Investors generally expect that profits realized from investment vehicles traded will be taxed at 50% of their marginal tax rate as capital gains. However, there are instances where trading activity can be considered 100% taxable, even if it's done via their tax-free savings accounts (TFSA).
“Under the tax rules, if a TFSA carries on a business then it must pay income tax on its business income,” said Jamie Golombek, managing director of Tax & Estate Planning with CIBC Wealth Strategies Group, in a piece contributed to the Financial Post
According to Golombek, the Canada Revenue Agency (CRA) has been focusing on taxpayers who actively traded securities through their TFSA. At the recently held conference of the Society of Trust and Estate Practitioners, the CRA said “millions of additional taxes have been recovered as a result of audits of TFSAs.”
When asked for guidelines on the acceptable limits on securities trading on a TFSA before it can be seen as “carrying on a business,” the CRA cited a recently released Income Tax Folio saying that it “can only be determined following a review of the taxpayer’s particular circumstances.”
The factors considered in the assessment, according to Golombek, include:
- The frequency of transactions;
- The duration of holdings;
- The intention to acquire securities for resale at a profit;
- The nature and quantity of securities; and
- The time spent on the activity
As an example, he discussed the case of a certified financial analyst who appealed for capital gains treatment in the face of a CRA reassessment.
In early 2009, he liquidated the holdings in both of his brokerage accounts. He said he originally planned to use the cash to pay down his mortgage, but instead saw “an unprecedented opportunity to invest in stocks that met his criteria.”
“In the remaining ten months of 2009, he bought and sold stocks of 34 issuers costing about $2,500,000, involving 38 purchase transactions and 50 sale transactions, realizing a total gain of about $550,000,” Golombek said.
The man’s trades were guided by information he said he happened to learn in his day job following market news, analysts, and research. The average hold period was around 50 days, and the average return on any given stock was around 30%.
The man declared the profit as a capital gain on his 2009 personal tax return. The CRA, however, reassessed it as business income — a decision he tried to appeal in court.
“Weighing all the evidence, the judge concluded that the taxpayer was trading in the securities as a business activity, or, at the very least… as part of an adventure in the nature of trade,” Golombek said. He explained that the judge saw the man’s primary intention was to sell the stocks as soon he could get a decent return.
“As a result, the judge held the taxpayer’s profits to be 100% taxable as business income.”
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