Did you really generate a capital gain on your transactions?
More and more investors are managing their own personal finances and portfolios. Since stock quotes have become more democratic, it is now easy to trade on different stock exchanges.
Investors believe that their transactions must generate a capital gain or loss. However, tax laws are not so automated when it comes to market transactions.
What were the investor's intentions?
The investor must ask themselves; what were their intentions when they carried out transactions, because in the eyes of the tax authorities, it may be considered a source of income. Of course, everyone in the market has the intention of making a profit. That is not the question. Rather, the investor's intention and motivation must be examined when the securities are purchased:
- Did the investor intend to dispose of the security as soon as they could generate a profit?
- Or did they intend to hold the security for a period of time because of the prospect of an increase in value and the dividends it provides?
In the first case, the investor would be labeled a trader and could generate a business income. In the second case, they would trigger a capital gain on the transactions they would make.
Tax legislation defines the term "business" broadly: in addition to including professions and industries, it covers all speculative activities. For example, an investor who acquires securities with intent to sell them as soon as possible would be subject to corporate income taxes. As a result, the taxes payable could be substantially higher, since all of the profit generated on business income is taxable, compared to 50% for capital gains.
Factors to Consider
At what point does one become a speculator? There are no specific guidelines in the tax laws so we have to rely on jurisprudence and other literature. To identify an investor's intention, many factors are analyzed, including:
- frequency of transactions;
- holding period of securities;
- market knowledge;
- sources of funding;
- other businesses of the taxpayer;
- and time allocated to the activity of investing.
Note that none of these factors is a determinant per se. However, a combination of several of them could indicate that market transactions generate business income.
Frequency of Transactions
Contrary to popular belief, there is no minimum number of transactions required in order to be affected. Indeed, a single transaction can be declared business income and many decisions have been made in this respect in the case of very low transaction volumes.
For our part, we question the intentions of a taxpayer who carries out more than 100 transactions in a year, as usually, unless an investor holds a large portfolio, they carry out a limited number of transactions over a period of one year.
As to the length of time the securities are held, it is customary in case law that if they are held for a period of less than seven days, it would involve business income, unless there is a good reason for such quick resale.
We question the intentions of a taxpayer who frequently holds securities for less than 15 days. However, these periods of seven or fifteen days are not absolute. A longer holding period may be subject to business income rules because of the taxpayer's intentions at the time of purchase. Furthermore, unfavorable conditions may delay the sale of a security when the intention was to speculate at the time of purchase.
Analysis of this issue is important because the tax treatment of a capital gain versus business income results in totally different tax payments. In addition, this distinction is fundamental with regard to:
- Expenses, which may be use to offset profits;
- Carrying forward losses and their future application;
- Transactions that can be made in an RRSP and TFSA.