The TFSA was designed to encourage Canadians to save over the long term – just as they can using RRSPs – and benefit from tax-free accumulation of income and capital gains. But using a TFSA in a manner other than the way it was intended can land the accountholder in hot water.
The Canada Revenue Agency (CRA) has found that some financial advisors have been engaging in high-frequency or day trading within their TFSAs to boost the value of their accounts, thereby carrying on a securities trading business within those accounts in the eyes of the CRA. And advisors found to be doing so could be on the hook for taxes on the gains.
However, some advisors and others in the investment industry disagree with the CRA’s approach.
The CRA has been auditing high-value TFSAs aggressively to determine whether such gains should be taxed as business income. Earlier this year, the tax agency estimated that it’s owed some $110 million in taxes based on audits of TFSAs.
The maximum cumulative amount an individual could have invested in a TFSA since the account was introduced in 2009 is $57,500. However, some individuals have accumulated gains of 20 or more times the amount invested, largely through the use of ineligible investments. These investment strategies include securities swaps and other prohibited investments; speculative trading; non-arm’s-length transactions; and high-frequency trading of qualified investments.
(Qualified investments within a TFSA include securities listed on a designated stock exchange, investment funds and investment-grade fixed-income securities, such as government bonds.)
Tim Clarke, tax litigation lawyer with QED Tax Law Corp. in Vancouver, says there are no defined values that would prompt the CRA to select a TFSA account for audit. But, he suggests, the accounts audited usually range from “$100,000 to $200,000.”
Advisors, in particular, who have built up substantial value within their own TFSAs are most vulnerable to CRA audits because advisors have experience in the securities market, spend much of their time studying the market and typically conduct securities transactions as part of their business. These three key advantages that advisors have over the average investor may be used by the CRA in its determination that an advisor is carrying on a business within a TFSA.
Other variables the CRA looks at during audits include frequency of transactions, period of ownership of securities, the speculative nature of investments made, whether securities purchases were financed primarily by margin or some other form of debt, and whether the advisor made his or her willingness to purchase securities known to the public.
Heather Holjevac, senior wealth advisor with TriDelta Financial Partners Inc. in Oakville, Ont., says most advisors “are not stock-pickers and typically have a long-term view of the market.” Therefore, they are unlikely to engage in day trading.
Nonetheless, Holjevac believes that advisors who are good at stock-picking and are able to build high-value TFSAs should not be penalized for their investment success: “Their objective is to maximize gains.”
Prem Malik, chartered professional accountant and financial advisor with Queensbury Securities Inc. in Toronto, believes that advisors are less likely than do-it-yourself investors to engage in day trading.
“Most advisors would not [engage in day trading within a TFSA] because they are subject to compliance controls at a firm level,” Malik says.
Yet, if you are inclined to engage in high-frequency trading to enhance the value of your TFSA, you must be aware of CRA stipulations to avoid running afoul of the taxman. You should avoid engaging in trading activities to “such a magnitude that would attract attention,” Holjevac says.
The CRA’s position on carrying on a business doesn’t have merit, Clarke says, adding that the CRA has not published guidelines on what constitutes carrying on a business inside a TFSA. If the intent is to limit the amount of income that a TFSA can earn tax-free, he says, such legislation should be in place.
There is need for a “bright line” test to reduce the uncertainty about what is or isn’t taxable within a TFSA, Clarke adds.
The CRA has issued guidelines on making speculative investments in registered plans, in which case the income derived will be taxable. However, if you engage in day trading of qualified securities within your RRSP, that income will not be taxable. Therefore, the case can be made for the same rules to be applied to TFSAs.
“There is a valid purpose for buying and selling qualified securities within a TFSA,” Clarke says. Thus, in his view, if you engage in day trading within your TFSA, you should not be seen as carrying on a securities business – if you’re trading qualified securities.
Holjevac, for her part, suggests that some advisors evidently have exploited a loophole in the tax law.
She believes the federal government should plug that loophole rather than have the CRA target advisors for audits.