David Rotfleisch is the founding tax lawyer of Rotfleisch & Samulovitch PC, a Toronto-based boutique tax law firm.
As both a tax lawyer and a chartered accountant, I would love to somehow carry out my Canadian tax law practice through my tax-free savings account. Or even through an RRSP, where the income tax would be deferred until the age of 71 – or even longer if I were to convert it into a registered retirement income fund (RRIF). Unfortunately, I’m out of luck. And so is Fareed Ahamed, who traded heavily inside his TFSA and recently lost his case at the Tax Court of Canada – a case that was rightly decided.
A tax-free savings account (TFSA) allows taxpayers to make an annual contribution (cumulative for years in which a full contribution was not made) into a registered account that is completely tax-free. There is no tax deduction when funds go in but no taxation on earnings or withdrawals. This is in contradistinction to an RRSP, for which a tax deduction is available for contributions, earnings are tax-free when incurred, but all withdrawals are taxable.
TFSAs and RRSPs differ significantly from each other from both a policy and statutory point of view. This important distinction was the subject of the Tax Court decision in Ahamed, released in February.
While a taxpayer cannot carry out a business in an RRSP, investments in arm’s-length private corporations are permitted, and share trading as a business is acceptable. This formed the basis of Mr. Ahamed’s arguments in his case. Justice David Spiro analyzed the different statutory provisions governing TFSAs and RRSPs and concluded, rightly in my view, that the provisions permitting a trading business in an RRSP are irrelevant to the different wording in the provisions governing TFSAs.
That’s why it’s no surprise the Canada Revenue Agency has for some years had an audit program of TFSAs with large returns. There have been a number of types of transactions or activities within TFSAs that are, in the view of CRA, abusive or prohibited within a TFSA.
One of the activities the agency considers to be outside the bounds of a TFSA was precisely what Mr. Ahamed was doing – namely, running a share trading business.
Mr. Ahamed, a licensed investment adviser, established the TFSA as a self-directed TFSA trust, so he was responsible for making all purchases and sales. Almost all the investments held under the TFSA were speculative penny stocks of nominal value and held for only short periods. Mr. Ahamed capitalized the TFSA by making appropriate maximum contributions throughout 2009, 2010 and 2011. While the amount of his cumulative contributions in 2011 only totalled $15,000, the value of the TFSA was more than $617,000, thereby attracting the eagle eye and ire of the CRA, which proceeded to assess him for the income earned in the TFSA.
From a policy point of view, a different Tax Court ruling would have been perverse. The TFSA is a laudable program that encourages Canadians to save more by allowing investments to earn income and capital gains on a tax-free basis. So, if someone was lucky or astute enough to buy shares of Tesla at the equivalent of US$1.50, hold onto them and sell at the peak of more than US$400, those capital gains are rightly tax-free. This is not the same as someone who actively buys and sells securities on a regular basis, as that is, in effect, running a business.
The fact that RRSPs are subject to a different tax regime with respect to securities transactions is not particularly offensive, since those profits will be taxed on withdrawal. Parliament at the time of tax reform 50 years ago made the deliberate decision to permit these types of activities within an RRSP. Similarly, when the TFSA rules were introduced some 15 years ago, Parliament clearly set out that these types of trading activities were not allowed.
The issue is not the amount of profit but rather the method by which that profit was earned. I should not be permitted to shelter my tax law practice earnings from taxation, as much as I would like to.