Show Transcript
If you trade too frequently inside your Tax-Free Savings Account (TFSA), you could get taxed on the income generated. Nicole Ewing, Director, Tax and Estate Planning, TD Wealth, joins Kim Parlee to discuss a recent ruling from the Tax Court of Canada that highlights the potential risks of day trading inside your TFSA. Here’s what you should know.
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Canadian investors who frequently trade inside their tax-free savings account might be feeling a little uneasy following a recent ruling coming out of the tax court of Canada in a case involving an investor who was engaging in day trading through this account. A judge ruled that the investor was generating business income, which could mean a potentially giant tax bill.
For some clarity around investing through TFSAs, we are joined by none other than Nicole Ewing, director of Tax and Estate Planning at TD Wealth. Nicole, great to have you with us. Let's get down to it. A TFSA, just to remind people, is a registered account. That means if you're 18 or older, you can earn your tax-free investment income inside of that through a whole different range of different kinds of investments. So why is day trading problematic?
Well, I mean, very simply, it's because in the act itself, the language of the act prohibits it. So when we look at Section 146.2, Sub 6 of the Income Tax Act, that's where TFSAs are dealt with. And it explicitly says that to the extent you're investing in nonqualified investments or having business activity in the TFSA, it will be taxed. And it's a long-standing position of CRA in the courts that excessive trading, trading in foreign currency, option writing, all of this is regarded as business activity. And so business activity is taxable within a TFSA.
The implications of this, of course, is that we go from tax free to not just being taxed on capital gains, for example, but being taxed at the full rate, because if it's business income, it is fully taxable. And you don't get those preferential capital gains rates. So it's a pretty big deal to be trading in your TFSA.
It's from one extreme to the other, to be clear in terms of what it is. So let's get clear about when you talked about business activity in the TFSA and there within that, meaning day trading. So what qualifies, or what is day trading, then, from their perspective?
So we wish-- we wish there was an easy definition where like, x number is OK, x plus 1 trade is not OK. Unfortunately, that's just not the case. We don't have a bright line. But we do have CRA's views and the court's interpretation that says we're going to look at certain factors that are going to be indicative of whether something is business activity.
So we look at the frequency of trades. How long the individual's holding on to certain investments. Is it a very brief period of time? Or is it with the idea of a regular investment that you would hold it for some time? How knowledgeable is the individual? Are they in the business of doing trading like this? What type of investment are you in? Is it speculative or dividend paying?
So all of these factors are going to be looked at and determined whether or not that it's day trading. There's no definition in the Income Tax Act that we can turn to. We just have to look really at question of fact and law and see whether our behavior is more in line with a business, as opposed to a typical investor.
What about the RRSP? I mean, if you can do this with TFSA, what do we know that it could mean for this kind of activity in RRSP?
Well, that's certainly the argument that was made in the case you were referring to, [INAUDIBLE],, where the individual is essentially saying, look, there's no difference and between registered plans. RRSP's pretty similar to TFSAs. And RRSPs actually have a carve-out. So the same section-- so here, we're looking at 146 4(b) for RRSPs. And the same rules apply to RRIFs.
But it essentially says yes, all of your business income is taxable. But to the extent that it's only taxable on the amount in excess of qualified investment income. And so what that essentially means is day trading is OK in your RRSP. But it's only OK because there's a specific provision of the act that allows it, whereas the TFSA, which the legislation was written after at that point after RRSPs, so the legislature had the opportunity to include that exemption, as well, with TFSAs. And they chose not to. So very clearly, RRSPs, you have the opportunity to earn the qualified investment income as business income within an RRSP, not the same exemption from the TFSA.
Nicole, I've only got about 15 seconds. But I know the particular case that is catching everyone's attention. This the specific investor grew their investments, I think, from $15,000 to $617,000 over a three-year period. Wow. So is that part of the issue? Is the amount that happened?
I would suggest that it certainly is going to be a flag that the CRA would likely notice that over other accounts. But it's the behavior that really matters. So if you have been fortunate enough to to invest in a qualified investment that earns you that type of return in a short period of time, and you're not engaging in day trading, that's absolutely fine. So it's really the behavior as opposed to the figure that we need to pay attention to. But if you have that high amount, you might be the target of an investigation, but really no concerns. You'll come out of that just fine, as long as you weren't doing any of that.
