For the average Canadian, investing in a TFSA is generally a conservative matter even though it is meant as an investment account and not a savings account. However, a subset of Canadians have taken the concept of investing to heart…they are betting big, and sometimes winning. And when they win, the CRA is starting to take notice.
Are you running a trading business?
A scenario that the CRA is now starting to examine more closely is the idea of using your TFSA to generate massive amounts of tax-free income in a professional capacity; in other words they are cracking down on perceived business traders. If you are too successful with your investment choices, you risk a CRA audit and having to legally defend yourself if you are hit with penalties and taxes.
CRA audit guidelines
In order to determine whether you are engaging in a trading business, the CRA looks at a variety of factors according to tax and legal experts. Among them are how often you make trade and how long (or short) you own specific shares. Excessive trading and repeatedly owning shares for only a brief period of time will set up a red flag.
If you show a substantial knowledge of how stock markets work, perhaps by your successful showings in investments outside your TFSA, or if you run a (taxable) trading business already as a source of income, this will send up a red flag. It’ll be up to you to show that you are keeping your legal trading business separate from your TFSA investment “hobby”.
If you consistently make trades on margin or some other form of debt, and focus on speculative non-dividend securities, these will send up a red flag. Both show you are willing to win big (or lose big), which are indicative of professional business traders. It’s up to you to prove you are not doing it professionally.
CRA audits and proof of burden
Of course one of these in isolation won’t trigger a CRA audit, but a combination of several factors, coupled with huge gains in your TFSA investments, will most likely alert the CRA that you may be operating a trading business. So far the CRA has focused on those actually making huge money inside their TFSA, so if you are doing any of the above but losing money, the CRA currently assumes you are harmless. Watch out if you make a big turnaround though!
Whether you actually are running a trading business or not is up to interpretation; many people show significant profits in their private investments because they are gifted or financially educated. Unfortunately, the CRA may not necessarily know that and it’s up to you to prove your investment gains are legal.
Withdrawing during an audit
Another issue that is cropping up is the fact that some investors under a CRA audit are finding themselves unable to withdraw their investment money from their TFSA. If the CRA deems you made your gains illegally, you’ll need to pay the penalty taxes. However if you already withdrew your money, your TFSA issuer (your bank or brokerage firm) could be on the hook for this! Of course they don’t want to be on the hook for your transgression, therefore you could be banned from getting at your money if you find yourself getting audited!
CRA audits in future years
Year after year, the amount of money investors have to play with is only increasing. As well, with the added publicity of savvy investors seeing 6 figure gains in their TFSA portfolio after only 5-6 years of growth, the CRA is probably going to be taking a much closer look at accounts with large amounts sitting inside.
Because the TFSA is so new and these instances have only recently been publicized, there is little or no case law in this area. So for now it seems to be a grey area, and one where savvy investors are using the tax-sheltered nature of the TFSA to make large tax-free gains to enjoy in the future. If you think you fall into this category but have not yet received a CRA audit, you may well want to talk to a financial advisor or tax lawyer to determine if what you are doing is indeed legal.