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CRA targeting successful TFSA investors
December 3, 2014
9:05 pm
Loonie
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http://business.financialpost......=ff08-e4c3

I'm no lawyer or accountant, but I can't see how trading can be considered a "business" when there is no customer, no bill, and no payment for services to the TFSA holder. But it's going to cost someone in legal fees to find out.

December 3, 2014
10:02 pm
Jon
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I can see trading as a business; you provide liquidity to the market which in return, you may get a higher than market average return, but the fed really need to set clarify this matter really well.

December 3, 2014
10:14 pm
Loonie
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Jon said

I can see trading as a business; you provide liquidity to the market which in return, you may get a higher than market average return, but the fed really need to set clarify this matter really well.

But, on that basis, wouldn't all market investments count as "business"? TFSA specifically permits investments in the market. There are a few restrictions but not many, and those are not at issue as I understand it.

I deleted an additional paragraph, to which Norman1 was simultaneously referring, after I posted it because I realized that it would not be an issue if it were considered a business.

December 3, 2014
10:25 pm
Norman1
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Stock trading most certainly is a business. It is what stock dealers do.

In tax law, the legal term for that kind of regular activity is engaging in "an adventure or concern in the nature of trade". CRA Interpretation Bulletin IT459 discusses the concept.

In such cases, the shares are no longer investments but are inventory. Outside of a TFSA or RRSP, gains and losses are taxed as income and income losses, instead of capital gains and capital losses.

December 3, 2014
10:28 pm
Norman1
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Loonie said
....

Also, if they are going to successfully go after this sort of thing, then they need to also allow all the other perqs that go with operating a business - such as deducting losses. It goes both ways, but I'll bet they have no intention of doing that.
...

Yes, one can deduct losses and expenses if one is doing what a stock dealer does.

December 3, 2014
11:19 pm
Loonie
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Thanks for the reference, Norman1. It is informative, but highly technical, and I think well beyond what the average person could be expected to have known and understood before they started. I would have thought, not being a pro in this field, that "trading" simply meant selling one stock, taking profits or losses as the case may be, and buying another that seemed more promising, and that there would be no harm in that.

It is only quite a ways down in the document that I can start to understand what they are talking about, when the word "investment" is first mentioned. The distinction between "trading" and "investing" is certainly one that would have been lost on me. Apparently one is supposed to avoid doing what a trader would do. How can the average person be expected to be so knowledgeable about what traders do?

The worst part is that it is still not entirely clear what would count as "trading" and what would count as "investing". What is clear is that TFSAs were not anticipated when it was written. It seems to be more directed towards people who were flipping real estate.

Canadians need and deserve more clarity on this, and it should be made clear in gov't publications about what you can invest your TFSA in. I have now looked at several CRA pages in regards to TFSAs and don't find this the least bit clear. They are implying that it's entirely up to their judgment. There are comments about "prohibited investments" and "non-qualifying investments", which appear to be separate categories, but they are not very clear or extensive.

Let's say I have some ETFs in my TFSA. Based on what I have read about investing, I rebalance them periodically to minimize risk and optimize returns. Some say I should rebalance annually or semi-annually; some, especially advocates of technical analysis, say I should rebalance monthly. Still others in the technical analysis camp say I should rebalance whenever my analysis of market trends so indicates. In a volatile situation, this could turn out to be frequently. CRA is concerned about frequency of trading. How frequent is "frequent"? They provide no answer except to imply that I should compare myself to a "trader". I have no idea how "traders" spend their time, and I doubt any of them are planning to tell me. There is even a clause in there somewhere that says that if you are spending a lot of time on this, then it would constitute trading. Are they now going to be examining our computers to find out how much time we spend educating ourselves and trying to implement plans??

December 4, 2014
6:06 am
Brimleychen
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I highly suspect the story itself. This hypothetical story is a typical advertisement for the investment industry prior to TFSA / RRSP season.

Good luck for those guys for playing high beta stocks. We are in process of witnessing the sharp drop of oil patch speculative stocks.

The investment industry want your money being locked and they can charge the fee.

The intention of late jim flaherty for TFSA is to encourage your saving, and yet you can just move around by withdrawal, instead of transfer.

December 4, 2014
7:51 am
Bill
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A lot more to it but my understanding is: the difference between trading and investing is how frequently you do it, is it your main job?, is it something pursued on a regular vs infrequent basis, how long you hold securities, and so on. Basically, if it's a "hobby" or you pursue it as do most Canadians, i.e. just invest your money you're saving from your real job or business, then you're fine. If you're acting more like a full-time trader, then it's business income or loss.
This is not limited to TFSA money, it applies to investments in any accounts. It's just that CRA keeps track of everybody's TFSA, thanks to the requirements for the financial institutions to report your activity to them, so CRA can easily target whose TFSAs are doing unusually well. CRA likes to cherry pick the easy stuff (they're not very good at finding stuff that isn't reported at all, it's too much work to find that), and the data re TFSA balances in our accounts is staring them right in the face.

