A recent decision by the Federal Court of Appeal serves as a reminder to all Canadians that if you actively trade marketable securities in your tax-free savings account, the Canada Revenue Agency may consider this activity to constitute a business, and the TFSA, rather than being tax free, could be subject to tax on its business income.
Frequent trading in a TFSA has been a focus area for the CRA’s audit and reassessment activities. This recent case was an appeal by the taxpayer of a 2023 Tax Court decision. The Vancouver-based investment adviser opened up his first TFSA at the beginning of the program’s launch on Jan. 2, 2009, and grew it to more than $617,000 from $15,000 in three years by frequently trading penny stocks.
It was a self-directed TFSA and all securities purchased and sold by the TFSA were “qualified investments,” as specified in the Income Tax Act.
Qualified investments include: money, guaranteed investment certificates and other deposits; most securities listed on a designated stock exchange such as shares of corporations, warrants and options, and units of exchange-traded funds, real estate investment trusts, mutual funds and segregated funds; debt obligations of a corporation listed on a designated stock exchange; and debt obligations that have an investment-grade rating.
A comprehensive list of qualified investments can be found in the CRA’s Folio S3-F10-C1, Qualified Investments — RRSPs, RESPs, RRIFs, RDSPs and TFSAs.
The taxpayer primarily invested in non-dividend-paying and speculative stocks in his TFSA, with the majority being junior mining penny stocks listed on the TSX Venture Exchange. The TFSA held most of the shares for only short periods of time.
In each of his TFSA’s first three years (2009, 2010 and 2011), he contributed the allowed maximum of $5,000 in early January of each year. By Dec. 31, 2011, his TFSA had grown to a fair market value of $617,371. By the end of 2012, the TFSA’s market value had dropped to $564,483. In January 2013, the taxpayer sold all the securities in his TFSA and withdrew proceeds of nearly $547,800 on a tax-free basis.
The CRA reassessed the taxpayer’s TFSA for each of the 2009, 2010, 2011 and 2012 taxation years on the basis that the TFSA carried on a business of trading qualified investments in each of those years and, therefore, the income from carrying on that business was subject to tax. The tax assessed was based on taxable income of $44,270 in 2009, $180,190 in 2010, $330,994 in 2011 and $14,027 in 2012.
Generally, the CRA will look at several factors when deciding whether a taxpayer’s gains from securities constitute carrying on a business, including the frequency of the transactions, the duration of the holdings, the intention to acquire securities for resale at a profit, the nature and quantity of the securities and the time spent on the activity.
At the Tax Court, the judge said there was no doubt the taxpayer was conducting a stock-trading business in his TFSA based on his trading activity. The consequence of doing so is clearly spelled out in the Income Tax Act, which states that a TFSA is generally exempt from tax on its income, subject to two exceptions: the TFSA holds non-qualified investments or it carries on as a business. If either exception applies, then tax is payable by the TFSA on its taxable income.
It’s important to note that this rule is in direct contrast to the rules governing active trading in a registered retirement savings plan (RRSP) or registered retirement income fund (RRIF). The Income Tax Act specifically exempts both RRSPs and RRIFs from paying tax on business income when that income is derived from investing in qualified investments.
“This means … that 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,” the CRA states in its folio on qualified investments.
The taxpayer tried to argue that the rule exempting an RRSP from paying tax on business income from day trading of qualified investments should be applied to a TFSA as well. “There could have been no legislative purpose for making a TFSA … taxable on the income from carrying on a business of trading qualified investments when an RRSP carrying on the very same business is not taxable,” he said.
But the Tax Court judge disagreed, noting that Parliament deliberately chose not to make the TFSA regime the same as the RRSP regime when it comes to business income in the plans. “Had Parliament also intended to exempt from tax a TFSA’s income from carrying on a particular type of business — trading qualified investments — Parliament would have legislated accordingly, just as it had for RRSPs,” he said in his decision.
The judge concluded that it was clear the taxpayer, a professional investor with deep knowledge and experience in the securities market who traded frequently, buying and selling shares that were mostly speculative in nature and owning them for short periods, was carrying on a trading business in his TFSA. As a result, the TFSA was found to be taxable.
The taxpayer appealed this decision to the Federal Court of Appeal, which heard the case last week. In a short, five-page decision delivered orally from the bench, the three-judge panel unanimously confirmed the Tax Court’s decision, finding “no legal error” in its conclusions.
The appellate court agreed that the taxpayer’s wishful reading of the qualified investment rules in the Income Tax Act is “unsupported by the text, context, and purpose” of the rules, “and would amount to a re-drafting of the provision … It is not for this court to make new tax policy or amend existing tax legislation.”
Accordingly, the court dismissed the taxpayer’s appeal and awarded the Crown costs.