Formerly considered a gimmick for geeks and gamers, digital currencies, such as Bitcoin, have since grown into a worldwide phenomenon that now garner significant public attention. Among the interested parties are both regulators and governments, including, recently, the Senate of Canada (Canada’s Upper House of Parliament). Pursuant to its investigative mandate, this past summer the Senate Committee on Banking, Trade and Commerce completed an assessment of the challenges and opportunities associated with digital currencies, publishing its findings in a report entitled “Digital Currency: You Can’t Flip This Coin!

The report, the result of mass consultation among experts and industry, concludes that the benefits of digital currencies largely outweigh the risks. For this reason, the report recommends that the Canadian government exercise a “light regulatory touch” and create an environment that fosters innovation for digital currencies and their associated technologies to flourish.

Although the report represents the opinion of the Senate alone, it does offer an idea of one possible direction the government may take. This is especially true given that the previous federal government had opted to wait on the Senate’s findings before undertaking to pursue or develop an agenda on digital currencies writ large. A new federal government was elected at the end of October and it remains to be seen whether it will adopt the Senate position on digital currencies. With that said, Senate reports are generally considered highly authoritative and are typically received quite favourably by the House of Commons in its deliberations. The new Liberal government is therefore likely to give considerable weight to the Senate position, which advocates for a hands-off regulatory approach, recommending that the government only develop digital currency legislation as and when issues arise.

Legal risks and possible government responses

The report identifies a number of legal risks associated with digital currencies including money laundering, terrorist financing, and tax evasion. The report highlights the fact that the anonymity of digital currencies makes them particularly conducive to illicit activities. It suggests that such activity is best detected at the “on and off ramps” of digital currency exchanges - the site at which digital currency is converted from, or into, state-issued currency. On this basis, the report recommends that the federal government require digital currency exchanges to meet the same requirements as money service businesses in terms of client identification.

The report also recommends that the federal government work with other countries to develop global guidelines on digital currencies, keeping in mind the need to maintain a regulatory light touch. If acted upon, this recommendation signals the start of a wider movement to regulate digital currencies globally and may foreshadow the development of a global regulatory framework or perhaps even an international treaty. Such developments are likely to take time, however, but any eventual international consensus will have implications for the regulatory environment in Canada. Savvy businesses are therefore wise to monitor such developments closely.

Tax implications of digital currencies

Conveniently, the report also summarizes the position of government departments and agencies on the tax implications of digital currencies.  Of note, the Department of Finance favours minimal regulation to avoid stifling innovation, a view shared by the Royal Canadian Mounted Police. This supports the Senate’s call for light regulation and, in turn, suggests that the Canadian government will likely opt to manage digital currencies through the existing tax structure.  The report further recommends that the federal government provide concise information on the tax obligations of digital currencies, but provides no additional prescriptions of what those obligations might be. The report does include the opinions of the Department of Finance and the Canada Revenue Agency, which may be instructive. In particular, the two parties said that they intend to treat digital currencies as either property or a commodity for income tax purposes, making digital currency investments subject to the rules of capital gain and loss. As a consequence, businesses involved in digital currency transactions should expect similar tax treatment as applies to transactions involving regular state-issued currencies.

Conclusion

The Senate appears optimistic about the potential of digital currencies in Canada, but cautions against knee-jerk regulation that is driven by the fear of uncertainty. Instead, the Senate calls for a hands-off regulatory approach, which, if followed, means that digital currencies will continue to operate relatively free from regulation for the foreseeable future.