The government recently announced that they have started to audit the Tax Free Savings Accounts (TFSA) of individuals with significantly large balances.
Their argument is that people who trade frequently within their TFSA are carrying on a business – and should be required to pay taxes on the gains within their TFSA. This is despite the fact that losses within a TFSA are not deductible for tax purposes.
Related: Hidden Advantages of the TFSA
As TFSA balances grow and people continue to make annual contributions, the issue is expected to become even more of a focus for CRA.
What’s even worse is that some have been barred from making withdrawals by their investment dealers who fear they will get stuck with a large tax bill.
Can The CRA Audit Your TFSA?
Current legislation states that they can (and will) audit a TFSA if needed. They are using a dated tax ruling which basically disallows anyone from using their TFSA from running a business.
Related: How Does CRA Determine Who to Audit?
The worst part is that the CRA only needs to declare a “balance of probabilities” as proof that the TFSA is being used as a business. This means it would then be up to the individual to prove they aren’t running a business.
So what does CRA look at when they try to determine if someone is earning (taxable) business income in their TFSA?
– Frequency of trading. Someone who makes a large number of trades (such as a day trader) would be more scrutinized than someone who makes a few trades per month.
– Investment strategy. Someone who sells all their shares at the end of each trading day would be more scrutinized than someone who holds for the long term (such as a dividend investor).
– Time & Knowledge. In CRA’s view, someone who spends a significant portion of their time, efforts and training on their investment portfolios is more likely to be running a business than someone who has less knowledge and takes a passive approach to their money.
– Nature of Investments. Speculative traders who focus on high-risk, high-reward stocks (such as penny stocks) are more heavily scrutinized than someone who invests in blue-chip, dividend paying companies that are held for the long term.
– Financing. Stocks purchased on margin are another potential red flag for CRA.
How Big is Too Big?
Last year MoneySense magazine held a TFSA balance and the winner had a balance of about $300,000.
While there are a lucky few who have a huge TFSA balance, the large majority of us don’t have a balance anywhere near $300,000.
The focus for a potential audit, experts say, is not just the balance – it is the nature and frequency of transactions as well. If two people have a balance of $100,000, a day trader would have a harder time arguing he/she is not using their TFSA to run a business than someone who invests in dividend stocks for the long term.
In other words – there is no specific threshold CRA uses to trigger a TFSA audit.
Should TFSA Gains Be Taxable?
The TFSA was created as a tax-saving vehicle for regular folks to invest their money and have the earnings be free of all taxes.
If the government wanted to tax earnings over a certain threshold within a TFSA, they should have stated so when it was created back in 2009. They also should have clarified exactly what types of investments mean the TFSA holder is running a business within their TFSA.
Related: Common Tax Myths
Now that some people are making serious gains within their TFSA, the government is calling for a piece of the earnings pie.
Losses within a TFSA are not deductible for taxes, so why would earnings be taxable?
Conclusion: although the odds of an audit are low for most people, CRA has started to audit the TFSA balances of regular investors who have made significant gains. There are several factors they look at, but it ultimately comes down to whether the person is using their TFSA to run a business.
Should the earnings within a TFSA be taxed?
Related: The Ways We Overpay on Taxes