A Tax Court judge has ruled that an investor who trades stocks in their tax-free savings account must pay income tax, opening the door to hefty tax bills for other frequent investors.
Tax Court of Canada Judge David Shapiro ruled that the investor was carrying on a business inside his TFSA, which grew from $15,000 to more than $617,000 over a three-year period. The amount of tax due, and whether interest will be added, were not disclosed.
A TFSA is a registered account that allows Canadians aged 18 and over to currently contribute $6,500 a year and earn tax-free investment income on a wide range of eligible investments, including stocks, bonds, exchange-traded funds and mutual funds. However, a TFSA holder is liable to pay tax under the Income Tax Act if the income is from non-qualified business or investments in the account.
Fareed Ahamed, a licensed investment adviser and the plaintiff in the case, argued that since the Canada Revenue Agency exempts business income from day trading when done in a registered savings plan -retirement, it should also exempt business income accumulated in a TFSA.
However, when Parliament included this rule in the tax law governing RRSPs, TFSAs did not exist.
“Parliament could have adopted, but chose not to adopt, the same legislative approach for TFSAs as for RRSPs and RRIFs,” Justice Shapiro wrote in his ruling. “It further demonstrates that Parliament did not intend to exempt business income from the disposition of qualified investments held in a TFSA.
Tim Clarke, a Vancouver tax lawyer with QED Tax Law Corporation and counsel for Mr. Ahamed, appealed. Mr. Clarke declined to comment on the matter.
Mr. Ahamed is a test case for frequent TFSA transactions for the Tax Court of Canada, an independent tribunal that deals with disputes relating to income tax, goods and services tax and tax. ‘Employment Insurance.
He filed the case in 2015 after the CRA began auditing a number of tax-free savings accounts. Between 2009 and 2017, the agency assessed approximately $114 million in taxes as a result of these audits, of which about 10% came from TFSA accounts considered to be carrying on a business, such as day trading, which can generate high returns. through aggressive securities transactions.
Mr. Ahamed was one of many self-directed investors who received notice from the CRA. He opened a personal TFSA account with Canadian Western Trust Company in 2009 and for three years deposited the maximum annual contribution of $5,000. By the end of 2011, the value of his TFSA had reached $617,317.24.
All of the securities he bought and sold were qualified investments, with most being speculative in nature and not paying dividends, according to court documents. The majority of the investments were penny stocks listed on the TSX Venture Exchange in the junior mining sector, and the stocks were only held for short periods.
By 2012, the total account value had dropped to $564,482.90. Mr. Ahamed sold the securities and transferred the majority of the funds out of the TFSA. The CRA reassessed his tax owing from 2009 to 2012.
The CRA has been criticized by many in the investment community for not providing clear rules on how much money can be accumulated in a TFSA. In 2018, the agency told The Globe and Mail that 1,696 TFSA account holders disputed their contributions over a two-year period ending March 31 of that year.
The CRA was unable to provide an update on the current number of TFSA audits or the number of account holders who disputed their re-contributions.
Jamie Golombek, managing director of tax and estate planning at CIBC Private Wealth Management, says it’s no longer unusual to see six-figure balances in TFSAs – and while it may be a red flag for the ARC, the average investor need not worry.
“The problem is not your account balance, but your activity in the account,” Golombek said in an interview. “If you have half a million dollars in your TFSA, that may be considered abnormally high and may raise suspicions from the CRA as to how you got there, but you have nothing to worry about unless you haven’t been day trading.”
Currently, in determining whether a TFSA is operating as a business, the CRA considers eight factors, including frequency of transactions, period of ownership, taxpayer knowledge of securities markets, and whether or not the taxpayer has announced its willingness to purchase securities.
Although the TFSA trust occupied Mr. Ahamed’s time, attention and work, Mr. Clarke acknowledged that it failed to meet a number of CRA criteria, he argued, and that the court should have concluded that the TFSA was not carrying on a business.
Mr. Clarke also questioned whether the existing test should be applied in the first place. He said investors’ investment strategy in a TFSA differs from taxable investment strategies because the tax-exempt nature of withdrawals provides an incentive to invest for large gains, which can include taking on more risk, trading more frequent and earlier selling of losing positions.
That means the practice of applying the traditional test to TFSAs “is against the taxpayer,” he argued. Mr. Clarke believes that under the TFSA rules, the traditional test appears to exclude professional investors for unfavorable tax treatment.
Given the same number, frequency and level of risk of investments, according to the traditional test, an experienced professional investor could operate a business, while a less experienced investor would not. “Such a test would prevent professional investors from taking advantage of the TFSA exemption to invest after-tax capital. This cannot be Parliament’s intention,” Mr Clarke said.
He argued that the court should craft a new test recognizing that investors in a TFSA are required to follow a set of restrictions that do not apply to taxable investors.