have guessed is applicable to any privately controlled Canadian corporation. A privately held Canadian 25

26 corporation may elect to use IFRS as its reporting standard, however it is generally more complex and expensive for smaller, private companies to implement. In our analysis of financial reporting for Bitcoin, we will look at both IFRS and ASPE, as they are of equal importance for our purposes. GOALS The goals of Part IV of this report are as follows: To accurately define Bitcoins for financial reporting purposes To identify what businesses may include Bitcoins in their financial statements To offer guidance in classifying Bitcoins in the financial statements of various types of businesses that may need to report them based on ASPE and IFRS reporting requirements BITCOIN - A FINANCIAL REPORTING DEFINITION Up until this point, we have looked at a brief technical explanation of what Bitcoins are, how they are created and how they are used and traded. We have also learned who uses Bitcoins in Canada and the tax implications of their activities. As we have just seen, taxation and financial reporting vary significantly in their goals and relevance of information. What we have yet to do is establish a proper definition of Bitcoins that can be used by preparers of financial statements to accurately and succinctly explain what Bitcoins are to the readers of their financial statements. The International Accounting Standards Board (IASB) states that a fundamental qualitative characteristic of financial statements is relevance, and that an enhancing qualitative characteristic of financial statements is to provide the users with understandability these will be our goals while defining Bitcoins for financial reporting purposes. We want to keep our definition of Bitcoins relevant, that is, to ensure that our explanation and definition of Bitcoins is relevant to the financial statements. Although Bitcoin is widely regarding as a virtual/digital/alternative currency, it cannot be treated exactly the same way as a foreign currency due to the several differences in the creation and use of Bitcoins versus traditional currencies. As such, it can be regarded as a hybrid digital currency since it is not necessarily a commodity, nor is it a recognized currency. 26

27 Keeping the goals of relevance and understandability in mind and given all that we have seen about Bitcoins so far, the following definition of Bitcoins is proposed for use in financial reports: Bitcoin: A digital hybrid currency that is limited in supply, created and traded through open-source software and used as both a means of exchange and a store of value. This is a definition that is relevant to financial statements as it explains what Bitcoins are, how they are created and traded and what they are primarily used for. In terms of understandability, there are no terms in the definition that will be unfamiliar to even the most casual investor and while further research may be required, operating with the knowledge gained solely from that definition will allow the reader of the financial statements to understand how the Bitcoins are being reflected and used for. COMPANIES THAT WILL REPORT BITCOINS We have already taken a look at the users of Bitcoins in Canada and from that, we can gather that there will be several different types of businesses reporting Bitcoins in their financial statements. The potential reporting entities are as follows: Bitcoin Resellers o Their main business activity consists of buying and selling Bitcoins, so the implications are important Bitcoin Exchanges o They will hold Bitcoin balances in escrow and this must be reflected in their financial statements Bitcoin Payment Processors o They will hold Bitcoin balances while they wait to convert the Bitcoins for fiat currency Bitcoin Miners o A company that exists to mine Bitcoins will have significant financial reporting issues related to Bitcoins BITCOIN CLASSIFICATION IFRS In order to determine the best way to classify Bitcoins under the IFRS standards, we will identify the main uses of Bitcoins and then link them to the relevant IFRS standards that are already in existence. Bitcoins will effectively have two different purposes for companies: they will either be held as an investment with the hope of earning returns in the form of future increases in the value of Bitcoins, 27

28 or companies will hold Bitcoins with the goal of reselling them for a profit in the course of their regular business. We know that Bitcoin resellers, payment processors and some miners would likely want to resell Bitcoins to earn a profit rather quickly as this is the nature of their business, while some other miners and other companies may want to hold on to their Bitcoins for a little while and hope to profit off of the increases in value. As such, we derive two classifications: Bitcoins held as an investment Bitcoins held for immediate resale BITCOINS HELD AS AN INVESTMENT Classification If an entity is holding Bitcoins for investment purposes, we will want to see if Bitcoin can be considered as a financial asset under IFRS reporting. Holding Bitcoins as an investment would mean that the Bitcoins are not available-for-sale and are not being held as inventory, but rather they are being held to earn a return. IAS 32 defines a financial asset as any asset that is: a) Cash; b) An equity instrument of another entity; c) A contractual right: (i) to receive cash or another financial asset from another entity; or (ii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity; or d) A contract that will or may be settled in the entity's own equity instruments As we can see, Bitcoins do not fit within that definition. However, we must consider the goals of financial reporting (relevance and understandability). Bitcoins held as an investment are very similar in nature to investing in an equity instrument of another entity because in both cases: a) Gains are earned on the changes in value b) They are held for the sole non-strategic purpose of earning a return It could therefore be argued that Bitcoins are most fairly represented in financial statements as a financial asset if they are being held for investment purposes. 28

29 Reporting If we can argue that Bitcoins held as an investment are most accurately represented as financial assets under IAS 32, then we look to IFRS 9 for guidance on recording Bitcoins in financial statements. Initial Recognition According to IFRS 9, when we first acquire Bitcoins we must measure Bitcoins at their fair value through profit or loss (FVTPL). This means that on the date that Bitcoins are acquired, they will be recorded as a financial asset at the market value at the date of acquisition. Subsequent Periods At every year-end, the Bitcoins will then be remeasured on the financial statements at their fair value on the year-end date. That means that at the end of every financial reporting period, Bitcoins will be reflected in the Statement of Financial Position at their fair value any increases or decreases in the originally recorded value will be recognized as gains or losses in the Statement of Operations. Sale of Bitcoins When Bitcoins are sold, the gain/loss recognized on the sale of Bitcoins will be based on the last recorded fair value on the Statement of Financial Position, with the gain/loss being recognized in the Statement of Operations. BITCOINS HELD FOR IMMEDIATE RESALE For a company that is not investing in Bitcoins but actually holding them for sale soon after their acquisition, recording Bitcoins as financial assets may not be the most accurate method of financial reporting. In this sense, Bitcoins are less like securities but more like inventory. Classification IAS 2 deals with inventories, and sets out the following definition for them, stating that inventories are assets: a) held for sale in the ordinary course of business; b) in the process of production for such sale; or 29

