Depositing money into a bank means lending that money to the bank, and, in exchange, the bank gives you interest. Yield farming or liquidity mining (these are different terms for the same thing) means lending cryptocurrency to a new crypto platform wanting to raise capital.
The lender often gets interest payments for doing this or might get a share of the platform’s transaction fees instead. They will usually also get units of the new cryptocurrency in question to thank them for investing in a new platform.
With some reward tokens, the owners vote on the protocols of the new cryptocurrency platform, even though these tokens may not be traded. This means many people offering their liquidity hope the new platform does well and, therefore, the tokens they hold will increase in value. This, of course, means a significant payoff if everything goes well.
By now, you’re wondering what the tax implications of such a trade will be. And if you make money on such a trade, does that count as capital gains, investment income or business income?
The Income Tax Act in Canada has different rules for each type of income, so yield farmers or liquidity miners can understandably be confused about what taxes, if any, they will have to pay and how to report these earnings.
Canadian citizens must pay tax on ‘taxable income,’ which is their annual income minus any deductions from the Income Tax Act Division C section, such as policy-based deductions, tax-relief provisions, etc.
Annual income comprises small business deduction tax credits for a Canadian-controlled private corporation’s business income, investment income but not business income and a private corporation’s investment income but not business income.
Investment Income vs. Business Income vs. Capital Gains
Investment income and business income are treated similarly concerning taxation, although capital gains taxes are different. Investment income and business income are 100% taxable, while capital gains income is only 50% taxable. On the other hand, investment and business losses are 100% deductible against any income source, but only 50% of capital gains losses are deductible.
Income from property refers to income coming from property. For example, bonds will yield interest, and shares will yield dividends. Real property yields rent, and intellectual property can yield royalties. This means investment income is passive and comes from you simply owning the property in question. You don’t have to put any time or effort into maintaining these properties. If you buy public shares and earn some dividends, this counts as an investment income because you’re earning from them without putting time or effort into this share ownership.
Business income is different because this does require some degree of time and effort. So, let’s say an investment dealer can buy and manage a public shares portfolio. Any revenues as a result of this is business income since a ‘business’ is defined by Canadian law as something that has activity as well as the motive of turning over a profit. A business typically includes activity, entrepreneurship, enterprise, and some commercial risk. Making a profit is often the main factor that sets a business apart from a pastime or hobby.
This means investment and business income are differentiated according to the activity that goes into earning the income. So just using a property doesn’t define what kind of income it’s yielding. A taxpayer who manages a restaurant and one who leases out their spare bedroom are both technically making money from their property. Without the property in question, they wouldn’t be earning on it. In this scenario, the restaurant manager will be earning a business income, and the spare bedroom renter will be earning an investment income or property income.
The use of property can result in investment or business income, but capital gains income is again different. Income from property does not include a gain resulting in selling the income-generating property. A loss from the property, in the same vein, would not involve a loss upon selling it. So, if you sell your house after renting a room out, the profit you make will not be characterized as investment income for your tax return. It will either be a business income or a capital gain. Capital gains mean a disposition of the investment constituting a capital property. The Income Tax Act in Canada only recognizes two types of properties when it comes to taxation:
- Inventory figuring into a business income computation, and
- Capital property which would result in a gain or loss if sold
Many more factors must be considered when it comes to liquidity mining, which is why it’s well worth seeking professional advice from our expert tax consultants who are well-versed in Canadian law.
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