December 4, 2014
9:29 am
Bill
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Now that I'm thinking about this a little more - CRA's issue is not with what specific investments are held in a TFSA, it's with how actively, frequently, successfully, the investments are traded, managed, etc. CRA says you can't operate a business within a TFSA but is that just their opinion - is that what the Income Tax Act, the legislation, actually says? Does it specifically exclude this "operating a business" concept from TFSA activity or is this just CRA's own added requirement to get at folks who've made lots of dough in their TFSA by spending lots of time in investing activity? I'm not an expert in the Act itself - if anyone is, let us know!

December 4, 2014
10:07 am
Greg Franklin
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Brimeleychen, I agree with you about how the flexibility of TFSA's versus RRSP's are not liked by those selling investments to the smaller investors like us. It is not like RRSP's that has big tax consequences and fees that can tie up our money.

This is maybe why they called it a TFSA and not a TFIA, tax free savings account versus tax free investment account. It was not meant to be earning 20%, 30%, 40%+ annual returns or 900% to 1000% in a few years.

They wanted Canadians to save more and being tax free in a low interest rate, dividend environment made it more attractive for contributing for middle to lower income Canadians.

I think that a specific, reasonable limit on how much your TFSA could gain per year that qualifies for tax free status. Just as an example, it could be maximum simple 15% per year without compounding seems a decent amount. This is about 5 times the highest 5 year GIC's are paying which is a decent multiple.

Anything over that amount would be subject to capital gains taxes which is still much lower than all other incomes, 12% to 17% for most Canadians versus 25% to 34% for interest, annuities, employment, RRSP, RRIF income etc.

This would not be popular and not liked by some Canadians but it would put clarity on what one can do with their TFSA's. The annual contribution limit is one part of this but simplicity is not government's best trait.sf-frown

December 4, 2014
10:34 am
AltaRed
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The only 'new' news here is the aspect about 'carrying on a business' within a TFSA. The CRA rules about the difference between 'investing' and 'carrying on a business' have been around a long time in non-registered accounts for example. Trading as a business has been discussed in other forums, e.g. Financial Wisdom Forum, over the years. Those of you wanting more clarity might search other forums on more specifics on this.

The issue has become more prevalent in recent years because trading costs have come down dramatically so that more people are getting into frequent trading (day trading as one example) and thus more people are 'getting surprised' by CRA audits and investigations. The vast majority of us will never get into the crosshairs of CRA since the vast majority do not trade even once a week.

December 4, 2014
12:14 pm
Greg Franklin
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Yes, there is this distinction between personal investing and business activities investing as a businesses or professionally and as such it is capital gains 50% tax free versus regular or ordinary income that is fully 100% taxable.

However, there is no problem from the government rules on TFSA's that capital losses are not applicable or eligible for TFSA's. If this person lost 90% or more of his or her TFSA, $28,000+ then that is clear, you can't claim capital losses but now that someone has $270,000 gain it is an issue.

It is called a TFSA, it is tax free. As long as everything is legally earned in a TFSA, it should not matter if you trade, invest, deposit etc.

This is one of the inconsistencies in tax rules and tax laws that are not right or fair. They strive for tax fairness but consistency of tax rules and tax laws should be part of fairness.sf-confused

December 4, 2014
1:16 pm
AltaRed
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Greg Franklin said

It is called a TFSA, it is tax free. As long as everything is legally earned in a TFSA, it should not matter if you trade, invest, deposit etc.

This is one of the inconsistencies in tax rules and tax laws that are not right or fair. They strive for tax fairness but consistency of tax rules and tax laws should be part of fairness.sf-confused

That is the rub. Carrying on a businesss is NOT a legal investment in a TFSA, so by default CRA argues that trading, which is itself a business, is therefore not legal in a TFSA. I am guessing it will take awhile for that to sort itself out and will catch relatively few people..... and even then, if it is indeed illegal, the folks caught might simply be told to 'halt' the practice henceforth.

I have no personal stake in this - just pointing out there may be 'just cause' for that position.

December 4, 2014
2:35 pm
Loonie
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Apparently the TFSA is governed by the Income Tax Act. I had some trouble finding it. There does not appear to be separate legislation for it.
http://laws-lois.justice.gc.ca......html#h-79

December 4, 2014
2:48 pm
Loonie
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AltaRed said

The issue has become more prevalent in recent years because trading costs have come down dramatically so that more people are getting into frequent trading (day trading as one example) and thus more people are 'getting surprised' by CRA audits and investigations. The vast majority of us will never get into the crosshairs of CRA since the vast majority do not trade even once a week.

This is the problem, as I see it. We have no assurance that trading once a week will not raise the hackles of CRA. Where is the cut-off? Is once a week acceptable? Twice a week? Once a month? They are silent.

December 4, 2014
4:24 pm
Greg Franklin
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AltaRed, so if trading in TFSA's is illegal for tax purposes then why are capital losses not allowed. This is the inconsistencies in tax rules and laws. The rules and laws are not fair and are only in their favor.

