Getting screwed by the CRA

[SharperDingaan]

It really comes down to 'intent'.
The concept behind the TFSA is that as a tax free savings vehicle, the amount in it shouldn't greatly exceed the cummulative limit ($57,500 for 2018) as funds should be both contributed AND withdrawn over time. Especially as the TFSA has now been around for 10 years.

BUT, assume that you have been a good saver, and learnt the virtues of patience & value investing. You make a $50,000 investment in a junior mining company at an average cost of 25c/share - in the expectation that at some point; there will eventually be a mine Should it ever occurr, the 200,000 shares will be worth much more than you paid for them. 200K, if they go to $1.00/share.

Rather than take the $ out of the TFSA, you have the TFSA contribute it as the down payment on a 2nd house that you rent. To avoid 'complications' maybe you put up 60% of the downpayment, & the TFSA 40%; with ownership of this 2nd property divided 60/40. Tennant rent pays the costs, and 40% of the property appreciation and annual profit accumulates in your TFSA account, tax free. Ultimately, a lifetime of wealth could accummulate INSIDE the TFSA - & you may never take it out until you eventually die. When it passes to your estate TAX FREE as a withdrawal of capital from a tax free account (estate fees excluded).

Obviously this is not the intent of the account, and maybe 2% of the population end up in this position. But as these are also very smart individuals, the amounts in their TFSA's could also quite easily grow to the hundreds of millions. Most places don't penalizing citizens for simply being smart, but the outlying amounts are going to attract attention.

As with insurance we promote the big payouts, as marketing to purchase the product (insurance). However, promoting the top 2% to get the other 98% of the population to conribute to a TFSA, could really screw up your day. Too many people start doing this, even if only moderatly successful, and your tax stream drops like a brick.

Karma.

SD

[rb]

How does the CRA find out what is going on in TFSA's and RRSP's as there are no trading summary sent to them unlike for non-registered accounts? Maybe that I am wrong on that one but, that is my understanding.

They do get information about what's in your RRSP and TFSA. That's why you don't have to report foreign holdings in RRSP and TFSA on T1135. They also collect information to meet their duties under various information sharing agreements.

Regarding this, I disagree:

"The rules are what the rules are - the Income Tax Act. The CRA's job is also not to make the rules, it's to collect tax according to the rules."

The section describing what should be on capital vs income account is subject to wide interpretation. Of course, there is common sense to it but, I would not call it a rule.

Cardboard

That's fair.

[rb]

Rather than take the $ out of the TFSA, you have the TFSA contribute it as the down payment on a 2nd house that you rent. To avoid 'complications' maybe you put up 60% of the downpayment, & the TFSA 40%; with ownership of this 2nd property divided 60/40. Tennant rent pays the costs, and 40% of the property appreciation and annual profit accumulates in your TFSA account, tax free. Ultimately, a lifetime of wealth could accummulate INSIDE the TFSA - & you may never take it out until you eventually die. When it passes to your estate TAX FREE as a withdrawal of capital from a tax free account (estate fees excluded).

Yea..... you're not allowed to do this. In fact you're really not allowed allowed to do this. If you do it, you will get caught and the government will tax the living daylights out of you. Currently the penalty for doing that is 100% of income and 50% of assets.

[SharperDingaan]

Rather than take the $ out of the TFSA, you have the TFSA contribute it as the down payment on a 2nd house that you rent. To avoid 'complications' maybe you put up 60% of the downpayment, & the TFSA 40%; with ownership of this 2nd property divided 60/40. Tennant rent pays the costs, and 40% of the property appreciation and annual profit accumulates in your TFSA account, tax free. Ultimately, a lifetime of wealth could accummulate INSIDE the TFSA - & you may never take it out until you eventually die. When it passes to your estate TAX FREE as a withdrawal of capital from a tax free account (estate fees excluded).

Yea..... you're not allowed to do this. In fact you're really not allowed allowed to do this. If you do it, you will get caught and the government will tax the living daylights out of you. Currently the penalty for doing that is 100% of income and 50% of assets.

The financial instrument just has to be one of the many types of 'eligible' asset that a TFSA may hold. Were this transaction to occurr, it would be structured as one of those 'eligible' assets (expensive) - but the bigger the TFSA investment, the more cost effective that 'structuring cost' would become (& this 2% would very likely know the best of the creative). Ultimately it would come down to whether the undying attention of the CRA is really worth the hassle.

SD


   

[rukawa]

You're right. Business income designation can happen for any account. I'd say it's reasonable. I would also say that in the incident you've quoted the person didn't get screwed by the CRA. The rules are what the rules are - the Income Tax Act. The CRA's job is also not to make the rules, it's to collect tax according to the rules. It seems to me that they were just doing their job the way they were supposed to. The individual in the article also knew or should have known the rules but chose to ignore them.

