Author Topic: Getting screwed by the CRA  (Read 3609 times)

rukawa

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Getting screwed by the CRA
« on: April 05, 2018, 07:58:42 AM »
I'm not getting screwed by the CRA. But I thought I would start this thread as a collection of stories of people who have gotten screwed by the CRA and how to avoid it. The best story I've found is this one:

http://business.financialpost.com/personal-finance/stop-using-your-tfsa-to-frequently-trade-stocks-the-cra-may-see-it-as-business-income
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The taxpayer, a certified financial analyst, was the co-head of institutional trading at a Canadian investment firm and an investment industry veteran with over 25 years of experience. He was licensed by securities regulators in several Canadian and U.S. jurisdictions, including as a trader and dealer in securities.....In the remaining ten months of 2009, he bought and sold stocks of 34 issuers costing about $2,500,000, involving 38 purchase transactions and 50 sale transactions, realizing a total gain of about $550,000. His average hold period of stocks was about 50 days and his average return on any particular stock was about 30 per cent....Weighing all the evidence, the judge concluded that the taxpayer was trading in the securities as a business activity,...As a result, the judge held the taxpayer’s profits to be 100 per cent taxable as business income.

Note that the article title is totally misleading since it implies that this can only happen in a registered account (TFSA, RRSP). The truth is that in any account if you trade too frequently and you are considered a financial professional, you can be declared to be indulging in a "trading business" in your investment account in which case you gains are taxed as income instead of capital which basically doubles your taxes.

I'm guessing that no one on this forum has had this happen to them but if anyone has an interesting story please post it.


Cigarbutt

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Re: Getting screwed by the CRA
« Reply #1 on: April 05, 2018, 08:41:10 AM »
FWIW, I think that the distinction between trading (short term thinking) and investment (long term thinking) is fair and should be treated differently from the tax point of view.
And the rules are somewhat clearly spelled out.

I have had a large number of "interactions" with CRA and will share what may be interesting or relevant for others. This has quieted down in the last 2 or 3 years (in correlation to decreased turnover and level of activity).

With investment income, what seems to trigger their interest are unusual returns (especially if lumpy and in tax-deferred accounts RRSPs and TFSAs), "children" accounts (rules have been tightened here) and "professional" accounts (rules are being tightened here).

I have heard many negative comments and some went through horror stories but my experience has been relatively positive.

Negatives:
-CRA tends to send a dry first tax assessment notice with amounts owed having little correlation with reality.
(from interactions with CRA, I was told that many who receive such notice pay the amount on the spot)
-paperwork can be tedious and voluminous.
-may need to repeat the process as they often don't understand the first time around.
-with repeat interactions, often get confusing or contradicting information on the substance of the claim and on the steps required to fix the problem.

Positives:
-with adequate documentation and explanations (investor mindset and rationale, correlation across portfolios), in all episodes, matters settled for non material amounts.
-most people I spoke to or communicated with were open to well prepared presentations and supporting documentation.
-in my experience, CRA will accept substance over form arguments.

rb

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Re: Getting screwed by the CRA
« Reply #2 on: April 05, 2018, 11:55:36 AM »
Note that the article title is totally misleading since it implies that this can only happen in a registered account (TFSA, RRSP). The truth is that in any account if you trade too frequently and you are considered a financial professional, you can be declared to be indulging in a "trading business" in your investment account in which case you gains are taxed as income instead of capital which basically doubles your taxes.

I'm guessing that no one on this forum has had this happen to them but if anyone has an interesting story please post it.

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.

This has actually happened to two of my clients. One of them was guilty as hell. In that case the CRA agreed not to tax the whole account as business income but only specific trades. The other one, also guilty, was an idiot who didn't know what he was doing and thought he was a trader cause he watched CNBC. The CRA agreed to let him go if he didn't do it again.

From my experience dealing with the CRA they are very reasonable as long as you conduct yourself in a respectful and a professional manner. If you start with crap like the government are idiots and you shouldn't pay taxes cause you're special they tend to loose their grace. The IRS on the other hand.... those guys are all assholes. Every time you have to deal with them you know you're gonna have a bad experience.

gokou3

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Re: Getting screwed by the CRA
« Reply #3 on: April 05, 2018, 12:05:02 PM »
I wonder if CRA only taxes TFSA accounts with large gains from frequent trading by professionals?

My concern is if I buy and own a warrant (or whatever securities that the general public tends to view as "exotic") for a couple years and gain 10x on it, CRA will suddenly want to share my gain.

rb

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Re: Getting screwed by the CRA
« Reply #4 on: April 05, 2018, 12:09:30 PM »
I wonder if CRA only taxes TFSA accounts with large gains from frequent trading by professionals?

My concern is if I buy and own a warrant (or whatever securities that the general public tends to view as "exotic") for a couple years and gain 10x on it, CRA will suddenly want to share my gain.
In the situation you've described you're ok. But if your TFSA is chock full of warrants and call options you'll have to share.

gokou3

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Re: Getting screwed by the CRA
« Reply #5 on: April 05, 2018, 12:14:02 PM »
I wonder if CRA only taxes TFSA accounts with large gains from frequent trading by professionals?

