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CRA targeting successful TFSA investors
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It is important to note that an IT Bulletin is just CRA's interpretation, considered in light of what courts have decided to date, of what the legislation intends. So, even if it could be done (each case is unique and different factors are important or not important for each one) there would be no point in being specific (e.g. "3 times a month is ok, 4 times isn't") because judges come along and say "I don't care what CRA's bulletin says, the wording of the law, the Income Tax Act, says, in my view, something different." Then CRA has to decide whether to ignore the decision and carry on, appeal the decision, or change their interpretation in line with the decision going forward. New realities arise (e.g. the widespread holding of stocks by everyone, the rise of frequent trading due partly to virtually zero cost of trading) so tax interpretation, and the law, is in a constant state of flux, just the way it is. What's more interesting to me is that CRA's audit efforts are often directed at the average guy instead of focussing on criminals and the shenanigans of the wealthy - but, as a law enforcement agency it does make sense to make sure the mass of taxpayers stays in line and to select the easy prey, the vulnerable, i.e. less energy expended, reduced risk.
Loonie
I hear what you are both saying, Norman1 and Bill.
I still don't think it's fair, though. The problem could be addressed in several ways. Two that I can think of, as a layperson in this regard, are:
1. an update to the relevant ITs which take into account changes in the last 30 years. This is long overdue. They ought to consider, at a minimum, changing patterns of individual do-it-yourself investors, greater access to markets on the part of do-it-yourself investors due to lowered costs and increased variety of investment options; creation by legislators of TFSAs; more recent interpretations by the courts. 30+ years ago, and I remember it well, mutual funds were still a relatively new idea for retail investors, never mind ETFs, $6.99 trades, options, futures and derivatives. In those days, little old ladies would hold Bell Telephone stocks which they likely bought 40 or 50 years ago, and that was the extent of exposure for most people, if that. The concept that people who were not wealthy could and should invest in the stock market is still a relatively recent invention, historically, and it's unreasonable to put all the burden on the individual to figure out matters that were previously in the domain of brokerage houses and wealthy individuals. The system, which is regulated by gov't, wanted our money in the markets, and they have a responsibility to allow us to do it with some clarity as to the consequences.
2. a revision to the Income Tax Act which provides greater clarity on what is and is not permitted in TFSAs. There is nothing to prevent them from providing better definitions, for the purposes of TFFSAs at least, of what would be considered acceptable in the areas that are problematic. They have not made any effort in this regard. In fact, in the absence of such information, it makes the TFSA look like a sloppy slap-dash piece of legislation, invented primarily to get votes in the last election.
The average person ought not to have to incur the costs of going to court to defend their actions in regards to their TFSAs which are made in good faith. The example Norman provides is one. Another might be macro events which can unbalance the world's markets and cause some to take flights to safety - natural disasters, assassinations, wars, etc. In addition, people might simply decide to change their risk profile or re-evaluate the suitability of particular investments. The point, as every book on the subject seems to testify, is to make money for the investor. In fact, as I have been reading these books, I have been surprised that none, so far, has talked about investing for the good of the economy. It's all about the investor and what they can get out of it. If that's the purpose, then people ought not to be penalized for pursuing it.
I suggest that those of you who are considering basing your vote in the next election on the basis of TFSA contribution limits ask candidates for promises to update the legislation to protect taxpayers from unforeseeable hassles from CRA.
AltaRed
Loonie said
Unfortunately, that is a non-starter. The more preciseness legislation has, the more the armies of tax accountants and lawyers will find ways to push the law close enough to the edge to take advantage of potential loopholes/back doors. I am no friend of the CRA but I empathize with them because of the above forementioned armies of tax professionals looking for ways to beat it. I've been a corporate executive where the tax department always looked for angles and what sometimes holds them at bay is enough rope left for those professionals to hang themselves in Tax Court. Not unlike how income trusts, flow through shares, shady charitable structures, etc. exploit(ed) the (intent of) law.
People embarking on significant possible ventures that may be "beyond intent" should seek advance tax rulings. That was the best way to approach it in the corporate world. That said, this particular CRA adventure should have, instead of actually chasing individuals, actually said from this date forward, it is no longer acceptable (and grandfather past practices).