30 c) in the form of materials or supplies to be consumed in the production process or in the rendering of services. As we can see, some companies may want to record Bitcoins as inventory using this definition, particularly resellers, payment processors and some miners. In their cases, Bitcoins are clearly being held for sale in the ordinary course of business. Reporting Initial Recognition Inventories of Bitcoins shall be measured at the lower of their cost and their net realizable value. These are two important concepts, as the amounts could be very different. IAS two defines costs as all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. Using this definition, a miner would record his Bitcoin inventories at the cost of mining them including the market price of Bitcoins at the date they were mined as well as any electricity and other production costs. A Bitcoin reseller or payment processor would use the purchase price of the Bitcoins as a cost. The concept of net realizable value (NRV) is that the NRV of Bitcoins is the amount of money that would be received for the Bitcoins on the date that the financial statements are prepared. This could potentially be a lot greater than the cost of the Bitcoins. For example, if a reseller purchased Bitcoins for $10 and still didn t sell them, but at the end of the year they were worth $20, there is a substantial unrealized gain. Recording Bitcoins as inventory means that this gain would not be recognized until the Bitcoins are sold. Subsequent Periods If Bitcoins are unsold at the end of the year, they will be remeasured at the lower of their cost and NRV at the end of the reporting period. This will only change the value of Bitcoins if the market price has dropped below the cost of acquiring the Bitcoins. Sale of Bitcoins When Bitcoins are sold from inventory, the value of inventoried Bitcoins will be treated as an expense that will offset the revenues earned from selling the Bitcoins. As such, the Bitcoins will be removed from the company s inventory and profit will be recognized. 30

31 BITCOIN CLASSIFICATION ASPE Under ASPE, we will keep the same two classifications for Bitcoins: Bitcoins held as an investment Bitcoins held for immediate resale BITCOINS HELD AS AN INVESTMENT Classification If an entity is holding Bitcoins for investment purposes, we will want to see if Bitcoin can be considered as a financial asset under ASPE reporting. Section 3856 of the CICA HB defines a financial asset in the exact same way that IFRS does. As such, it could therefore be argued that Bitcoins are most fairly represented in financial statements as a financial asset if they are being held for investment purposes. Reporting If we can argue that Bitcoins held as an investment are most accurately represented as financial assets as per Section 3856, then measurement will be as follows: Initial Recognition According to Section 3856, when we first acquire Bitcoins we must measure Bitcoins at their fair value. This means that on the date that Bitcoins are acquired, they will be recorded as a financial asset at the market value at the date of acquisition. Subsequent Periods At every year-end, the Bitcoins will measured at their original cost less any reduction for impairment. The Bitcoins will only be impaired if the market value at year-end is less than the cost at which the Bitcoins were initially acquired. There is an optional election for companies under ASPE that will allow them to record their financial assets at subsequent periods at fair value, like is done under IFRS. If a company elects to do so, their decision is irrevocable and at every year-end the increase/decrease in fair value will be recorded as a gain/loss on the Income Statement. 31

32 Sale of Bitcoins When Bitcoins are sold, the gain/loss recognized on the sale of Bitcoins will be based on the last recorded fair value on the Balance Sheet, with the gain/loss being recognized in the Income Statement. BITCOINS HELD FOR IMMEDIATE RESALE For a company that is not investing in Bitcoins but actually holding them for sale soon after their acquisition, recording Bitcoins as financial assets may not be the most accurate method of financial reporting. In this sense, Bitcoins are less like securities but more like inventory. Classification Section 3031 deals with inventories and has an identical definition for inventories that IAS 2 does. As such, under ASPE Bitcoins held for resale will also be recognized as inventory. Reporting See the section above for reporting inventories under IFRS, as there are no significant differences between the two standards. CONCLUSION As we can see, we have successfully defined as digital hybrid currency that is limited in supply, created and traded through open-source software and used as both a means of exchange and a store of value. We have also identified the best ways to report Bitcoins. What is clear is that there is a distinct advantage to report Bitcoins as an investment, as any gains will be recognized immediately on the financial statements, however this also means that any losses will also be immediately recognized. Recording Bitcoin as inventory will result in a more conservative approach, however it may reduce net income if gains can t be realized immediately. One important factor to consider is the lack of an official exchange rate for Bitcoins. While the most popular exchange, Mt. Gox, is usually referenced as a source for Bitcoin exchange rates, it is by no means accurate for every currency since most trades are conducted in USD. Furthermore, the intense volatility of Bitcoin values may result in inaccurate valuation of Bitcoins using the fair value method, where historical cost might be most relevant. 32

33 BIBLIOGRAPHY Canada Border Services Agency. Memorandum D : Cross-Border Currency and Monetary Instruments Reporting Print. Canadian Income Tax Act Canadian Excise Tax Act Canadian Institute of Chartered Accountants Handbook: Parts I & II MacTaggart, Murdoch. "Introduction to Cryptography, Part 3: Asymmetric Cryptography." DeveloperWorks. IBM, 01 Mar Web. Nakamoto, Satoshi. Bitcoin: A Peer-to-Peer Electronic Cash System Print. European Central Bank. Eurosystem. Virtual Currency Schemes. European Central Bank, Oct Web. 33