My concern is if I buy and own a warrant (or whatever securities that the general public tends to view as "exotic") for a couple years and gain 10x on it, CRA will suddenly want to share my gain.
In the situation you've described you're ok. But if your TFSA is chock full of warrants and call options you'll have to share.

What if the whole TFSA account consists just that one warrant (i.e. 100% allocation)?  :)

Understanding that you are not providing tax advice here.

rb

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Re: Getting screwed by the CRA
« Reply #6 on: April 05, 2018, 12:41:29 PM »
I wonder if CRA only taxes TFSA accounts with large gains from frequent trading by professionals?

My concern is if I buy and own a warrant (or whatever securities that the general public tends to view as "exotic") for a couple years and gain 10x on it, CRA will suddenly want to share my gain.
In the situation you've described you're ok. But if your TFSA is chock full of warrants and call options you'll have to share.

What if the whole TFSA account consists just that one warrant (i.e. 100% allocation)?  :)

Understanding that you are not providing tax advice here.
You're fine.

Cardboard

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Re: Getting screwed by the CRA
« Reply #7 on: April 06, 2018, 05:57:56 AM »
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.

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.

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KCLarkin

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Re: Getting screwed by the CRA
« Reply #8 on: April 06, 2018, 07:18:29 AM »
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?

AFAIK, they look for, and audit, TFSAs with high balances.

I'm not sure if they are as aggressive with RRSPs since these will eventually be taxed.

Here is a court case from 2014 saying that trading in RRSPs is not a business:
http://www.ey.com/ca/en/services/tax/taxmatters-november2014-active-trading-rrsp-not-evidence-trading-business

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In the Court’s view, the RRSP regime is unique and intentionally provides special tax treatment under the Income Tax Act (the Act), with restrictions on the types of investments that may be acquired, tax benefits that flow from their ownership and tax consequences that flow from their disposal.

The Court concluded that because of this unique tax regime, trading activity within an RRSP cannot constitute a business of the taxpayer.

However, this was not a precedent setting ruling. And I'm not sure if later cases have set a precedent.

Edit:
Here is a link describing the auditing practice for TFSAs (and the lack of similar enforcement for RRSPs):
https://www.theglobeandmail.com/globe-investor/personal-finance/taxes/keep-your-tax-hands-off-my-tfsa/article22922076/

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The issue

In my recent discussions with the CRA, it's clear that rumours of a tax-audit project focusing on TFSAs are true. The CRA seems to be focusing on TFSAs that have a very significant value. And perhaps this should be no surprise, because those dollars will one day be withdrawn tax-free. It's not clear what dollar value in a TFSA might create a red flag for the taxman.

A big area of concern for the CRA is where investors are actively trading – often called day trading – in their TFSAs. In these cases, when certain criteria are met, the CRA may come to the conclusion that an individual is actually carrying on a business when trading in securities – sometimes referred to as an "adventure in the nature of trade" – in which case the profit could be taxed as business income. The CRA's argument is that business income earned inside a TFSA should be taxable (unlike capital gains, which would be tax-free inside the plan). There have been no court cases yet on this issue, but I expect we'll see a case or two in the next couple of years.

The RRSP comparison

Let's think about registered retirement savings plans for a minute. RRSPs, to my knowledge, have never been attacked when a taxpayer is successfully day-trading in his account. And no wonder, because those assets are taxed when they're withdrawn. Why should the CRA take offence? In fact, the CRA will collect more tax if the taxpayer is successful in his or her RRSP investing.
« Last Edit: April 06, 2018, 07:22:40 AM by KCLarkin »

Cigarbutt

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Re: Getting screwed by the CRA
« Reply #9 on: April 06, 2018, 07:32:13 AM »
Have incomplete information here and think that for RRSPs, the CRA disclosure requirements for financial institutions may be limited to contribution limits. For some reason, there seems to be less emphasis on RRSPs. Maybe CRA realizes that the amounts will eventually, by definition, be taxed at relatively high marginal rates for large accounts. (edit: KCLarkin said it first)

However, for TFSAs, my understanding is that CRA is "watching" as regulatory disclosure requirements seem to be very extensive. See appendix A.
https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/rc4477-tax-free-savings-account-tfsa-guide-issuers/tax-free-savings-account-tfsa-guide-issuers.html#P11

So, I think they know about the balance and number of transactions and simply trigger audits by defining thresholds.

It looks like CRA is becoming ever more sophisticated (aggressive tax planning teams etc) and have screening tools that even look at publicly available information (including Facebook and others) to make sure that your "lifestyle" fits with your tax bill.

The following link offers some interesting perspective:
http://www.millerthomson.com/assets/files/article_attachments3/TaxesAndWealthManagement_8-2.pdf?utm_source=Mondaq&utm_medium=syndication&utm_campaign=View-Original

In terms of the "rules" (nicely laid out in the previous link), they are more factors or criteria and there are grey zones.
For instance, for exactly the same transactions, if you're questioned/audited by security regulators, you may have to convincingly explain complex financial aspects in order to show that you are not an insider while, at the same time, if you're questioned/audited by CRA, you may underline the aspects that you do this on your free time, using basic knowledge and perhaps that you just got lucky. Not suggesting to lie, only saying that the way you paint the picture may have an effect on the interpretation of the rules.

Have heard that many people have been "screwed" by the CRA but imagine that it goes both ways. Need to find a balance.