Earnings within tax-free savings accounts (TFSAs) and other tax-deferred plans are, in principle, supposed to grow tax free. However, some taxes still apply, including the 'advantage tax' which applies at the rate of 100% of any advantage (as defined in the Income Tax Act). This tax has become one of the Canada Revenue Agency's (CRA's) favourite tools to effectively expropriate what it views as improperly boosted returns within a TFSA. When the CRA assesses an advantage, it imposes a 100% tax on the entire increase in the value of the TFSA in gain years. However, in loss years the CRA gives no credit for the downtick in value.
Louie v The Queen is the first Tax Court case to consider the scope of the advantage tax. This decision significantly undercuts the CRA's interpretation of the advantage rules.
In Louie the taxpayer had a self-directed TFSA at a discount brokerage firm. She contributed the initial maximum of C$5,000 in 2009. The brokerage firm's rules permitted her to swap publicly-traded securities between her TFSA and her other accounts for a C$45 fee. These swaps were not executed through the facilities of the stock exchange. The brokerage firm allowed accountholders to choose any price between the high and the low trading price of the day at which to execute the swaps.
Given the swap parameters which were set by the brokerage, Louie adopted a buy low, sell high strategy for her TFSA. Towards the end of the trading day, she would swap shares into her TFSA for cash from another of her accounts at the low price of the day and pay the C$45 transaction fee. Then, either on the same day or within a short period thereafter, she would swap those shares or others out of her TFSA for cash at the high price for the stock on that day. This proved to be a low-risk (or no-risk) method of systematically increasing the value of her TFSA.
Louie had undertaken 71 swap transactions by October 2009 and her TFSA account value had grown substantially based in part on those swaps. It rose further in value in 2010, declined in 2011 and grew again in 2012. The CRA assessed her for 100% of the increases in value for 2009, 2010 and 2012 – whether realised or not – on the basis that she had received an advantage through her use of TFSA swaps. The CRA gave her no credit or reduction for the disadvantage in 2011 when her account declined in value.
The Tax Court upheld the advantage tax assessment for 2009 but overturned the assessments for 2010 and 2012. The court found that the trades did not occur between parties dealing at arm's length and further that they did not reflect the transactions that would have occurred in the market; the former was based on the understanding that Louie had directed both sides of the transaction and the latter because of the use of hindsight in selecting the trade price. Further, every trade had operated to the disadvantage of Louie's other accounts and for the TFSA's benefit.
In upholding the 2009 assessment, the Tax Court found that the increase in value in 2009 was attributable to Louie's numerous swap transactions. Further, the court found that the swap transactions were caught by the advantage rules at the time, even though the Income Tax Act had been amended in October 2009 only to specifically capture swap transactions and Louie's swaps had all occurred before that date. However, Justice Lamarre stated that he did:
not consider the increase in [fair market value] to be attributable to each swap transaction taken individually. If the Appellant had made only one swap transaction or just a few such transactions over a long enough period of time I might have concluded, on the facts, that the increase in value is not attributable to the swap transactions.
In overturning the 2010 and 2012 assessments, the Tax Court rejected the CRA's contention that once an account is tainted by an advantage, then all gains or increases in value thereafter are forever captured by the advantage tax. The court stated that the gains in 2010 and 2012 arose from market forces, noting the strong market recovery in 2010 (which had begun in 2009) and finding that the gains from 2010 onwards were not directly or indirectly attributable to the swap transactions. The 2011 loss bolstered the court's finding in this regard.
While there remain some gaps to fill in the interpretation of the advantage tax, this decision provides a sensible result in the face of complex legislation which the CRA is applying aggressively.
For further information please contact David Davies at Thorsteinssons LLP by telephone (+1 416 864 0829) or email ([email protected]). The Thorsteinssons LLP website can be accessed at www.thor.ca.
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