May 31, 2019
TAX FREE SAVINGS ACCOUNT - Issues Regarding Day Trading
Tax-free savings account holders will now be ultimately liable for any tax owing on income earned in a TFSA if the Canada Revenue Agency (CRA) determines that the holder has been carrying on a business of day trading in the account, according to the changes made by the Federal government in it's last budget March 2019.
Under the old legislation, if a tax liability arises from the carrying on of a business in a TFSA, the TFSA itself and the financial institution that issued that TFSA was “joint and severally” liable for the tax owing, but not the account holder.
IIAC member institutions that issued TFSAs were concerned about being on the hook for the tax liability in cases where there were insufficient funds in a client’s TFSA to cover the liability, or in situations where the TFSA had been transferred out of the institution.
“What the budget measure does is provide clarity in terms of which party is responsible for that liability [related to tax owing for carrying on a business in a TFSA],” Rando says. “It ensures that the liability will follow the [TFSA holder] taxpayer.”
Normally, income earned in a TFSA, and any withdrawals from the account, are free of tax. However, if the CRA determines that a taxpayer has been carrying on a business in a TFSA, that account is liable for tax owing on income earned in the account.
In the 2019 budget, the federal government proposed that the joint and several liability of a trustee of a TFSA in regard to business income earned would be limited to the property held in the TFSA only.
“The TFSA issuer remains liable to the extent of the money in the TFSA, [but] if there are insufficient assets in the TFSA to cover that tax bill, the holder now becomes liable,” says Wilmot George, vice president of tax, retirement and estate planning with CI Investments Inc.
In the budget document, the government was making the change “to recognize that a TFSA’s holder is typically in the best position to know whether the activities of the TFSA constitute carrying on a business.” The government indicated that its proposed measure would apply to the 2019 and subsequent taxation years.
George says that government’s changes makes sense.
“The financial institution is acting in good faith along the way, and ultimately it’s the TFSA holder’s TFSA,” George says. “If the holder is conducting activity that would render the TFSA to be carrying on a business, the TFSA holder along with the TFSA [itself] should have to manage that tax liability because the financial institution might not even realize that [the TFSA] is carrying on a business.”
In recent years, the CRA has been looking closely at high-value TFSAs, in particular whether trading activity in these accounts amounts to carrying on a business of trading. According to the CRA, as of Dec. 31, 2018, it had assessed approximately $114 million in taxes resulting from its audits of TFSAs between 2009 and 2017, some of which was related to TFSAs being determined to be carrying on a business.
The CRA has said that it looks to set of factors to determine whether a TFSA has been carrying on a business, including the frequency of trading, whether the TFSA holder has specialized knowledge of the markets, and the time the TFSA holder spends on researching trades. The government did not provide any additional guidance to taxpayers of what it considers to be carrying on a business, something the IIAC and certain tax practitioners have long asked for, in the 2019 budget.
Day Trading Court Case - For Criteria
So since the government didn't provide any further guidance on day trading here is a good summary from another member Jamie.Golombek CPA, CA on this issue as follows;
The factors that the CRA looks at include: the frequency of the transaction; the duration of the holdings; the intention to acquire the securities for resale at a profit; the nature and quantity of the securities; and the time spent on the activity.
For an example of how the CRA applies these factors to an individual’s particular circumstances, let’s take a look at the recent case of a taxpayer who found himself arguing for capital gains treatment in the face of a CRA reassessment.
The taxpayer, a certified financial analyst, was the co-head of institutional trading at a Canadian investment firm and an investment industry veteran with over 25 years of experience. He was licensed by securities regulators in several Canadian and U.S. jurisdictions, including as a trader and dealer in securities.
In the first two months of 2009, he liquidated his holdings in both of his brokerage accounts and converted them to cash. He testified he did this because he originally intended to pay down his mortgage when it was scheduled to renew. Instead, he saw “an unprecedented opportunity to invest in stocks that met his investment criteria given that the market was considered by many to have bottomed out in its decline during the financial crisis that started to hit the markets in 2008.”
In the remaining ten months of 2009, he bought and sold stocks of 34 issuers costing about $2,500,000, involving 38 purchase transactions and 50 sale transactions, realizing a total gain of about $550,000. His average hold period of stocks was about 50 days and his average return on any particular stock was about 30 per cent.
He testified that he gleaned information on the markets from his day job, even though he did not necessarily need to know this information to do his job. In addition, he estimated he spent about 45 minutes daily reading and watching business and market news. He also followed market analysts and research.
In five cases, he sold his stock positions within the first week of buying them. In ten cases, sales began within 30 days of purchase and in 20 cases, within 60 days. In at least one other case, he started selling the day after he bought – even before his purchase settled – for a gain of less than 1 per cent. In his Canadian account, the longest hold period was 274 days while in his U.S. account, the longest hold period was under 30 days.
The taxpayer reported the $550,000 profit on his 2009 personal tax return as a capital gain but was reassessed by the CRA as business income on the basis that the taxpayer was buying and selling securities as either a business activity or as an “adventure in the nature of trade.”
In court, the taxpayer testified that his investment strategy has always been to invest in diversified securities that he feels have the potential for 30 per cent returns, including distributions and growth, within what he thinks will be a “certain reasonable time frame.”
The judge quoted prior jurisprudence which stated that “All of these cases turn on their own facts and illustrate the importance of the factual underpinning that supports a finding that a person has crossed the line from investing to trading.”
Or, as tax law professor Vern Krishna wrote in his monumental tome on tax principles, “Was the taxpayer intending to trade (do business) or invest (hold property)?”
Weighing all the evidence, the judge concluded that the taxpayer was trading in the securities as a business activity, or, at the very least, was buying and selling the securities as part of an adventure in the nature of trade. He reached this conclusion by considering that the taxpayer’s primary intention when purchasing the securities was to sell them at a profit as soon as a reasonable return could be realized. The taxpayer also spent “considerable time” daily monitoring markets beyond what he testified was required for his job. He was buying and selling regularly throughout the year and his holding periods were “clearly short and often very, very short.”
As a result, the judge held the taxpayer’s profits to be 100 per cent taxable as business income.
So beware of significant short term trades in your TFSA or else a surprise may arise to you!
By Peter Wiesner CPA, CA