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GST/QST - Taxing Canadian Tax Free (TFSA) Savings Accounts

In 2009, the federal government introduced the tax-free savings account (“TFSA”) program. Under the TFSA program, individuals are entitled to contribute annually an amount initially settled at $5,500. Contributions to a TFSA are not tax-deductible, but investment returns inside the TFSA are tax-free and both contributions and returns may be withdrawn from the TFSA tax-free.

Is it tax free or not ?
In most cases it is. However, it seems that what God has given us, can be taken back in a sense. In fact, the Canada Revenue Agency (CRA) is aggressively reviewing certain TFSAs. On the basis that in certain cases the holders of TFSA are carrying on a securities trading business inside the TFSA, the agency considers investment returns as business income.

Generally, holders of TFSAs with high balances and who are investment advisors or have significant knowledge and experience in the securities industry will be targeted. In other cases, it is because the TFSA has traded frequently in speculative stocks.

Business income is taxable income. The CRA says that a TFSA that successfully engages in frequent trading is carrying on a business of trading in securities, and therefore gains from the sale of securities by the TFSA should be taxed as business income.

The factors that guide the CRA to determine whether a TFSA is carrying on a business of trading in securities are those developed over the years by the jurisprudence. The factors appear to be the same as those listed in paragraph 11 of Interpretation Bulletin IT-479R (archived) :

  1. frequency of trading transactions;
  2. length of time the securities are owned;
  3. the taxpayer's level of knowledge and experience in the securities market;
  4. whether securities transactions form part of the taxpayer's ordinary business;
  5. the amount of time the taxpayer spends studying the securities markets and investigating potential purchases;
  6. whether securities purchases are financed by debt;
  7. whether the taxpayer has advertised that he or she is willing to purchase securities; and
  8. the nature of the securities, i.e., whether they are income producing or speculative.

When the TFSA was created, we can assume that Parliament intended that TFSAs earn income from marketable securities as investments, which requires buying and selling them from time to time. The CRA’s position is not without merits, but it can be argued that it is unduly aggressive.

A TFSA’s assessment could have costly and complex consequences. Taxpayers who have already been selected for an audit or audited by the CRA should seek competent professional advice. Some targeted taxpayers could only have been lucky which would be a defense. Remember that assessments are presumed valid, and that the initial burden of the taxpayer is to demolish ‘’ prima facie’’ the tax authorities’ assumptions.