Authors: Jason Heath, Cfp
Fareed Ahamed is an investment advisor in Vancouver who opened a tax-free savings account (TFSA) in 2009, when it was first introduced by the federal government. By the end of 2011, his $15,000 of contributions had grown to over $600,000. He was trading speculative penny stocks, mostly in the junior mining sector, with relatively short holding periods.
Canada Revenue Agency (CRA) took the position that Ahamed’s trading activity constituted a business from 2009 to 2013, and that the profits, despite being inside a TFSA, were in fact taxable. In a recent Tax Court of Canada decision, Justice David E. Spiro validated the CRA’s interpretation, though the taxpayer is appealing the ruling.
What does the CRA consider day trading in a TFSA?
CRA has previously contended that securities transactions may not always be on account of capital and may be considered income if the taxpayer is deemed to be carrying on a business.
According to the CRA, “some of the factors to be considered in ascertaining whether the taxpayer’s course of conduct indicates the carrying on of a business are as follows:
- frequency of transactions—a history of extensive buying and selling of securities or of a quick turnover of properties,
- period of ownership—securities are usually owned only for a short period of time,
- knowledge of securities markets—the taxpayer has some knowledge of or experience in the securities markets,
- security transactions form a part of a taxpayer’s ordinary business,
- time spent—a substantial part of the taxpayer’s time is spent studying the securities markets and investigating potential purchases,
- financing—security purchases are financed primarily on margin or by some other form of debt,
- advertising—the taxpayer has advertised or otherwise made it known that he is willing to purchase securities, and
- in the case of shares, their nature—normally speculative in nature or of a non-dividend type.”
It bears mentioning that none of the individual factors alone is typically sufficient to cause a taxpayer’s trading to be treated as a business, but rather, the combination of factors needs to be considered.
Day-trading income within non-registered accounts
If a taxpayer is deemed to be carrying on a business in their non-registered account, profits will be fully taxable as business income, instead of as a capital gain with only 50% taxable. This at least doubles the resulting tax payable—maybe more if the higher income inclusion pushes the taxpayer into a higher tax bracket.
This tax treatment can apply to currencies, including cryptocurrencies. It can also apply to short sellers who sell a stock short, as well as to profit when they buy back the stock at a lower price.
Some of a taxpayer’s trading activities may be considered on account of income (business income treatment) while others on account of capital (capital gains tax treatment). This might apply if they have an account that is actively traded and another that is less active, for example.
Day-trading income within tax-free savings accounts
The Ahamed decision, though it is being appealed, is a warning for other investors who engage in day trading or other speculative activities in a TFSA.
Doing so risks having otherwise tax-free income and profits subject to full taxation as business income, along with associated interest and penalties if that income is added to a previous year’s tax return in a subsequent year.
Other registered retirement accounts
Registered retirement savings plans (RRSPs), registered retirement income funds (RRIFs), and similar registered retirement accounts are exempt from the business income taxation of trading.
According to the CRA, “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 cash, bonds, guaranteed investment certificates (GICs), stocks, mutual funds, exchange traded funds, warrants and options, foreign exchange, gold and silver, and other listed securities and investment funds.
This day trading exemption for RRSPs may seem like good news at first. But it may be less so when you consider why the CRA exempts these accounts.
Because RRSP accounts are eventually subject to the RRIF minimum withdrawal requirements starting no later than age 72 and are fully taxable on death (unless left to an eligible beneficiary like a spouse or financially dependent minor child or grandchild), the CRA will get their tax eventually. Growing your RRSP or RRIF account by day trading, if you are successful, means a larger tax liability is looming in the future since withdrawals are fully taxable.
It appears to be that the tax-free nature of TFSAs, and the tax-preferred treatment of capital gains (only 50% taxable), causes TFSA and non-registered accounts to be at risk.
Trading within RESPs
Registered education savings plans (RESPs) are registered accounts, which can be at particular risk if an investor is found to be carrying on a business. According to the CRA, “an RESP is revocable pursuant to paragraph 146.1(2.1)(c) [of the Income Tax Act] if it begins carrying on a business.”
This could cause government grants to become repayable and the accumulated income to be taxable in addition to a 20% penalty tax.
Should traders become corporations?
The CRA has confirmed that a “trading business may be considered an ‘active business’ and any gains or losses, as well as any interest or dividend income . . . could be entitled to the small business deduction.” One benefit of incorporation is a day trader may be able to take advantage of the low tax rate on small business income.
The small business rate ranges from 9% to 12.2% currently depending on the province or territory, which is much less than even the lowest personal tax rate.
Should you trade within your investment accounts?
TFSA contributions and balances are reported by financial institutions to the CRA each year. This makes large TFSA balances and large gains in TFSAs easy to identify. The CRA is auditing taxpayers who may have been day trading in their TFSAs and will continue to do so.
Taxpayers should be aware of the tax implications of day trading and how this may impact different accounts. Investors should consider the risks of day trading.
This article was written by Jason Heath and Cfp from MoneySense and was legally licensed through the Industry Dive Content Marketplace. Please direct all licensing questions to firstname.lastname@example.org.