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25 November 2016
Almost since tax-free savings accounts (TFSAs) were first introduced in 2009, the Canada Revenue Agency (CRA) has been clamping down on what it views as inappropriate activities undertaken within TFSAs. One issue in particular has raised the ire of the CRA and given rise to numerous assessments – namely, the frequent trading of publicly-traded securities within a TFSA. In the CRA's view, frequent trading is a strong indicator that the TFSA is carrying on a business. When a TFSA carries on a business, income from that business is taxable within the TFSA (notwithstanding the tax-free aspect of TFSAs) at the top combined federal and provincial marginal tax rate.
Recently, the CRA released a new income tax folio that indirectly addresses an argument that taxpayers have raised to counter the CRA's position that a TFSA is carrying on a business when it undertakes frequent trades. In Income Tax Folio S3-F10-C1, titled "Qualified Investments – RRSPs, RESPs, RRIFs, RDSPs and TFSAs", dated September 2 2016, Paragraph 1.91 states:
"The [Tax Court of Canada] decision in Prochuk v The Queen… held that trading in a registered plan is not a relevant factor in determining whether a taxpayer is carrying on a trading business outside of the plan. This decision does not stand for the proposition that the trading of securities in a registered plan will not in any circumstance be considered to be carrying on a business by the plan."
The Prochuk decision itself is not new – it was decided by the Tax Court of Canada in 2014. However, it is notable in that the CRA does not often deign to discuss particular cases in interpretation bulletins or, now, in income tax folios – unless it is to disagree with the reasoning in those cases.
In Prochuk the taxpayer had personally invested his money in an offshore fund promising stellar returns. He lost his entire investment and attempted to deduct it against other income for tax purposes as a business loss. Viewed in isolation, the court found that Prochuk's personal investing activities fell far short on all tests of being sufficient to constitute a business. The offshore fund was clearly an isolated personal investment acquired for the purpose of earning a return from holding it and thus capital in nature.
However, Prochuk also actively traded stocks within his self-directed registered retirement savings plan (RRSP). He argued that the court ought to view his personal investment in the fund in conjunction with the numerous stock trades that he orchestrated in his RRSP. He said that when viewed together, the totality of those activities was more than sufficient to constitute a business.
The Tax Court of Canada disagreed with Prochuk:
"Counsel for the respondent argued that I could not take into account the trades Mr Prochuk made within his RRSP since it is a unique vehicle under the Income Tax Act… I agree. A person trading within his RRSP cannot be considered to be operating a business. Therefore, the transactions within the RRSP cannot be taken into account." (Emphasis added).
The Prochuk decision is authority for the proposition that buying and selling securities in a TFSA cannot under any circumstances constitute the carrying on of a business. This is the assertion that the CRA addressed in the income tax folio excerpt quoted above.
It is unclear whether a TFSA will be viewed as carrying on a business where its only activity consists of buying and selling qualified investments such as publicly-traded securities. No Tax Court of Canada decisions have yet addressed this issue.
The Prochuk decision may further assist taxpayers if the CRA attempts to bring in evidence of other stock trading activities of the TFSA holder in related accounts in an attempt to show that the totality of the trading activities of the individual – both individually and via his or her TFSA or within another tax-free or tax-deferred account (eg, an RRSP) – are sufficient to constitute a business. The decision provides the foundation for an argument that the relevant factors in determining business income must be applied independently to each entity (TFSA, RRSP and the individual) on his, her or its own merits without combining all trading activities on accounts controlled by a single decision maker.
The CRA's pronouncements are far from authoritative. It remains to be seen whether the Tax Court of Canada will agree with the CRA.
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