TFSAs: IIAC seeks clarity

“What we’re looking for is clarity,” says Barbara Amsden, managing director of the IIAC in Toronto. “Clarity for individual investors and clarity for dealers and trustees.”

The IIAC asked the CRA in a letter dated Dec. 8, 2014, “to expedite development of a one-page summary” on the issue, something the IIAC has been requesting since 2013.

Over the past few years, the CRA has been scrutinizing high-value TFSAs, looking for instances of investors using the accounts in ways the CRA considers to be offside.

In cases in which an accountholder has built up a significant balance in a TFSA through what the CRA considers trading in a manner characteristic of someone carrying on a business – such as overly frequent trading – the CRA will regard any income and gains realized in the TFSA as taxable business income. The CRA also may assess penalty taxes associated with carrying on a business.

The CRA would not indicate an asset threshold above which it selects TFSAs for closer examination but acknowledges in an emailed statement to Investment Executive that the CRA’s aggressive tax-planning program has reviewed TFSAs “with holdings several times greater than the contribution limit.”

The CRA adds that the program has “identified a small number of sophisticated investors – fewer than 1% [of TFSA holders]” whose activities warranted a closer look.

“Where you see a significant amount in a TFSA relative to the contribution limit, and relative to recent market rates of return, it may very well raise a red flag for the CRA,” says Wilmot George, director of tax and estate planning with Mackenzie Financial Corp. in Toronto. “That may cause the CRA to have a peek [at the TFSA] to see what the TFSA holder’s activities have been.”

The CRA refers to an interpretation bulletin (IT-479R) to determine whether a taxpayer is carrying on a business in trading. The bulletin outlines eight guiding factors: the frequency of the taxpayer’s trading activity; the period of ownership of securities purchased; the taxpayer’s knowledge of the securities markets; whether the taxpayer’s ordinary occupation involves the transaction of securities; the time spent studying securities and investigating purchases; if securities traded are speculative in nature; if the purchase of securities is financed primarily on margin; and if the taxpayer advertises that he or she is willing to purchase securities.

“No one factor on its own is indicative of whether you’re running a business,” George says. “The CRA is actually going to look at all factors together.”

In the IIAC’s dialogue with the CRA and the Department of Finance Canada, the association has argued that taxpayers have not been given sufficient or clear guidance to determine whether or not they may be carrying on a business within their TFSAs.

The IIAC’s December letter states: “While the provisions of IT-479R may be well understood by day traders, we believe this will not be true, for example, in the case of retirees who may do some online investing as a hobby.”

The IIAC letter also argues that IT-479R, first published in 1984, is outdated and that the guiding factors don’t reflect the economic and technological changes that have occurred since then.

The decline of defined-benefit pension plans, as well as the long-term drop in interest rates, for example, have compelled an increasing number of Canadians to become proactive investors rather than passive savers in order to grow their retirement nest eggs. In addition, changes in technology have allowed individuals to study and trade securities for themselves via discount brokers.

The IIAC letter says that although the association understands that the CRA determines whether a taxpayer is carrying on a business within a TFSA on a case-by-case basis, more accessible and better communicated guidance would help taxpayers.

“We will never get the clarity in terms of how much money [in a TFSA], or how many trades [made], would mean that a client doesn’t have to be worried [about being audited],” Amsden says. “But even just to let clients know that if they’re doing a lot of trading, they could be subject, not just to taxes on ordinary income, which is like your day trader treatment, but, in fact, [to] penalties [in their] TFSAs.”

The IIAC also is in dialogue with the government on several technical issues regarding TFSAs. The most important may be which party ultimately is responsible for a tax liability arising from a TFSA.

Under current legislation, the TFSA trustee is liable for any tax penalty arising from a TFSA. In the business agreements between TFSA trustees and financial services firms that actually offer TFSAs, the liability typically is transferred from the trustee to the firm. In at least one case, the IIAC letter says, a member firm was left with a significant tax penalty liability on a TFSA that had been reassessed by the CRA after the account had been closed.

The IIAC is asking for changes to tax legislation to make sure that any tax liability or penalties regarding a TFSA fall on the TFSA holder rather than on the trustee or financial services firm.

“Ultimately, it should be the TFSA holder who should be paying the taxes,” Amsden says.

If the liability issue isn’t resolved, Amsden adds, firms could be left with little choice but to prevent clients from transferring TFSAs with large balances until there is some form of guarantee that there isn’t a tax liability associated with the account.

“Dealers can’t afford to be on the hook,” Amsden says, “for somebody else’s taxes.”

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