From: AlanBaggett@volcanomail.com   
      
   When Tax-Free Savings Accounts Are No Longer Tax Free: CRA SOTW    
      
      
   When Tax-Free Savings Accounts Are No Longer Tax Free: The Canada Revenue   
   Agency's Aggressive Audit Campaign Against TFSAs Carrying On A Business—A   
   Canadian Tax Lawyer's Analysis :    
      
       
   Article by David Rotfleisch   Rotfleisch & Samulovitch P.C.   
      
   IntroductionTax-Free Savings Accounts Audits   
   Introduced in 2009, the tax-free savings account allows individuals to set   
   money aside tax free. While you cannot claim tax deductions for your TFSA   
   contributions, the TFSA's earnings are tax free even when withdrawn. If the   
   tax-free savings account    
   carries on a business, however, that income is taxable under subsection   
   146.2(6) of Canada's Income Tax Act.   
      
   Recently, the Canada Revenue Agency has hung its hat on the business-income   
   exclusion as the basis for an aggressive audit campaign. The CRA claims that   
   it has identified over $75 million owing from inappropriate TFSA use. Of the   
   $75 million, 20 percent    
   comes from tax-free savings accounts that, according to CRA, carry on a   
   business.   
      
   This article first discusses the factors that the Canada Revenue Agency uses   
   to determine whether a TFSA carries on a business. Next, it compares the   
   Agency's approach to TFSAs with its contrary stance on registered retirement   
   savings plans. Finally,    
   this article offers several tips that may prove worthwhile to the concerned   
   reader.   
      
   TSFAs Carrying On A Business: Frequent Traders With Large Balances Beware of   
   Tax Audit   
   When auditing a tax-free savings account, the Canada Revenue Agency applies   
   several factors to determine whether the account carries on a business and   
   thus earns taxable income. These factors come from a long line of Canadian tax   
   cases wrestling with the    
   question of whether a gain or loss from selling securities should be on income   
   account or capital account.   
      
   As a result, the following factors may cause the Canada Revenue Agency to   
   conclude that your TFSA carries on a business:   
   •	you conduct frequent securities transactions within your TFSA   
   •	you quickly relinquish ownership of the securities in your TFSA   
   •	you have knowledge of or experience in securities markets   
   •	securities transactions form a part of your ordinary business or employment   
   •	you spend ample time studying securities markets and potential purchases   
   •	you use debt financing to purchase securities that you transfer to your   
   TFSA   
   •	you advertise your willingness to purchase securities   
   •	the securities within your TFSA are speculative in nature or do not   
   distribute dividends   
      
   In addition, the CRA insists that extraordinary growth within your tax-free   
   savings account serves as an important indicator of business activity.   
      
   Some question, however, whether Parliament actually wished to bar frequent   
   securities trading within a tax-free savings account. Although the Income Tax   
   Act expressly renders taxable the business income of a TFSA, it seems that   
   this caveat simply ensures    
   that taxable businesses need not compete with tax-exempt TFSAs.   
      
   In addition, not only are publicly traded securities a permitted investment,   
   but also the TFSA contribution-room formula seemingly anticipates fairly   
   frequent trading activity. Indeed, this recent round of CRA tax audits were   
   triggered by individuals    
   amassing impressive TFSA balances without overstepping their contribution   
   limits.   
      
   Inconsistent Treatment? Trading in An RRSP   
   Others simply find it puzzling that the Canada Revenue Agency seemingly adopts   
   a contradictory position without explanation when it comes to registered   
   retirement savings plans. Like a TFSA, a registered retirement savings plan is   
   tax-assisted savings    
   vehicle. Moreover, an RRSP permits the same investment holdings as those   
   allowed in a TFSA. Yet, in Prochuck v the Queen (2014 TCC 17), the CRA and the   
   Crown found themselves arguing that frequent trading within an RRSP does not   
   amount to carrying on a    
   business since an RRSP is "a unique tax-protected vehicle."   
      
   In Prochuck, the taxpayer suffered a substantial loss on an investment outside   
   his RRSP. He wished to characterize the loss as a fully deductible business   
   loss. The CRA argued that the loss was only a one-half deductible capital   
   loss. In response, the    
   taxpayer pointed to the 512 trades that he made within his registered   
   retirement savings plan during the taxation year at issue. The CRA and the   
   Crown took the position that trading inside an RRSP cannot be considered a   
   business. The Tax Court of Canada    
   agreed. The court reasoned that the Income Tax Act "treats an individual who   
   trades within his RRSP differently than a taxpayer who is in the business of   
   trading." In particular, while a taxpayer earning business income from trading   
   must report all    
   income on a yearly basis, a taxpayer trading within a registered retirement   
   savings plan can move funds around inside of the RRSP without tax consequence   
   and accumulate tax-free income on funds held in an RRSP. On this basis, the   
   court concluded that "   
   trading within an RRSP does not amount to carrying on the business of   
   trading."Interestingly, a tax-free savings account seemingly exhibits the same   
   features that the Prochuck court found relevant when deciding that trading   
   within an RRSP does not    
   constitute a business.   
      
   But perhaps the CRA's treatment of TFSAs finds justification from the fact   
   that TFSA funds remain tax free even after the account holder withdraws.   
      
   Tax Tips   
   Based on the methodology that the CRA employs, your status as an amateur   
   investor does not guarantee your escaping a tax audit. That is, while   
   professional investors trading within a TFSA seem a more likely target,   
   amateur investors generating large    
   balances with a frequent-trading strategy may find themselves subject to CRA   
   tax snooping. The difference between a tax-free savings account earning   
   taxable business income and one earning non-taxable investment income turns on   
   the specific facts of each    
   case. Moreover, the courts have not yet been asked either to determine   
   precisely when a TFSA "carries on a business" or whether Prochuck's treatment   
   ofRRSPs should also apply to TFSAs.   
      
   The content of this article is intended to provide a general guide to the   
   subject matter. Specialist advice should be sought about your specific   
   circumstances.   
      
      
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