When putting money away for retirement into an RRSP this season chances are you'll probably either pick a mutual fund with a solid track record, an ETF, or even a blue chip stock or two to invest those long-terms savings. But for some investors, the RRSP, and in particular a self-directed plan, can be used as a vehicle to engage in regular, frequent stock trades, with the added bonus of not having to pay tax on any of that trading activity until funds are ultimately withdrawn from the RRSP or its common successor, a RRIF.
In a Tax Court decision released last month, a judge had to determine whether a taxpayer who engaged in frequent trading activity exclusively within his RRSP could treat a failed investment outside his RRSP as a business loss, such that it could be written off against other income, as opposed to capital loss, which could only be used against other capital gains.
In January 2005, the taxpayer withdrew $250,000 from his RRSP to invest in a foreign exchange currency fund which was to mature in two years time and that promised a "guaranteed" annual return of 17.52%, paid semi-annually. Unfortunately, the investment turned out to be a fraud. The taxpayer received a total of $64,000 from the fund before the cashflows stopped and he therefore realized a loss of the difference ($186,000) which he tried to claim as a business loss on his 2007 tax return.
The Canada Revenue Agency argued that the loss should have been classified as a capital loss and reassessed him accordingly.
The taxpayer, a civil engineer, worked for a provincial hydro company until he was laid off in 1985. He rolled his severance package into his RRSP and began working for various financial companies, at which he was ultimately not successful. He eventually decided that he would focus on making money for himself, inside his RRSP. He claimed to have increased the capital in his RRSP eightfold during the period from 1987 to 1999. From 2000 onwards, his only reported income on his tax returns consisted of RRSP withdrawals and later, CPP and OAS.
The taxpayer tried to demonstrate to the Court that he was in the business of trading and therefore his loss on the fraudulent investment scheme should be a business loss. He claimed he was an "active" trader, making 512 trades within his RRSP in 2007 alone. He also argued that he had been trading his entire life, he "had run a business within his RRSP" and that "his livelihood depended on the profits he made trading within his RRSP."
Unfortunately for the taxpayer, the Judge concluded the taxpayer was not entitled to a business loss since "the Act treats an individual who trades within his RRSP differently than a taxpayer who is in the business of trading. For this reason, trades within an RRSP are not relevant in deciding whether an individual is in the business of trading."