TFSAs and Day Trading Risks

Everyday TFSA investors are not businesses, but day trading can result in TFSA taxation.

Many Canadians use a Tax-Free Savings Account (“TFSA”) as a long-term savings and investment vehicle. TFSAs provide a strong incentive to contribute the maximum allowable after-tax amount annually in order to maximize future tax-free growth, be it from dividends, interest, or capital gains. Naturally, the concern of many investors is whether that growth will become taxable if it is “too profitable”.

This concern recently came to the forefront in the Tax Court of Canada decision in Ahamed v. The King, where an investor was held to be a day trader, and his substantial gains in his TFSA Trust were taxed as business income.

While this decision highlights risks for investors who trade frequently in their TFSAs, it is important to note that this decision is not necessarily a red flag for everyday investors and is currently under appeal.

In my view, the intention of this decision is merely to prevent clear day trading businesses from running through nontaxable TFSAs to shield business profits from tax, rather than to prevent investors from making large gains in their TFSAs. The stated goals for TFSAs, being to encourage savings, facilitate tax-free growth, and generate tax-free investment income through relatively passive savings and investment activity, remains unimpeded.

Unlike a RRSP or RRIF where growth and profits on qualified investments are eventually taxed upon withdrawal, TFSAs are generally intended to be tax free, and therefore the CRA will take the potential materialization of a taxable business seriously.

So, when does trading in a TFSA become a day trading business? The general rule in Canadian tax law is that a business can emerge where the activity constitutes an “adventure or concern in the nature of trade.”¹ This broad phrase has been interpreted by multiple Courts and CRA rulings, however this generally boils down to whether there is habitual activity capable of generating a profit.

Accordingly, the CRA generally considers day trading to occur when there is a high volume of trades, with a relatively brief period between buying and selling individual stocks, often within a single day. When making this determination, the CRA would examine multiple relevant factors during a review. These factors would include the frequency of trades, the types of securities being traded, the quantity of securities traded, the skill of the investor, the time spent on trading, and intention to hold investments and resell them for a profit.

This determination of a day trading business is fact-specific and would depend on each taxpayer’s circumstances, but ultimately the evidence that a TFSA is a business and not a successful investment should be determined primarily by how frequent or “habitual” the trading activity is, rather than by its performance. For instance, investments in publicly traded “penny stocks” left to grow exponentially over a period of weeks or months would not be a “habitual activity”, even if the result is a profit.

Notionally, generating income and capital growth are common sense goals to any investor. No investor is intentionally selecting stocks or funds for a TFSA with any intention to lose money. Therefore, it is reasonably foreseeable for TFSA investors to think long term and take on less conservative investments that may have significant fluctuation and growth.

As the cumulative TFSA contribution amount increases and more time passes, TFSAs worth significantly more than their contribution amounts will become increasingly common. Subject to any significant legislative change, the provisions of the Income Tax Act pertaining to TFSAs do not contain any bright line rule or threshold on how much growth is allowable.

Where it becomes unreasonable and worrisome is where strategies are assessed hourly, daily, or even weekly, along with significant trading activity. The key factor appears to be how much time, effort, and skill one is expending to grow their portfolio.

Investors should not have to be worried if they have stocks, ETFs, mutual funds, or other investments that are otherwise allowable investments for a TFSA that proceed to experience rapid growth, nor should any TFSA investor be considered a business because their investment portfolio has experienced some significant gains with reasonable and periodic review.

Conversely, if one is spending several hours daily or weekly performing in-depth research and analysis, making multiple transactions, using years of education and industry experience, and, in essence, turning the management of their TFSA into a “day job”, one may also expect to receive some less than cordial correspondence from the CRA with a significant tax bill attached.

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¹ Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), ss. 248(1) “business”.