I am on the same page as Greg, TFSA is a saving account, not an account for speculation or risky investment, anyone that earn more than a certain percentage should pay tax. Such clear cut rule is going to make things a lot simpler for us and make sure it will not sounds like CRA is setting up a trap for successful speculator to step into.
AltaRed, the best thing to avoid loopholes in tax system is to make the system as simple as possible. Such as getting rid of all the exemptions, but reduce the general tax rate instead. A simple system also reduce the time and money use for filing tax and the time and money use by the government to audit our tax filing while keeping the the same income for the government. I really don't see the reason why we are not doing that.
AltaRed said
It is unrealistic to expect people to ask for and receive a ruling from CRA before they decide to sell an investment because they aren't sure if it's too soon to do so, "frequency" being the issue and timeliness being a necessity. There is no need for millions of people to be asking the same questions, but there IS a need for greater clarity in the legislation.
I don't think anyone here is trying to protect "armies of tax accountants" or people who are trying to work obscure angles. Nor do we as individuals live in the corporate world or have an understanding of its tools. We just need some basic clarity. If they can't give that, then they should just say that all we can invest in is savings accounts, bank- or CU-issued GICs and prov/fed govt-issued bonds held to maturity. It wouldn't seem like such a great deal then, but so be it.
I agree that it would make more sense to have a "henceforward" rule, but that too will require them to be specific about what is not allowed.
The average person is not going to hire accountants to pursue the angles or go to court, because it's beyond their means if nothing else. There has to be some clarity for the little guy. I don't want to find out later that, for instance, because I bought a certain promising tech stock and got lucky with it, that selling it "too soon" or even changing my mind and deciding to reinvest, is going to get me in trouble. The tech sector can be volatile, and selling could be a very sensible move. Sure beats watching it run down. Now, if they never wanted TFSA money to go into RIM, for instance, then all they needed to do is publish a list of permitted investments and acceptable "frequencies". Let THEM do the work ahead of time and make it public, not keep us guessing and paying lawyers and accountants and trying to read their minds.
Norman1
People who are not wealthy have long invested, or should we say speculated, in stocks. Classic investment books that mention such endeavors are Reminiscences of a Stock Operator written in the 1920's and Where Are the Customers' Yachts? written in 1940.
What consititutes business activty or "an adventure in the nature of trade" does not change because more people are doing it or because it is easier to do because of online brokerages. Moving inventory through a website is just as much of a business as doing it through a storefront. That people can now do stock transactions for $9.99 each instead of $50 - $100 each also does not change things.
TFSA's are new. But, conducting transactions through a TFSA doesn't make the transactions any more or less of "an adventure in the nature of trade" than conducting them outside of a TFSA.
Agreed, Norman1. The "average" person, the 99% who use a TFSA as intended, as a savings vehicle, does not have to read the legislation or CRA Bulletins as they have nothing to worry about. Stick it in People's and get 3%, or buy a few mutual funds or ETFs or stocks every now and then, no problem, you'll never hear from CRA. But if you're that rare creature that is sophisticated enough 1) to be an active trader, AND 2) to make an unusually large pile of dough at it (i.e. someone who's not likely to be on sites dedicated to high interest bank accounts), then you should also be smart enough to know that CRA might be checking you out to see what's going on (after all, that's the kind of work we hire them to do) and that you should look into the possible tax implications of your activities.
There has to be some clarity for the little guy. I don't want to find out later that, for instance, because I bought a certain promising tech stock and got lucky with it, that selling it "too soon" or even changing my mind and deciding to reinvest, is going to get me in trouble. The tech sector can be volatile, and selling could be a very sensible move. Sure beats watching it run down. Now, if they never wanted TFSA money to go into RIM, for instance, then all they needed to do is publish a list of permitted investments and acceptable "frequencies". Let THEM do the work ahead of time and make it public, not keep us guessing and paying lawyers and accountants and trying to read their minds.
CRA is not going to tell the little guy how to engage in "an adventure in the nature of trade" without it looking like "an adventure in the nature of trade". It's similar to the police not detailing how to commit premediated murder and make it look like an accident.
Also, what you just described sounds like speculation and not investing. Buying a stock that (a) one hopes will go up and (b) one hopes one will sell before it inevitably comes back down sounds like trading and not long-term investing to me.