All right, if you have a question, always talk to a planner. Nicole, thanks so much for joining us.
Oh, my pleasure, Kim.
[MUSIC PLAYING]
Canadian investors who frequently trade inside their tax-free savings account might be feeling a little uneasy following a recent ruling coming out of the tax court of Canada in a case involving an investor who was engaging in day trading through this account. A judge ruled that the investor was generating business income, which could mean a potentially giant tax bill.
For some clarity around investing through TFSAs, we are joined by none other than Nicole Ewing, director of Tax and Estate Planning at TD Wealth. Nicole, great to have you with us. Let's get down to it. A TFSA, just to remind people, is a registered account. That means if you're 18 or older, you can earn your tax-free investment income inside of that through a whole different range of different kinds of investments. So why is day trading problematic?
Well, I mean, very simply, it's because in the act itself, the language of the act prohibits it. So when we look at Section 146.2, Sub 6 of the Income Tax Act, that's where TFSAs are dealt with. And it explicitly says that to the extent you're investing in nonqualified investments or having business activity in the TFSA, it will be taxed. And it's a long-standing position of CRA in the courts that excessive trading, trading in foreign currency, option writing, all of this is regarded as business activity. And so business activity is taxable within a TFSA.
The implications of this, of course, is that we go from tax free to not just being taxed on capital gains, for example, but being taxed at the full rate, because if it's business income, it is fully taxable. And you don't get those preferential capital gains rates. So it's a pretty big deal to be trading in your TFSA.
It's from one extreme to the other, to be clear in terms of what it is. So let's get clear about when you talked about business activity in the TFSA and there within that, meaning day trading. So what qualifies, or what is day trading, then, from their perspective?
So we wish-- we wish there was an easy definition where like, x number is OK, x plus 1 trade is not OK. Unfortunately, that's just not the case. We don't have a bright line. But we do have CRA's views and the court's interpretation that says we're going to look at certain factors that are going to be indicative of whether something is business activity.
So we look at the frequency of trades. How long the individual's holding on to certain investments. Is it a very brief period of time? Or is it with the idea of a regular investment that you would hold it for some time? How knowledgeable is the individual? Are they in the business of doing trading like this? What type of investment are you in? Is it speculative or dividend paying?
So all of these factors are going to be looked at and determined whether or not that it's day trading. There's no definition in the Income Tax Act that we can turn to. We just have to look really at question of fact and law and see whether our behavior is more in line with a business, as opposed to a typical investor.
What about the RRSP? I mean, if you can do this with TFSA, what do we know that it could mean for this kind of activity in RRSP?
Well, that's certainly the argument that was made in the case you were referring to, [INAUDIBLE],, where the individual is essentially saying, look, there's no difference and between registered plans. RRSP's pretty similar to TFSAs. And RRSPs actually have a carve-out. So the same section-- so here, we're looking at 146 4(b) for RRSPs. And the same rules apply to RRIFs.
But it essentially says yes, all of your business income is taxable. But to the extent that it's only taxable on the amount in excess of qualified investment income. And so what that essentially means is day trading is OK in your RRSP. But it's only OK because there's a specific provision of the act that allows it, whereas the TFSA, which the legislation was written after at that point after RRSPs, so the legislature had the opportunity to include that exemption, as well, with TFSAs. And they chose not to. So very clearly, RRSPs, you have the opportunity to earn the qualified investment income as business income within an RRSP, not the same exemption from the TFSA.
Nicole, I've only got about 15 seconds. But I know the particular case that is catching everyone's attention. This the specific investor grew their investments, I think, from $15,000 to $617,000 over a three-year period. Wow. So is that part of the issue? Is the amount that happened?
I would suggest that it certainly is going to be a flag that the CRA would likely notice that over other accounts. But it's the behavior that really matters. So if you have been fortunate enough to to invest in a qualified investment that earns you that type of return in a short period of time, and you're not engaging in day trading, that's absolutely fine. So it's really the behavior as opposed to the figure that we need to pay attention to. But if you have that high amount, you might be the target of an investigation, but really no concerns. You'll come out of that just fine, as long as you weren't doing any of that.
All right, if you have a question, always talk to a planner. Nicole, thanks so much for joining us.
Oh, my pleasure, Kim.
[MUSIC PLAYING]
