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ARTICLE

Understanding Crypto Fraud and Scams: Protecting Your Investments

Cryptocurrency has revolutionized the financial world, offering new opportunities for investment and innovation. However, with these opportunities come risks, particularly in the form of crypto fraud and scams. Understanding these threats is crucial for anyone involved in the crypto market. This blog will explore common types of crypto fraud, how they operate, and tips to protect yourself.

 

Cryptocurrency Digital Assets
Cryptocurrency Digital Assets

Common Types of Crypto Fraud and Scams

 

  1. Pump-and-Dump Schemes


    How It Works: Fraudsters artificially inflate the price of a cryptocurrency (the "pump") through misleading claims, hype, or coordinated buying. Once the price peaks, they sell off their holdings (the "dump"), causing the price to crash and leaving unsuspecting investors with significant losses.

 

Example: A group of promoters might spread false news about a new partnership or technological breakthrough to drive up the price of a little-known cryptocurrency.

 

  1. Pig Butchering Scams


    How It Works: Scammers build a relationship with the victim, convincing them to invest in a fake crypto trading platform that appears to generate high returns. Once the victim invests significant funds, the scammer disappears, and the victim cannot withdraw their money.

 

Example: A scammer might pose as a financial advisor or romantic interest, gradually gaining the victim's trust before introducing them to the fake platform.

 

Still, specific options may be available for crypto scam victims to reduce their tax burden by claiming the crypto losses.

 

 

Business Losses Arising from Crypto Transactions

 

Business losses arising from crypto transactions (or from any other transactions) can be deducted against non-capital income, with losses earned after 2005 eligible to be carried forward for 20 years and back three years. For instance, a business loss from 2018 can offset income from 2015 to 2038. However, only 50% (66.67% after June 25, 2024) of capital losses are deductible, and these can only offset capital gains. Capital losses can be carried forward indefinitely or back three years.

When determining whether cryptocurrency transactions result in capital gains or business income, courts consider various factors, including:

  • Transaction frequency/volume: High frequency or quick turnover suggests a business.

  • Length of ownership: Brief holding periods point to business activities rather than capital investing.

  • Knowledge of markets: Advanced knowledge or experience in cryptocurrency markets favours a business characterization.

  • Relationship to other work: Cryptocurrency transactions linked to a taxpayer's primary business or job suggest business activity.

  • Time spent: Significant time spent researching cryptocurrency markets leans toward a business assessment.

The taxpayer's intent when acquiring cryptocurrency is the key criterion for distinguishing between capital gains and business income. Courts assess intent by examining objective factors, such as the purchase and sale circumstances, along with the factors listed above. This comprehensive evaluation determines whether the gains or losses are capital or business-related.

 

Capital Losses Due to Involuntary Disposition


Under the Canadian Income Tax Act, a taxable event occurs when a property is disposed of, either voluntarily, such as through a sale or gift, or involuntarily, such as through theft, destruction, or expropriation.

If a taxpayer loses cryptocurrency to a pump-and-dump or pig butchering scam, it is treated as an involuntary disposition, with the proceeds of disposition valued at zero dollars. The victim can claim half (66.67% after June 25, 2024) of the cost of the lost cryptocurrency as a capital loss.

For involuntary dispositions, the Income Tax Act specifies rules to determine the timing of the disposition. The property is considered disposed of on the earliest of the following dates:


  • The day the taxpayer agrees to an amount as full compensation for the lost property;

  • The day compensation is finalized by a tribunal or court, if a claim has been made; or

  • Two years after the loss, if no claim is made before a tribunal or court.


These provisions ensure clarity in determining the timing and treatment of involuntary dispositions for tax purposes, particularly for situations like stolen cryptocurrency.

 

What Position Should a Crypto Fraud Victim Take Regarding the Losses?


While claiming business losses would be more advantageous—and most victims intended to trade when engaging with the fake websites—a key challenge is that no actual transactions occurred on these fraudulent platforms.

For capital losses due to involuntary disposition, victims must wait two years to claim the losses if no compensation is provided by a third party or tribunal. As a result, it is strongly advised that victims of pig butchering or pump-and-dump scams consult an experienced Canadian cryptocurrency tax lawyer to identify the best approach to minimize their tax liabilities.

 

 

FAQ:

What's the legal test for business losses vs. capital losses in crypto fraud such as pig butchering or pump-and-dump scams?


To determine whether a pig butchering scam victim engaged in an adventure in the nature of trade, which could support a business losses claim, Canadian case law examines the taxpayer's intention at the time of purchasing cryptocurrency. This intention is assessed based on several factors:

  • Transaction frequency or volume: Frequent or high-volume trading indicates a business activity.

  • Length of ownership: Short holding periods suggest trading rather than long-term investing.

  • Knowledge of cryptocurrency markets: Advanced understanding or expertise supports a business characterization.

  • Relationship to other work: Connections between cryptocurrency activities and the taxpayer's primary job or business point to trading motives.

  • Time spent on activities: Substantial time devoted to cryptocurrency dealings leans toward a business operation.

These factors collectively help establish whether the taxpayer's activities were conducted with the intent of trading, thereby qualifying for business loss treatment.

 

When can a taxpayer claim capital losses from an involuntary disposition?


A taxpayer can typically claim capital losses from an involuntary disposition on the earliest of the following dates:

 

  • The date the taxpayer agrees to a full compensation amount for the destroyed or taken property.

  • The date a tribunal or court finalizes the compensation amount, if a claim has been made.

  • Two years after the property was destroyed or taken, if no claim has been filed with a tribunal or court.

 

 

This article provides a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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