They have created a monster called the Canadian income tax act so they can have their cake and eat it too. Nobody wants to admit it that this is all about taking more taxes and has nothing to do with fairness. Tax free is tax free. Don't call something tax free if it is not.sf-smile

December 4, 2014
7:25 pm
Bill
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Thanks, AltaRed & Loonie, it does appear the Income Tax Act specifically indicates TFSAs can't participate in business activities. A CRA document which helps us distinguish between trading and non-trading activities is in CRA's Interpretation Bulletin IT479R, Transactions in Securities:
http://www.cra-arc.gc.ca/E/pub.....EADME.html
There are also various court decisions on this matter - in a recent one the judge listed the usual factors to determine the income vs capital issue, i.e. the frequency of the transactions, the duration of the holdings, the intention to acquire the securities for resale at a profit, the nature and quantity of the securities, the time spent on the activity and, critically, the intention of the taxpayer at the time the securities were acquired as determined by "his entire course of conduct.”
CRA will only select for audit TFSAs that have gone way up in value, not down. I suppose if you're down you can say you're a trader thus your losses are not capital so can be applied against other income. Of course, then you're stuck if you start having gains later.

December 4, 2014
8:37 pm
AltaRed
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Deleted.

December 4, 2014
9:57 pm
Loonie
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Thanks for that reference, Bill, to IT 479R. The themes are similar to the other IT, but with even more technical language that I, as an average person, do not understand.
This one too predates the creation of TFSAs by many years, and does not seem to me to adequately address the issues that they present. It also predates the expansion of do-it-yourself investing.

Specifically, paragraph 11, as follows, with my comments underlined.

"11. Some of the factors to be considered in ascertaining whether the taxpayer's course of conduct indicates the carrying on of a business are as follows:

(a) frequency of transactions - a history of extensive buying and selling of securities or of a quick turnover of properties,
There is no definition of “extensive”.

b) period of ownership - securities are usually owned only for a short period of time,
There is no definition of “usually” or “short”. Further, another paragraph says that doing something only once does not satisfy them that you were not trading.

(c) knowledge of securities markets - the taxpayer has some knowledge of or experience in the securities markets,
We are SUPPOSED to have “some knowledge” of the markets before we get involved; it would be foolish not to; and the more investing we do, the more experience we will have.

d) security transactions form a part of a taxpayer's ordinary business,
This is the only one that is clear and a valid distinction.

(e) time spent - a substantial part of the taxpayer's time is spent studying the securities markets and investigating potential purchases,
Financial literacy and good decision-making actually REQUIRE a “substantial part of the taxpayer’s time", especially if you are NOT a professional trader. Do they expect us to make investments WITHOUT spending this time investigating them? It ought to be up to the individual how much time they want to put into it.

(f) financing - security purchases are financed primarily on margin or by some other form of debt,
While best done only by more experienced and wealthier investors who are comfortable with more risk, this is a normal investment activity, and pretty well every book on investments discusses it.

(g) advertising - the taxpayer has advertised or otherwise made it known that he is willing to purchase securities,
What does “willing” mean? Am I “willing” if I am considering such an investment, or am I only “willing” if I am suggesting I will do it on behalf of others or tell them how I did it, or am I just sharing what I have learned? In ordinary speech, everyone knows what “advertising” is, and that should be the decisive factor. This IT predates the internet, and does not take it into account. If I'm not selling my services, then it's not advertising.
and

(h) in the case of shares, their nature - normally speculative in nature or of a non-dividend type.
This could eliminate a very large number of stocks. It depends on how you define “speculative”. Does it mean gold, penny stocks, all or most growth stocks? Which analyst’s opinion shall prevail? One person's "sure thing" may be another person's "speculative" stock. There is clearly a bias in favour of dividend stocks. If that’s what they mean, then that’s what they should say in the first place and save us the worry.

It is precisely because we are not professional traders that we need clear guidelines. Those who know more will probably have a better idea of what these criteria really mean.

December 4, 2014
10:45 pm
Norman1
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Unfortunately, Loonie, there is no single set of elements. This is from paragraph 4 of IT459 I mentioned:

In determining whether a particular transaction is an adventure or concern in the nature of trade the Courts have emphasized that all the circumstances of the transaction must be considered and that no single criterion can be formulated.

My understanding is that when my intention is to flip something I bought (shares, hen's teeth, stamps, books, coins, ....) at the first chance I get for a profit, then I'm engaging in "an adventure or concern in the nature of trade."

Now, we don't have the technology yet to read people's minds to determine their intentions with 100% precision. So, that's why I think CRA and the tax court will look at things you mentioned, like frequency of transactions, period of ownership, and so on, to calculate the taxpayer's probable intent. But, as the above text says, all the circumstances of the transaction must be considered.

If I bought twenty different blue chip stocks and then sold all of them less than a month later for a profit, then it would seem that I engaged in "an adventure or concern in the nature of trade." After all, 20 buys and 20 sells in less than a month sounds like I intended to flip the shares.

But, if my wife had a stroke a week after I bought the shares and I spent the money from the sale of the shares on her medical expenses and accessibility renovations to the house, then maybe the short holding period and large number of transactions is not indicative of an intent to flip the shares at the first chance I had for a profit.

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