Good grief! I'm not asking them to tell us how to avoid the law. I am asking them to tell us how to comply with it.
Norman, aren't people supposed to invest in stocks that might go down? All stocks might go down, and all do periodically, and some bottom out and disappear. When they start to go down, a lot of people will legitimately want to take their profits before it gets worse.
It seems to me, and I have never bought a stock in my life and find the prospect intimidating, that if you buy stocks, you do hope they will go up, for sure, or else there is no point at all. And, second, you certainly do hope to be able to sell them before they have a swan dive. Why wouldn't you? And under certain circumstances, precisely because you're NOT a sophisticated investor, you might sell as soon as you'd made a profit, just out of fear of losing it. And it might turn out that you did the right thing, for you.
There seems to be some kind of unwritten rule emerging that says you are only supposed to buy value stocks that produce dividends, and you are supposed to hold them indefinitely. If this is the case, then they should say so.
Loonie, I am not suggesting the average retail investor ask for 'advance tax rulings'. But perhaps the professional stock trader carrying on trading as a business should have done so?
I think it is the sophisticated trader, many of whom are stock market professionals, that CRA is really after. There are people who sit at computers each day using sophisticated software algorithms, e.g. proprietary like Vector Vest or their own developed algorithms, doing trades, perhaps anywhere from 5 to 20 a week, or even 5 a day. These are not typically amateurs although clearly there are some retail 'day traders' who are. These folks typically have considerable sophisticated knowledge of the markets and already know that such trading in a non-registered account is 'business income' and not investment income. That group probably did not even think about that aspect with respect to TFSAs and simply looked at the new TFSA vehicle as an oppotunity to 'avoid' taxation of their business. As someone else said in another forum, tweaking tax law for a 'special interest' group sometimes has unintended consequences.
Discount brokerages love these folks because they churn their accounts actively racking up commission costs and increasing brokerage profits. They have a motive to make a big deal out of CRA's actions. Hence, I think the issue is being made a mountain when it is really a molehill. The CRA really is not interested in the guy who has 50 stocks in his portfolio and makes maybe 20-50 trades a year. That is what many of us amateurs have been doing for years (myself included). The issue is likely of no consequence to anyone who posts or reads the posts in this forum.
Bill said
Now that I'm thinking about this a little more - CRA's issue is not with what specific investments are held in a TFSA, it's with how actively, frequently, successfully, the investments are traded, managed, etc. CRA says you can't operate a business within a TFSA but is that just their opinion - is that what the Income Tax Act, the legislation, actually says? Does it specifically exclude this "operating a business" concept from TFSA activity or is this just CRA's own added requirement to get at folks who've made lots of dough in their TFSA by spending lots of time in investing activity? I'm not an expert in the Act itself - if anyone is, let us know!
It doesn't look like it is just CRA opinion. Instead, CRA seems to be enforcing a limitation to the tax-free privilege of a TFSA in the Income Tax Act, Part I (Income Tax), Division G (Deferred and Other Special Income Arrangements), Section 146.2 (Tax-free Savings Accounts), subsection 6 (Trust not taxable).
Loonie gave this link to Section 146.2. This is the text from subsection 146.2(6):
Trust not taxable
(6) No tax is payable under this Part by a trust that is governed by a TFSA on its taxable income for a taxation year, except that, if at any time in the taxation year, it carries on one or more businesses or holds one or more properties that are non-qualified investments (as defined in subsection 207.01(1)) for the trust, tax is payable under this Part by the trust on the amount that would be its taxable income for the taxation year if it had no incomes or losses from sources other than those businesses and properties, and no capital gains or capital losses other than from dispositions of those properties, and for that purpose,
(a) "income" includes dividends described in section 83;
(b) the trust's taxable capital gain or allowable capital loss from the disposition of a property is equal to its capital gain or capital loss, as the case may be, from the disposition; and
(c) the trust's income shall be computed without reference to subsection 104(6).
Technically, a TFSA is not prohibited from carrying on a business. But, the TFSA needs to pay income taxes on the resulting business income.
My thanks to everyone for their contributions.
As a non-professional in these matters and non-businessperson, it would never in a million years have occurred to me that you could have a "business" which had no external customers, no bills of sale, no exchange of goods or services with another party.
