Taxpayers who hold TFSAs with large asset balances may fall under the scrutiny of the Canada Revenue Agency (CRA) as part of its ongoing audit program for these accounts. A key concern for the tax agency is whether a taxpayer is carrying on the business of day trading, a determination that would lead the CRA to tax any income earned in the TFSA as business income.
“Although the majority of those who use the TFSA as an investment vehicle do so in accordance with the law, some may use these accounts contrary to the spirit of the legislation in order to reduce the amount of taxes they owe significantly,” says Zoltan Csepregi, senior media relations advisor with the CRA.
The CRA has not specified an asset level above which it will flag a TFSA for review. Rather, the agency reviews TFSAs “with holdings several times greater than the contribution limit,” Csepregi says.
Earlier this year, the CRA announced that it had identified $75 million in taxes owing as a result of its TFSA audit program since 2011. The majority of this amount involves taxpayers who used prohibited investments, swap transactions and other “abusive” manoeuvers to build up balances of more than $1 million in their TFSAs.
Certain anti-avoidance rules – a.k.a. the advantage rules – were introduced in 2009 to help prevent the use of some of these strategies, which together are the primary focus of the CRA’s TFSA audit program. However, about 20% of the $75-million audit amount arose from individuals found to be carrying on a business in a TFSA.
The CRA looks at a variety of factors to determine whether a taxpayer’s trading pattern would constitute carrying on a business in a TFSA. These include: frequency of transactions; whether the transactions are speculative in nature; the period of ownership; the taxpayer’s knowledge of the securities market; and the time spent studying the market and the selection of securities.
Most ordinary TFSA holders – including those who might dabble in trading in a modest way – have little reason to be concerned about being deemed to be carrying on a business, says Jamie Golombek, managing director of tax and estate planning with the wealth strategies group at Canadian Imperial Bank of Commerce: “The average person who is not in the securities business and only trades a couple of times a month is probably not at risk.”
Adds Wilmot George, vice president of wealth planning with CI Investments Inc. in Toronto: “The majority of TFSA holders are investing with a mid- to long-term investing horizon in mind when they purchase securities. In those cases, I would suspect investors have less to worry about, as opposed to a professional trader.”
However, if you, as a financial advisor, engage in trading within your personal TFSA, you need to be careful about not tripping over the “carrying on a business” rules, Golombek says. You have knowledge of the securities market and spend time studying it – two of the factors the CRA uses to determine whether a taxpayer may be carrying on the business of trading.
“If you do this for a living, if you do this for clients, the CRA will take a closer look at your particular activity,” Golombek says.
The CRA indicates that there is “nothing unique to TFSAs” regarding the way it determines whether transactions in securities constitute carrying on a business. An individual could be found to be carrying on a business of trading in a non-registered account, for example.
However, there does appear to be an exception that allows for active trading in an RRSP or RRIF as long as certain conditions are met, Golombek says. In a folio covering the topic of registered plans and qualified investments, the CRA cites certain provisions in the Income Tax Act: “If an RRSP or RRIF were to engage in the business of day trading of various securities, it would not be taxable on the income derived from that business, provided that the trading activities were limited to the buying and selling of qualified investments.”
“Qualified” investments include most securities that are traded on designated exchanges; mutual funds and segregated funds; Canada Savings Bonds and provincial savings bonds; and certain other investments.
The intent of the CRA’s TFSA audit program is to ensure everyone is paying the taxes they owe, Csepregi says. “There is a small number of individuals using [TFSAs] in aggressive tax planning,” he says. “That’s not right, and the CRA is taking action to crack down on these individuals.”
However, Timothy Clarke, senior tax counsel with QED Tax Law Corp. in Vancouver, takes issue with the CRA’s focus on “high-risk” TFSAs. He contends that the agency appears to be specifically targeting taxpayers who have had success growing their assets in these accounts.
The CRA’s use of provisions such as the “advantage” and “carrying on a business” rules against larger TFSAs, Clarke says, has the effect of treating TFSA holders “as if there’s a limit that you can make in your TFSA that’s tax-free – which is ridiculous.”
The legislation that governs TFSAs doesn’t specify a maximum amount a taxpayer may earn in the plan.
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