CRA TARGETING CANADIANS WHO TRADE EXCESSIVELY IN TFSA
Tax-free savings accounts, created just five years ago by the Harper government as a tool that would allow Canadians to grow retirement investments while sheltered from capital gains taxes, are increasingly being challenged by Canada Revenue Agency auditors targeting investors that show large gains in their account. Here's what will get your TFSA audited by the CRA Canada’s Taxman has an audit project targeting Canadians it feels are in the business of trading securities and using their tax free savings accounts to shelter the proceeds. Here are the eight factors it looks at click here.
The CRA is also hitting invesors with audits if they trade too frequently for the agency’s comfort. The CRA has argued that investors who use their TFSAs for frequent trading and earn large gains are effectively running a trading business, and should be taxed on income.
The sudden growth in CRA scrutiny has triggered concern from the Investment Industry Association of Canada, which recently complained of “insufficient guidelines” for TFSA investors to determine whether they’ve run afoul of tax rules, in a letter to the Finance Department and the director general of the Canada Revenue Agency (CRA).
In addition, a Calgary law firm says it is readying to fight Ottawa over the growing use of the “business” interpretation.
Sources from the tax and legal sectors confirmed to the Financial Post that the CRA has rolled out a TFSA audit project that has become increasingly active in the past couple of years. However, the amount of activity or balance that will trigger an audit remains unclear and the CRA was unable to offer comment to the Financial Post on Monday.
Now a Calgary law firm says it is readying for a legal fight with Ottawa.
Follow us on Facebook
“There are a lot of people, day traders, with online brokerage accounts and they sit and buy and sell securities. Maybe 10 to 15 trades a day,” says Tim Clarke, a lawyer with Calgary’s Moodys Gartner Tax Law LLP, which is preparing to challenge the tax agency’s interpretation. “The CRA says that means you are trader in securities and you are carrying on a business.”
In the past, the CRA had targeted investors who were undervaluing closely held shares in their TFSA, exploiting the lack of liquidity to understate the equity’s likely value. Few people in the industry had argued against that crackdown.
But targeting vigorous — and successful — traders is a different approach by the CRA.
“They have no sense of humour about this. They assume since the maximum contribution you could make [as of 2013 was $31,000], if you’ve got $10-million in your TFSA something is wrong,” said Mr. Clarke. But often big TFSAs are held by high-risk investors who are simply enjoying their appropriate reward, he maintained.
If you’ve got $10-million in your TFSA something is wrong
“If you buy penny stocks and you’re an initial investor, you are taking a huge risk,” he said.
The TFSA, introduced in the 2009 tax year, is widely seen as a place to better take risks with investments, since all income including windfall gains, are tax-free forever, whereas in a registered retirement savings plan the money is taxed on withdrawal.
“There is a no case law on this business of carrying on a business in a TFSA,” said Lauchlin MacEachern, another lawyer with Moodys Gartner, who says he can’t comment on specific cases. “In the next year or two we expect there to be a case that goes to court and we’ll know whether carrying on a business in your TFSA means trading securities actively. We say that’s a question of fact and we also disagree with their legal interpretation.”
In all of these cases, the CRA has only to declare a “balance of probabilities” burden of proof has been met, leaving the onus on the taxpayer to prove that he or she should not be taxed as a business.
FotoliaSome taxpayers report that the CRA has offered them a deal where, if they agree to pay taxes on income within a TFSA, it will not demand additional penalties. The Investment Industry Association of Canada seems to agree there needs to be some clear-cut rules and is also concerned about liability its members may have if a taxpayer were to withdraw all their money out of a TFSA before the tax bill arrives.
“The IIAC requests comfort that TFSA trustees will not be liable for any shortfall in taxes should funds within a TFSA be insufficient to cover off any liability arising by virtue of a TFSA being found to have carried on as a business,” the group wrote, in its submission to Ottawa.
Some taxpayers report that the CRA has offered them a deal where, if they agree to pay taxes on income within a TFSA, it will not demand additional penalties. That tactic has resulted in settlements, according to sources.
That’s what happened to one Quebec investment advisor, who says he was called a “pirate” by a CRA auditor. The advisor — who did not want to be identified due to his clash with the tax agency — was told he must pay income tax on all the gains inside his TFSA or face his wages being garnished along with interest penalties. The CRA says someone operating a “business” pays income tax on earnings, which is an even higher rate than the capital gains tax usually charged on investment income.
The Quebec investment advisor says he was flagged after making about 200 trades in his TFSA, manoeuvring his account to a value of about $180,000. He has since taken all the money out and paid taxes on it.
The accountants and lawyers have told me to shut up
“I’ve already paid the $35,000 and now I’m sure the province is going to come after me for their money,” he said, referring to provincial taxes he’ll owe based on the federal assessment. “The accountants and lawyers have told me to shut up.”
He claims he was able to make all this money because he has some expertise in resource stocks. “I could have lost that money,” he says, adding when he filled out forms for his TFSA under the know-your-client rule he said his profile was “100% risk and 100% speculation.”
He said the idea that he is a “professional trader” makes no sense because he’s never taken any specific trading courses and doesn’t execute trades for clients. “I can tell you what caught their eye. It was the amount. The [auditor] told me ‘you’re not allowed to make $180,000 in there.’ You know what? I think they’re jealous.”
Mr. Clarke thinks this would not be happening if not for some of the high balances seen from a bullish stock market.
“To have a portfolio that increases in value, you need a run up in shares and the value of the stock market, which is what we’ve had, and you need the CRA to be scrutinizing it,” said the lawyer. “In my view, what we need is a black line test, if you put a qualified investment into a TFSA, as long as it’s within the categories of qualified investment, it shouldn’t matter how you earn or lose money. The income should not be taxable and the losses not deducted.”
Courtesy- Garry Marr Financial Post
Author - Atul Prakash
Please, check our blogs about different elements in Personal Finance - such as Insurance, Critical Illness, RRSP, RESPs etc.