I still think greater clarity is required, to protect the naïve amongst us.
I'm glad to know more about this than I did before.
Loonie, think of it this way: Your business can consist of buying things (i.e. financial instruments such as stocks), as inventory, from other (admittedly usually unknown) sellers, and you hope to sell that inventory to buyers for a higher amount. To conduct your business you need the assistance of service providers (the brokers, mutual fund companies, etc), hence your business costs are mainly the commissions you pay them for those services that facilitate the operation of your business.
Norman, aren't people supposed to invest in stocks that might go down?
Yes, it is not surprising that the market value of a stock may decline in the short term.
All stocks might go down, and all do periodically, and some bottom out and disappear. When they start to go down, a lot of people will legitimately want to take their profits before it gets worse.
That's the mindset of traders and speculators who are fixated with the current market value of a stock. If nothing is really wrong with the company or the reason is short term, investors would see the decline as temporary and as a buying opportunity.
A trader or speculator hopes that each individual stock purchased will go up afterwards. To the investor, that is not realistic.
With experience, the investor will find that about 1 in 4 to 1 in 5 stocks selected for a portfolio will disappoint. Instead, the investor hopes that the portfolio of stocks as a whole, not each individual stock, goes up in the long term. The winners will more than make up for the disappointments. The good years will more than make up for the bad years.
That's one way to invest, as opposed to speculate, in stocks.
The trader/speculator tries to profit from short-term movements in the stock price. In contrast, the investor tries to participate in the long-term growth of the company through dividends and growing stock price.
The two approaches will result in different motivations, different patterns of transactions, and different amounts of portfolio turnover.
That would be nice. But, I don't think greater clarity is possible.
Such cases rest on the intent of the taxpayer and not on the nature of the transactions themselves. I think they are, by their nature, complex.
Such "adventure in the nature of trade" issues are not new. The ones involving TFSA's are new because TFSA's are new. Here's one involving something more established: the principal residence exemption.
This is from the Marmer Penner newsletter (January/February 2014) - Abuse of the Principal Residence Exemption:
Some have become so enamoured with the opportunity to earn such tax free gains that they have taken to buying fixer-uppers, making some improvements while living in the home and then selling the home all in a short period of time. Given the length of this current real estate boom, it seems to be a no-brainer for anyone who is handy to do this and, much like the instructions on your shampoo bottle: "rinse and repeat".
... In September 2012, the Tax Court of Canada ruled on the Giguère case. Ms. Giguère and her spouse sold seven single-family residences within a six year period, claiming the principal residence exemption each time. They had owned properties for periods ranging from as little as three months to as long as two years. CRA successfully argued that the profits should be taxed as business income and that, in addition, gross negligence penalties should apply for failure to report the income. In this case, the court concluded that the intention of the taxpayers was to buy the properties and to sell them for a profit and not to live in each property as a principal residence. This intention, along with the frequency of the transactions led the court to the conclusion that, for this taxpayer, the real estate sales were on "adventure in the nature of trade".
CRA defines an "adventure in the nature of trade" as a situation where a person habitually does a thing that is capable of producing a profit notwithstanding that these activities may be quite separate and apart from his ordinary occupation. From now on, the courts and CRA will look at a taxpayer's intention at the time a property is purchased in addition to the frequency of real estate "flips". Where a taxpayer is a builder and does this with his own home, albeit less frequently, the same argument may apply because he is earning income from a "habitual" activity.
No, I'm afraid what you have said does not really help from my point of view, Norman.
I understand about the house speculators because I remember when that was a popular activity. I don't recall that I knew anyone who did it, but I do recall that such people were under the impression they could do it as long as they lived in the house for a while - and lots did. It's still the problem of divining intention. Sometimes it's obvious, but not always. At what point does sweat equity become "business"? Naturally, if the house needs fixing, a buyer will likely fix it up, knowing that it will make the house more liveable and pay off in the end. Most people will eventually sell their house and will get more for it than they paid. Is that always a "business" activity? If not, where do you draw the line? I really don't know.
