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If the Canada Revenue Agency sees frequent trading activity in a TFSA, it could argue that your client is running an active trading business, thus subjecting the TFSA to tax on its income and gains. That’s exactly what happened in a recent Tax Court decision.
The case, decided in February, involved a Vancouver-based investment advisor who opened his first TFSA on Jan. 2, 2009. It was self-directed, and all securities purchased and sold were “qualified investments” under the Income Tax Act.
Most of the taxpayer’s TFSA investments were non-dividend paying and speculative in nature, with the majority being penny stocks in the junior mining sector listed on the TSX Venture Exchange. The taxpayer’s TFSA owned most of the shares for brief periods.
The taxpayer contributed the maximum allowable contributions of $5,000 to his TFSA in early January 2009, 2010 and 2011. By Dec. 31, 2011, his TFSA had grown to a fair market value of $617,371. In January 2013, he liquidated the securities in his TFSA and transferred nearly $547,800 to himself on a tax-free basis.
The CRA reassessed the taxpayer’s TFSA for each of the 2009, 2010, 2011 and 2012 taxation years. The agency claimed the TFSA was carrying on a business of trading qualified investments and that its income from each of those years was therefore subject to income tax. The tax assessed was based on taxable income of $44,270 in 2009, $180,190 in 2010, $330,994 in 2011 and $14,027 in 2012.
When determining whether a taxpayer’s gains from securities constitute carrying on a business, the CRA considers a variety of factors, which include: the frequency of the transactions; 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. According to the judge, there was no doubt that, based on the taxpayer’s TFSA trading activity, the taxpayer was indeed conducting a business of active trading in his TFSA.
The consequence of doing so is clearly spelled out in the Income Tax Act, which states that a TFSA is generally exempt from tax on its income, subject to two exceptions: holding non-qualified investments or carrying on a business.
This rule is in direct contrast to the rules governing active trading in an RRSP or RRIF. When it comes to these registered plans, the Income Tax Act exempts both RRSPs and RRIFs from paying tax on business income when that income is derived from investing in qualified investments.
The crux of the taxpayer’s argument was that the rule exempting an RRSP from paying tax on business income from day-trading of qualified investments ought to be applied to a TFSA. He argued that “there could have been no legislative purpose for making a TFSA […] taxable on the income from carrying on a business of trading qualified investments when an RRSP carrying on the very same business is not taxable.”
In responding to this argument, the judge noted the government made a deliberate choice. “Had Parliament also intended to exempt from tax a TFSA’s income from carrying on a particular type of business — trading qualified investments — Parliament would have legislated accordingly, just as it had for RRSPs,” he wrote.
The judge concluded the taxpayer — a professional investor with deep knowledge and experience in the securities market, who traded frequently in shares that were mostly speculative in nature and held for short periods — was carrying on a business of trading in his TFSA. As a result, the TFSA was found to be taxable on its income.
Jamie Golombek, CPA, CA, CFP, CLU, TEP is the Managing Director, Tax & Estate Planning with CIBC Private Wealth in Toronto. Jamie.Golombek@cibc.com
Editor’s note: The advisor has appealed the decision to the Federal Court of Appeal.