A tax court judge’s ruling that an investor who was day trading stocks in his tax-free savings account must pay tax on the income opens the door to hefty tax bills for other frequent investors.
Justice David Spiro of the Tax Court of Canada ruled that the investor was carrying on a business inside his TFSA, which had swelled from $15,000 to more than $617,000 over a three-year period. The amount of tax owed and whether interest will be added were not disclosed. The investor is appealing the decision.
A TFSA is a registered account that allows Canadians 18 and older to currently contribute $6,500 annually and earn tax-free investment income on a wide range of qualified investments, including stocks, bonds, exchange-traded funds and mutual funds. However, a TFSA holder is required to pay tax under the Income Tax Act if the income is earned from a business or from non-qualified investments in the account.
Fareed Ahamed, a licensed investment adviser and the plaintiff in the case, argued that because the Canada Revenue Agency exempts business income from day trading when it is done in a registered retirement savings plan, it should also exempt business income accumulated inside a TFSA.
However, when Parliament included that rule in the tax act governing RRSPs, TFSAs did not exist.
“Parliament could have adopted, but chose not to adopt, the same statutory approach for TFSAs as it did for RRSPs and RRIFs,” Justice Spiro wrote in his February decision. “This further shows that Parliament did not intend to exempt business income from the disposition of qualified investments held in a TFSA.”
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Tim Clarke, a Vancouver tax lawyer with QED Tax Law Corp. and counsel for Mr. Ahamed, has filed an appeal. Mr. Clarke declined to comment on the case.
Mr. Ahamed’s is a test case for frequent trading in TFSAs for the Tax Court of Canada, an independent court that handles disputes related to income tax, the Goods and Services Tax and employment insurance.
He filed the case in 2015 after the CRA began auditing a number of tax-free savings accounts. Between 2009 and 2017, the agency assessed approximately $114-million in taxes from those audits, with about 10 per cent from TFSA accounts that were seen as carrying on a business – such as day trading, which can generate hefty returns through aggressive securities trading.
Mr. Ahamed was among many do-it-yourself investors who received a notice from the CRA. He opened a personal TFSA account with Canadian Western Trust Co. in 2009 and for three years deposited the then-maximum annual contribution of $5,000. By the end of 2011, the value of his TFSA had reached $617,317.24.
All the securities he purchased and sold were qualified investments, with most being non-dividend-paying and speculative in nature, according to court documents. The majority of the investments were penny stocks listed on the TSX Venture Exchange in the junior mining sector, and the shares were owned for only short periods.
By 2012, the total value of the account had dropped to $564,482.90. Mr. Ahamed sold the securities and transferred the majority of the funds out of the TFSA. The CRA reassessed his tax owing for 2009 through 2012.
The CRA has come under fire from many in the investment community for not providing clear rules about how much money can be accrued within a TFSA. In 2018, the agency told The Globe and Mail that 1,696 TFSA account holders disputed their assessments over a two-year period ending March 31 of that year.
The CRA was not able to provide an update on the current number of TFSA audits or the number of account holders who have disputed their reassessments.
Jamie Golombek, the managing director of tax and estate planning with CIBC Private Wealth Management, says it is no longer unusual to see six-figure balances in TFSAs – and while it may be a red flag for the CRA, the average investor need not worry.
“The problem is not the balance of your account, but comes down to your activity in the account,” Mr. Golombek said in an interview. “If you have half a million dollars in your TFSA, that may be considered unusually high and may raise suspicion from the CRA on how you got there, but you have nothing to worry about unless you have been day trading.”
Currently, when determining whether a TFSA is carrying on as a business, the CRA takes eight factors into consideration, including the frequency of transactions, the period of ownership, the taxpayer’s knowledge of the securities markets and whether the taxpayer advertised that they are willing to purchase securities.
While the TFSA trust occupied Mr. Ahamed’s time, attention and labour, Mr. Clarke acknowledged, it did not meet a number of the CRA tests, he argued, and the court should have found that the TFSA did not carry on as a business.
Mr. Clarke also questioned whether the existing test should be applied in the first place. He said the investment strategy of TFSA investors differs from taxable investment strategies because the tax-free nature of the withdrawals encourages investing for sizable gains, which can include assuming more risk, trading more frequently and selling losing positions earlier.
That means the practice of applying the traditional test to TFSAs “is stacked against the taxpayer,” he argued. Mr. Clarke believes that, based on the TFSA rules, the traditional test appears to single out professional investors for adverse tax treatment.
Given the same number, frequency and riskiness of the investments, under the traditional test an experienced, professional investor could be carrying on business, whereas a less experienced investor would not. “Such a test would result in professional investors not being able to enjoy the TFSA exemption in investing after tax capital. This cannot be Parliament’s intent,” Mr. Clarke said.
He argued the court should craft a new test recognizing that TFSA investors are obliged to follow a set of restrictions that do not apply to taxable investors.
Editor’s note: An earlier version of this story incorrectly named the tax court judge. It has been corrected to say the judge's name is Justice Spiro.
Clare O’Hara