If you use your registered plan for day trading, the revenue generated could be considered business income. In fact, the tax agencies have emphasized in numerous documents that income from stock market speculation may not benefit from the tax exemption provided for registered accounts, whether it's an RRSP, to RRIF or TFSA.
The Income Tax Act
Subsection 146(4) of the Income Tax Act ("ITA") provides that the business income earned in an RRSP will be subject to income tax [146.3(3) of the ITA for RRIFs]. This section of the Act is necessary to ensure equity among taxpayers. Tax laws are not intended to prevent taxpayers from making a profit on transactions, however business income must be realised outside of a registered account.
Stock market speculators may struggle to understand how their transactions could generate a "business income". Indeed, they have no storefront or employees, and they are not registered with any government agencies. However, these considerations are not necessary for a business income to exist because the courts have stated on numerous occasions that, in the eyes of the tax agencies, speculative operations produce business income. In effect, a speculator acts as a broker and their transactions therefore generate business income.
We agree that all taxpayers acquire stocks in the hope of making a profit. The investor’s intention when buying a security determines whether the transaction will be treated as income from a business or a transaction of a capital nature. If the taxpayer intends to quickly resell a security without regard to the receipt of a dividend, the odds are that business income has been realised.
Several factors are analysed to determine whether a capital gain or business income is concerned:
- The frequency of transactions and their history;
- The holding period of securities;
- The time spent on operations;
- Buying securities on margin;
- The short sale of securities;
- Knowledge of the taxpayer.
Interpretation Bulletin IT-479R1 reported the above factors and the interpretation that the tax agencies make of revenues on securities. This bulletin is being rewritten and has recently been archived. However, it is our understanding that the matters discussed are still applicable.
The Prochuk Case 2: A New Interpretation
A few weeks ago, the Prochuk judgment was published. Result: it contradicts the position of the tax agencies and sheds new light on the transactions that can be performed within an RRSP or RRIF.
In 2005, Allan O. Prochuk invested $250,000 in a fund that later turned out to be a fraudulent scheme. Having lost a significant amount of money, he wanted to deduct this as a business loss. He had to prove he was a day trader. During the year in which he incurred the loss, Allan Prochuk had traded only within his RRSP. In total, 507 transactions were made, and his RRSP had held securities for periods ranging from several hours to several months. Allan Prochuk argued that it was necessary to take account of the transactions in his RRSP in the analysis of his status as a speculator.
In her decision, the judge concludes that the transactions for market speculation made within an RRSP or RRIF have nothing to do with business income. In reaching this conclusion, she maintains that RRSPs and RRIFs benefit from a special tax treatment because the money paid to the annuitant of the plan will be added to future income. The fiscal policy inherent to RRSPs and RRIFs would be different from that to which is subject a business owner. In the future, profits realised from speculative transactions will be taxed when withdrawn from the RRSP or RRIF, whereas someone who conducts the same transactions in a non-registered account is taxed annually. The judge then relies on the arguments of the Canada Revenue Agency and declares that the transactions made by Allan Prochuk within his RRSP cannot grant access to a deduction for the loss on his investments.
Analysis: A Different Treatment for TFSAs
Many investors will welcome this decision as some feared that the tax agencies would be interested in the transactions in their registered accounts.
The decision of the judge is based on the tax deferral nature of RRSPs and RRIFs, and the fact that the money will be taxed upon withdrawal. However, we find it difficult to apply this reasoning to TFSAs because, unlike RRSPs or RRIFs, money withdrawn from a TFSA will not be taxed. In our opinion, speculative transactions within a TFSA are always taxed in the year they were made, despite the Prochuk judgment. In this regard, the provisions which allow for the exemption of business income in an RRSP, RRIF and TFSA are not written in identically. Therefore, the previous conclusion confirms that the fiscal policy is different for transactions in a TFSA and speculative transactions in such an account could be subject to tax.
Form T1135 – Transitional Rules Announced
In a previous newsletter, we discussed the requirements for taxpayers who hold foreign securities listed on a stock exchange, even if such securities are held with a Canadian registered securities dealer.
On February 27, the Canada Revenue Agency announced transitional rules. For the 2013 tax year, if you held such securities with a Canadian registered securities dealer, the following reporting method is allowed:
- The total amount of property held by a taxpayer is registered in section 6 of the form ("Other property outside Canada");
- If the taxpayer chooses this reporting method, they must use it for all accounts held with Canadian registered securities dealers.
- Only the following information must be provided:
- The name and account number of each account held with a Canadian registered securities dealer;
- Market value of all foreign property held in such accounts at the end of the taxation year;
- The total income earned on all foreign property held in these accounts throughout the tax year and
- Total gross income or loss realised on the disposition of all foreign property held in the accounts throughout the tax year.
In addition, for the 2013 tax year, the due date for this reporting method has been deferred to July 31, 2014 for all taxpayers.
These transitional rules are certainly good news for taxpayers who are planning their 2013 tax returns. However, the various issues discussed in our previous newsletter remain. We hope that the Canada Revenue Agency will change its approach over the coming months.
You can download the new form T1135 at the following link: http://www.cra-arc.gc.ca/E/pbg/tf/t1135/t1135-fill-13e.pdf. The document also provides guidance with respect to information that must be entered on the form.
1ARC, IT-479R – Transactions in Securities, 1984 (http://www.cra-arc.gc.ca/E/pub/tp/it479r/it479r-e.html).
2Prochuk v. The Queen, 2014 TCC 17 (Tax Court of Canada) http://www.canlii.org/en/ca/tcc/doc/2014/2014tcc17/2014tcc17.html.
Since the levels and bases of taxation can change, any reference in this publication to the impact of taxation should not be construed as offering tax advice; as with any transaction having potential tax implications, clients should consult with their own tax advisors.