As regards the stock market, there are "value" stocks and "growth" stocks. It seems like you are saying that "growth" stocks are speculative, and thus vulnerable to prosecution if conducted through TFSA. I can't understand this. As I understand it, the well-being of the economy requires that some people invest in "growth" stocks which do not bear dividends. How are these companies supposed to make a go of it if people don't invest in them? That, as I understand it, is how our economy of risk and reward is supposed to work. (Personally, I find this hard to accept. I am risk-averse, and I haven't invested in any of them, but it is my understanding of how it is supposed to work. To me, the whole thing is speculative, be it "value", "dividend-producing" or "growth", as, really, I have no idea how they'll all work out in the end, despite the odds. To my way of thinking, they are all speculative, some moreso than others perhaps.) Further, as far as I know, and I've only spoken to a couple, stock brokers would never be willing to tell you that some of your stocks will be duds. They sell them all with the idea that they will succeed, sooner or later.
I understand that there are conventional truths out there that disagree with my perspective. I'm just saying that it's really hard for someone like me to figure out what these people really mean, because my mind doesn't work the same way.
The only option, for someone like me, is to avoid stocks in TFSAs like the plague - which shouldn't be that hard. But I am annoyed that they are making it so difficult to understand and follow.
I don't agree that they couldn't make it clearer. They should just eliminate stocks as a category of TFSA investment, admitting that they are all speculative to some degree or other because, even if it's just 1 in 5 (and it could be more, or even all if you are unlucky), any of them could go belly-up. That, after all, is the reason I don't invest in them. I am not persuaded that it's OK if most of them succeed because they might not. No broker will guarantee anything whatsoever. CRA seems to only want TFSAs to invest in "value" stocks. They seem to want to penalize the "growth" side, or at least leave people confused about whether these will qualify.
I don't see any resolution to this. I will continue to avoid stocks in TFSAs. I may in the future invest in stocks outside of TFSA. I haven't decided if it's worth it yet. But I will not put money into anything that I personally don't consider an "investment". This doesn't mean, however, that the decision might not change tomorrow. I might decide in favour of something today but change my mind tomorrow if I learn something new or circumstances change for me or the company or the outside world or if I have made enough money that I feel I no longer need to take the risks associated with that investment; and I don't want to run any risks for that or have my decision-making interfered with by vague rules whose outcomes cannot be known. To me, stocks are all speculative, unknowable, and to be wary of. I am still assessing whether the risk would ever be necessary or desirable for me. So far I have not been convinced, but I might be eventually, and I would never want to give up my ability to get out of that investment when I chose to do so and for whatever reason made sense to me at the time; and I certainly don't ever want to have to argue the case with professional mind-readers at CRA.
Thanks for trying to explain it, but I think we are just poles apart in our perspective on this one.
Loonie, there is no need to be so hostile. I understand judging people by intention introduce ambiguity and uncertainty; but because it is impossible to set law that fit every circumstances, it is necessary to judge people's intention in order to keep the "spirit" of the law alive.
Jon, I don't think Loonie is being hostile at all, I can't speak for him but he just seems frustrated as he appears to be extremely risk-averse and wants guarantees or certainty in financial matters. Unfortunately when you buy things or give your money to anyone you can never be sure of what might happen, you can't even be sure that one judge will do the same as another, and Loonie isn't the only one who doesn't like that!
You got it, Bill.
I understand about the house speculators because I remember when that was a popular activity. I don't recall that I knew anyone who did it, but I do recall that such people were under the impression they could do it as long as they lived in the house for a while - and lots did. It's still the problem of divining intention. Sometimes it's obvious, but not always. At what point does sweat equity become "business"?
I think it is based on the purchaser's intentions when they buy the house. I think they embark on an "adventure in the nature of trade" the day they take possession, if their intentions were to sell it as soon as the renovations are done.
Naturally, if the house needs fixing, a buyer will likely fix it up, knowing that it will make the house more liveable and pay off in the end. Most people will eventually sell their house and will get more for it than they paid. Is that always a "business" activity? If not, where do you draw the line? I really don't know.
True: People will eventually sell. But, not ASAP after the renovations are done.
People who intended to occupy their house as a principal residence will kick back and enjoy their newly renovated place after tolerating months of sawdust, drywall dust, having to step over debris, and having to wash their dishes in the bathtub while waiting for their kitchen to be done. They won't be anxious to sell and do it all again. They certainly won't be going through seven fixer uppers in six years as the Giguères did!