The news earlier this month that a former Bay Street trader who has amassed $1.25 million in his tax-free savings account (TFSA) and could be facing a tax bill from the Canada Revenue Agency (CRA) on the profits earned therein may have caused some of your clients to panic and worry that maybe their TFSAs could be under review if they are too successful.
But any fear associated with this revelation is largely unfounded. Indeed, the CRA confirmed that, to date, it "has selected fewer than 1% [of TFSAs] for audit because activity indicated use beyond the legislative intent."
So, what's really going on here? Could your clients really be at risk for a TFSA audit? Could their TFSAs be subject to taxes on their accumulated value simply because clients have done very, very well with their investments?
That's quite unlikely. Rather, what the CRA is curious about, specifically, is whether or not an individual is running a securities trading business inside his or her TFSA.
Under the Income Tax Act, if a TFSA carries on a business, then taxes are payable on the taxable income arising from that business. The CRA stated in a technical interpretation letter published in October 2014 that speculative transactions carried on by an RRSP, RRIF, or a TFSA may be considered to be the operation of a business by the registered plan and could result in such income being subject to taxes.
To date, the CRA hasn't published specific guidelines on what it means to carry on a business inside a TFSA, but most tax professionals will refer you to the traditional factors listed in the CRA's 1984 Interpretation Bulletin entitled Transactions in Securities.
These factors are:
- High volume of trades: How often to you buy/sell securities?
- Short ownership period: Do you hold your securities for a brief period of time?
- Above-average knowledge of the stock market: Do you have specialized knowledge of the markets?
- Do you work in the securities business? Do you trade securities as part of your "day job"?
- Time spent: Do you spend a lot of time studying and researching the market and potential transactions?
- Advertising: Do you advertise to others that you can buy and sell securities on their behalf?
- Speculation. Do you buy speculative, non-dividend paying securities?
Although none of these factors, on their own, is evidence that your clients may be carrying on a business inside their TFSAs, they could face some questions from the CRA once several of these factors exist.
This past February, the Investment Industry Association of Canada (IIAC) sent a letter to the CRA suggesting that it provide a tax alert/factsheet "so that TFSA holders, when placing trades within TFSAs, have the basic information necessary so that they are materially less likely to be considered by the CRA to be carrying on a business."
According to an article published recently by lawyers Lauchlin MacEachern and Tim Clarke of Moodys Gartner Tax Law LLP, both the U.S. and the U.K. have somewhat similar plans to the TFSA but "neither the U.S. nor the U.K. tax authorities have adopted an interpretation similar to the CRA's position on the taxation of TFSAs trading in securities."
Although Bay Street veterans may have some cause for concern, the vast majority of our clients can continue to contribute and invest in their TFSAs without worry that the taxman will come to get them if they're successful.