Stop using your TFSA to frequently trade stocks — the CRA may consider it taxable business income

Jamie Golombek: You might be surprised to learn that your trading activity could constitute a business, even if it’s done in a tax-free savings account.

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Whether you invest in stocks, bonds or mutual funds, you generally expect any profits made on the sale of these securities to be taxed as capital gains at 50% of your tax rate. marginal rather than being 100% taxable as business income. But, depending on your particular situation, you may be surprised to learn that your trading activity could constitute a business, even if it is done inside a tax-free savings account.

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Under the tax rules, if a TFSA carries on a business, then it must pay tax on its business income. This has been the focus of recent audit and reassessment activities where the Canada Revenue Agency has targeted taxpayers who have actively traded securities in their TFSA.

Last week, at the Society of Trust and Estate Practitioners annual conference in Toronto, the CRA was asked to provide an update on the outcome of its audits and whether it had any plans to educate the public on acceptable limits on securities transactions to prevent a TFSA account from being considered “the carrying on of a business”.

The CRA said “millions of additional taxes have been recovered as a result of TFSA audits” and referenced a recently released income tax folio that says “the determination of whether a particular taxpayer is carrying on a particular business is a question of fact that can only be determined after an examination of the taxpayer’s particular circumstances.

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The CRA then cited its Interpretation Bulletin titled “Trading in Securities,” which sets out the court-developed factors that are relevant to determining whether trading in securities constitutes the carrying on of a business. It concludes that “as there is nothing unique about TFSAs in the context of securities trading, it is not intended to provide additional guidance specific to TFSAs”.

So what are the factors that must be considered in determining whether a taxpayer’s gains on securities constitute the carrying on of a business?

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The factors that the CRA looks at include: the frequency of the transaction; the length of detentions; the intention to acquire the securities in order to resell them at a profit; the nature and quantity of securities; and the time devoted to the activity.

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For an example of how the CRA applies these factors to an individual’s particular situation, consider the recent case of a taxpayer who found himself arguing for the treatment of capital gains in the face of a reassessment of the ARC.

The taxpayer, a chartered financial analyst, was the co-head of institutional operations of a Canadian investment firm and a veteran of the investment industry with over 25 years of experience. He has been licensed by securities regulators in several Canadian and US jurisdictions, including as a trader and broker-dealer.

During the first two months of 2009, he liquidated his holdings in his two brokerage accounts and converted them into cash. He testified that he did so because he originally intended to pay off his mortgage at the scheduled renewal. Instead, he saw “an unprecedented opportunity to invest in stocks that met his investment criteria given that the market was seen by many as having bottomed out during the financial crisis that erupted. started hitting the markets in 2008”.

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During the last ten months of 2009, he bought and sold shares of 34 issuers at a cost of approximately $2,500,000, involving 38 buy trades and 50 sell trades, realizing a total gain of approximately $550 $000. His average stock holding period was about 50 days and his average return on a particular stock was about 30%.

He testified that he gleaned market information as part of his day-to-day work, although he did not necessarily need to know this information to do his job. Additionally, he estimated that he spends around 45 minutes a day reading and watching business and market news. He also followed market analysts and studies.

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 his purchase – even before his purchase was settled – for a gain of less than 1%. In his Canadian account, the longest hold period was 274 days, while in his US account, the longest hold period was less than 30 days.

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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 in in the context of a commercial activity or a “Commercial adventure.”

In court, the taxpayer testified that his investment strategy has always been to invest in diversified securities which he believes offer the potential for a 30% return, including distributions and growth, in what he believes to be a “reasonable period of time”.

The judge cited previous case law which stated that “All of these cases stand on their own facts and illustrate the importance of the factual basis that supports the conclusion that a person has crossed the line from investing to trading.”

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Or, as tax law professor Vern Krishna wrote in his monumental book on tax principles: “Did the taxpayer intend to trade (do business) or invest (hold property)?

After weighing all of the evidence, the judge concluded that the taxpayer was trading in the securities in the course of a commercial activity or, at the very least, buying and selling the securities in the context of a commercial risk. He arrived at this conclusion considering that the primary intention of the taxpayer when purchasing the securities was to resell them at a profit as soon as a reasonable return could be realized. The taxpayer also spent “considerable time” monitoring the markets daily beyond what he said was necessary for his job. He bought and sold steadily throughout the year and his holding periods were “clearly short and often very, very short”.

Accordingly, the judge concluded that the taxpayer’s profits were 100% taxable as business income.

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Jamie Golombek, CPA, CA, CFP, CLU, TEP is Managing Director, Tax and Estate Planning at CIBC Wealth Strategies Group in Toronto.

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