TFSA wins targeted by taxman

Use of savings accounts to trade securities called a grey area

The Canada Revenue Agency has upped its enforcement of tax-free savings accounts to target taxpayers it says are trading too much in their TFSAs and recording significant gains, arguing those people are effectively running a business.

The move has caught the attention of the Investment Industry Association of Canada, which has written to the Finance Department and the director-general of the Canada Revenue Agency, complaining that taxpayers have “insufficient guidelines” to determine whether they have run afoul of TFSA rules.

Tax and legal sources say the CRA has an audit project that has become increasingly active in the past couple of years, chasing Canadians who seem to be doing too well in their TFSAs. What amount of activity or balance will trigger

In all of these cases, the CRA can just assume you’ve broken one of these rules on a balance of probabilities.

an audit isn’t clear and the CRA offered no comment Monday for this story.

Auditors have reportedly been using an old tax ruling that disallows Canadians from using their TFSAs to “carry on a business,” an interpretation described as vague by critics.

“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 Moodys Gartner Tax Law LLP in Calgary. “The CRA says that means you are trader in securities and you are carrying on a business.”

The TFSA, introduced for the 2009 tax year, is widely seen as a place to take investment risks since all the income is 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 can just assume you’ve broken one of these rules on a balance of probabilities and it’s up to the taxpayer to prove otherwise.

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 her money out of a TFSA but later face a tax bill.

“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.

The CRA has said to some taxpayers that if they agree to pay taxes on income within a TFSA, it won’t go after them for penalties. That has resulted in settlements, according to sources.

That’s what happened to one Quebec investment adviser, who was told he must pay income tax on all the gains inside his TFSA or face his wages being garnisheed along with interest penalties. The adviser, who doesn’t want his name used, says he made about 200 trades in his TFSA and manoeuvred his account to a value of about $180,000 from his original contribution of $31,000. He has since taken all the money out and paid taxes on it.

“I’ve already paid the $35,000 and now I’m sure the province is going to come after me for their money,” he says, referring to provincial taxes he’ll owe based on the federal assessment. “The accountants and lawyers have told me to shut up.”

The adviser 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 that when he filled out forms for his TFSA under the know-your-client rule he said his profile was “100-per-cent risk and 100-per-cent speculation.”

He said the idea that he is a “professional trader” makes no sense because he has 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.”