Capital or Business Losses?

National Post

2012-12-22



This Monday, Dec. 24, is the final day for tax-loss selling to ensure any loss from the sale of securities will settle in 2012 and therefore be available to be used immediately, as opposed to waiting until 2013.

Capital losses, of course, are quite restrictive in that they can only be used to offset capital gains, first in the current year, and if there is any excess, either in the prior three calendar years or in any future year.

But what if you could argue your market losses were not capital losses but rather part of regular trading activity which constituted an "adventure in the nature of trade" or, in plain language, a business. In that case, these "businesses losses" could be deducted against all sources of income, including employment income, rather than the restrictive rules for capital losses. (Of course, that also means any gains would be fully, instead of half, taxable.)

Take the tax case decided last month involving a taxpayer we'll refer to as Mr. M, who deducted business losses arising from his investments to the tune of $35,000 in 2006 and nearly $24,000 in 2007. He was reassessed by the Canada Revenue Agency, which denied the losses as business losses and instead assessed on the basis they were capital losses.

Mr. M is an engineer by profession and worked at a major Canadian company, averaging 32 hours a week. A self-described workaholic, he testified that he devoted an additional 25 hours each week to his trading activity. He read extensively, studied various Internet investing sites, watched financial and business-related television programs and attended numerous financial seminars.

He kept time logs of the hours spent on his trading activities, which included researching, actual trading, record keeping, banking and various related activities. He also kept meticulous records of all his trades.

In 2006, for example, he engaged in about 60 days of actual trading representing 160 trades with a total aggregate value of $3.2-million. He financed this trading activity using $100,000 of his own savings as well as borrowed money from his children and a line of credit. He also invested about $700,000 for other family members.

In determining whether the losses were capital losses or business losses, the Tax Court judge referred to the classic factors, based on prior jurisprudence, which must be considered to determine whether Mr. M was effectively a trader. These include the frequency of transactions, the duration of holdings, the intention to acquire for resale at a profit, the nature and quantity of securities traded, and the time spent on the activity.

The judge concluded Mr. M was clearly taking his trading seriously and allowed the losses to be claimed as business losses. As the judge wrote, "This was not the occasional call or check the newspaper's listings, this was a daily devotion to following the market, studying the market and ... playing the market. It is a classic example of an adventure in the nature of trade."