What are the rules exactly. As far as I can see there are no hard and fast rules so I don't know exactly what you mean when you say a person knew the rules. I mean I can understand if a person is a market maker. That is pretty clearly a trading business. But as far as I can see the question seems to be based on :
- frequency of trades and turnover
- are you a professional broker or trader. 
- how much time and effort you spend and how much specialized knowledge you apply. Here working harder, spending more time or knowing more is a bad thing...very especially if has connection to a "finance" time position related to trading or investing.
- intent - meaning whether you are aiming at high short term high returns or "investing". But what this means is extremely unclear to me. I think a dividend/income investor could very easily defend the idea that he was "investing". But any holder that is interested in price appreciation is in a more tricky situation.

THis is especially true if you are aiming to take advantage of a special situation. For instance there was a going private transaction I invested in based on the fact that the stock was trading 15% under the price it was going to be bought at. The whole thing happened over few months. I believe a situation like this or an merger arb is pretty much against the rules. I'm guessing though the CRA won't go after you unless you do a lot of these.

I'm curious as to whether funds are treated in the same way.  I'm guessing that there are funds where trading frequency is quite high compared to the situation I described in the original post. But I doubt holders of these funds have their gains taxed as income.

[Cigarbutt]

Your question/comment about funds is very relevant in terms of deciding if capital gains should be tax-treated in the capital or income account.
After all, average holding periods for "professional" investors has considerably come down (now down to a few months  ):
http://topforeignstocks.com/2017/10/01/average-stock-holding-period-on-nyse-1929-to-2016/
IMO, this is not healthy but, as far as I know, this is considered the norm and I have not heard of funds being hassled by the CRA for the short-term orientation.

On that topic, from Mr. Keynes (when he thought that investors were impatient):

"The spectacle of modern investment markets has sometimes moved me towards the conclusion that to make the purchase of an investment permanent and indissoluble, like marriage, except by reason of death or other grave cause, might be a useful remedy for our contemporary evils. For this would force the investor to direct his mind to the long-term prospects and to those only."


From the individual point of view, if you are good enough to make profitable investments consistently, you should be good enough to know the basic criteria or factors that the CRA has published and there is relevant case law. In a way, the CRA will make an assessment as to whether you are involved in an "adventure in the nature of trade" or not.

Here's a nice recent example (public domain):
 https://www.canlii.org/en/ca/tcc/doc/2017/2017tcc61/2017tcc61.html?searchUrlHash=AAAAAQAZYWR2ZW50dXJlIG5hdHVyZSBvZiB0cmFkZQAAAAAB&resultIndex=9

I would say that if go for a fight with the CRA, your credibility should be as unusual as your returns.

[rb]

You're right. Business income designation can happen for any account. I'd say it's reasonable. I would also say that in the incident you've quoted the person didn't get screwed by the CRA. The rules are what the rules are - the Income Tax Act. The CRA's job is also not to make the rules, it's to collect tax according to the rules. It seems to me that they were just doing their job the way they were supposed to. The individual in the article also knew or should have known the rules but chose to ignore them.

What are the rules exactly. As far as I can see there are no hard and fast rules so I don't know exactly what you mean when you say a person knew the rules. I mean I can understand if a person is a market maker. That is pretty clearly a trading business. But as far as I can see the question seems to be based on :
- frequency of trades and turnover
- are you a professional broker or trader. 
- how much time and effort you spend and how much specialized knowledge you apply. Here working harder, spending more time or knowing more is a bad thing...very especially if has connection to a "finance" time position related to trading or investing.
- intent - meaning whether you are aiming at high short term high returns or "investing". But what this means is extremely unclear to me. I think a dividend/income investor could very easily defend the idea that he was "investing". But any holder that is interested in price appreciation is in a more tricky situation.

THis is especially true if you are aiming to take advantage of a special situation. For instance there was a going private transaction I invested in based on the fact that the stock was trading 15% under the price it was going to be bought at. The whole thing happened over few months. I believe a situation like this or an merger arb is pretty much against the rules. I'm guessing though the CRA won't go after you unless you do a lot of these.

I'm curious as to whether funds are treated in the same way.  I'm guessing that there are funds where trading frequency is quite high compared to the situation I described in the original post. But I doubt holders of these funds have their gains taxed as income.

Ok, a couple of things. In my post i expressed myself incorrectly when I've said rules. That's because our tax system is not one based on rules. It is one based on principles. The other thing is that in your post you've pretty much answered your questions.

All of the points you've mentioned are taken into account when determining whether you are operating as a business or as an investor. In the case where you've found an arb opportunity because you're a smart guy, yes that's against the "rules" but really what you're doing is investing and just found an opportunity to make some more money cause you're smart. That's ok because you haven't broken the principle. If all or most of what you're doing is arb situations then you'r not really an investor. You're an arb business. Then you'll be taxed as a business.

When it comes to funds you're also spot on. The profits of people that have put the money into funds are not taxed as a business because they're not running a business. They've saved and given the money to other people to manage. The fees are even tax deductible. On the other side the profits of the fund management are fully taxable as business income. No carry charge loophole here.

It seems to me that you've got a good handle on how things work and it seems things are working pretty well.