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Hazy rules could put day traders offside in TFSAs
10/17/2017 4:55:11 PM
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By Knowledge Bureau  | Tuesday, August 01, 2017


 

TAX PLANNING FROM THE KNOWLEDGE BUREAU



By Evelyn Jacks

Day trading is effective for RRSP and RRIFs accounts but not for TFSA investing activities, according to the Canada Revenue Agency (CRA). This doesn’t seem to be a logical strategy on CRA’s part, seeing as it is currently looking for millions in penalties and interest from investors who didn’t understand the rules (see my previous article for details). If you are looking for a simple explanation, you probably won’t find it in CRA’s pre-investment information. This may be one of the reasons why TFSA account holders who are being audited are somewhat shocked.

A good starting point is to look at CRA’s Folios S3-F10-C1 and C2, which explain prohibited and qualifying investments for registered accounts, albeit poorly. Borrowing and business transactions are generally taboo in most registered plans. However, you will learn in these documents that TFSA accounts will not be offside for certain business transactions, i.e., if investors acquire and hold an interest in a limited partnership.

Tax treatment of RRSP/RRIF business income

If you are reading closely, you will note that this exception is not extended to RRSPs or RRIFs – at least not at first glance. You’ll have to look further, to a different section of the Income Tax Act, notably paragraphs 146(4)(b) and 146.3(3)(e), to calculate the amount of business income that is taxable to the RRSP or RRIF. After much complex language, you will see that for RRSP and RRIF purposes, any business income derived from the holding or the disposition of qualified investments, is excluded from tax, as is income from limited partnerships.

The CRA Folio goes on to address day trading, saying that if “an RRSP or RRIF were to engage in the business of day trading of various securities, it would not be taxable on the income derived from that business provided that the trading activities were limited to the buying and selling of qualified investments.”

Based on this, an investor could reasonably believe the only way that day trading would be considered a business for the purposes of an RRSP or RRIF is if the trading is not in qualified investments. It should also follow then, that these same rules should apply to any registered plan, including a TFSA.

But, as we know, the CRA does not seem to be assessing in this way. Is there any logic to the reclassification of income in these audits? Perhaps there is, when we think about what eventually happens with the earnings in these plans. The income in an RRSP or RRIF is going to be 100% taxed on withdrawal, similar to business income. That means there is really no cost to the government for allowing day trading in an RRSP or a RRIF. However, any income earned in a TFSA will never be taxed, so allowing day trading could potentially cost the government money.

Hazy tax rules on business income in TFSA

Problem is, none of this is particularly clear in the Folio or other communications from the government on TFSA investing or day trading in a TFSA. In fact, it’s simply not mentioned. That is truly unfortunate given the breadth and expense of the current audit initiative.

For these reasons, the TFSA proposal process is appropriate. Rules that are clear, transparent, and simple lead to greater compliance. When that happens, there is no need to penalize, tax, and charge many years of interest in retrospect. Notifying taxpayers in retrospect also gives them no way to mitigate their losses.

Remember that if you have received a TFSA audit letter, the proposed return is not a formal assessment of tax. Investors should take full advantage of their rights to provide a reasonable explanation for their pattern of investment activities and their understanding of this maze of complex laws – or lack thereof – at the time the investment was actually made.

What happens if you’re offside in TFSA investments?

Be sure to review whether investments in your TFSA are prohibited, and watch the frequency of your investment activities in your TFSA.

If you are offside, seek assistance in filing the TFSA Return from an experienced tax advisor. You should also note that the normal filing due date for this return is annually on June 30. If you have failed to file the return, you will be charged a late-filing penalty of 5% of the balance owing plus 1% of the balance owing for each full month the return is late, up to 12 months. If you were late in filing this return previously, your penalty will be higher: 10% plus 2% per month for up to 20 months.

This article originally appeared in the Knowledge Bureau Report, © 2017 The Knowledge Bureau, Inc. Reprinted with permission. All rights reserved.

Notes and Disclaimer

©2017 by Fund Library. All rights reserved.

The foregoing is for general information purposes only and is the opinion of the writer. No guarantee of investment performance is made or implied. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.

 
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