The COVID-19 pandemic and soaring stock market have given young Canadians a taste for buying and selling their own securities. But not all newbie DIY investors seem to know there are potential tax risks in trading too frequently inside a tax-free savings account (TFSA).
“We’ve seen cases on it,” says Jamie Golombek, managing director of tax and estate planning at CIBC Private Wealth Management.
“When I get calls from clients who say that their 19, 20-year-old sons want to open up TFSA accounts for trading, I caution them. I say, ‘you’ve got to be very, very careful,’” Golombek says.
The downside is risking unwanted attention from the Canada Revenue Agency (CRA).
Canadians can hold qualified investments like stocks, bonds, exchange-traded funds (ETFs), mutual funds and guaranteed investment certificates in their TFSA. And inside the account the investments grow tax-free (although foreign governments may withhold tax on income from foreign investments — an issue well-known to many Canadians who receive U.S. dividend income in their TFSAs).
But as noted in a recent warning from RBC in its Direct Investing site, “it’s important to remember that TFSAs are registered accounts intended for investing and growing your savings over time.” If you buy and sell investments frequently inside a TFSA, the CRA “may consider your account to be ‘carrying on a business,’” the note continues.
In such a scenario, investment income such as dividends, interest or any net gains from selling stocks would become subject to tax.
“The risk of individuals being characterized as carrying on a business for trading in their TFSA is much higher now than it would have been a few years ago, because there’s just simply more new inexperienced investors who are trading in their TFSA,” says David Dyck, head of client services at CI Direct Investing.
Canada has seen a surge in self-directed investing accounts since the pandemic started, he notes, with TFSAs making up a significant share of those accounts. And a sizeable share of the recently opened accounts belong to new investors who “have not had experience investing in the past and are kind of learning as they go along,” Dyck says.
Wealthsimple Trade, one of Canada’s popular trading apps, saw the number of new accounts grow ninefold in 2020 and then double in the first half of 2021, according to data provided by the company. Wealthsimple Trade launched in March 2019.
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There are no defined limits on trading in a TFSA.
“In general it is acceptable for a taxpayer to make periodic adjustments in their TFSA portfolio. This can be instigated by a fundamental change in the securities a taxpayer possesses, a change in their investing strategy, or a need to extract funds,” the CRA told Global News via email.
“Whether a taxpayer is using their TFSA to carry on a business is a question of fact that can only be determined after a review of their particular circumstances,” it said.
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Day trading — buying and selling an investment within the same day or multiple times within a day — is one of the activities that may constitute carrying on a business, according to the CRA. In its email, the tax agency said other factors that might be relevant to that determination include a history of owning securities only for a short time, the degree of knowledge an investor possesses about the securities market, whether an investor spent a significant amount of time studying financial markets and potential investment purchases and whether an investor primarily used debt to finance the purchase of their financial investments.
“Although none of the individual factors may be sufficient to characterize the activities of a taxpayer as a business, the combination of a number of those factors may well be sufficient for that purpose,” the agency said.
While Canadians don’t have to declare their year-end TFSA balance on their tax returns, their financial institution provides that information to the CRA annually, Golombek and Dyck note.
“When you look at balances at the end of the year and you see how much is in there compared to an individual’s TFSA contribution room, that might trigger some questions and a review by the CRA,” Golombek says.
The extra scrutiny, itself, is something investors may want to steer clear of, Dyck says.
“There’s an added burden that investors may want to avoid, even if in the end they’re not offside on the rules.”
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