Since the Tax-Free Savings Account (TFSA) was created in 2009 by the Federal Government it has been touted as a tax-free method to grow your investments, as long as the return on your investment happens within the registered account. Now, reports say the Canada Revenue Agency (CRA) wants to crack down on individuals who they say are using this account as a vessel for trading business. Reports say the CRA has been auditing individuals who use the account for frequent trading and have seen significant growth in their investments. If you have a TFSA and are worried that you may be targeted by CRA, here is what you need to know.
Understanding TSFA Rules
Six years after the TFSA was created, the rules are still murky on how this account can be used. It was launched as an option for Canadians to save for more of their immediate needs. But, some savvy investors have used its tax-free capability to significantly grow their investments. According to the CRA website, “All income earned and withdrawals from a TFSA are generally tax-free. Plus, having a TFSA does not impact federal benefits and credits. It's a great way to save for short and long-term goals.”
When Tax is Payable on TFSA Savings
There are some specific examples of when the CRA would ask you to pay tax on income earned inside the TFSA. This includes prohibited and non-qualified investments, for example. should you make a contribution while you are not a resident of Canada, or if your account contributions are in excess of your limit. You can check out the rules on what is taxable in a TFSA here. Generally speaking, most Canadians are well inside the rules of the TFSA and their investments will not be subject to being taxed.
What About The CRA Audits?
The CRA has started looking more closely at individuals who frequently trade inside their TFSA and have seen significant gains. To date Canadian residents have $31,000 in contribution room inside their TFSA. Some have been able to take that money and grow it many times over; the CRA wants to take a closer look at those individuals with large balances inside their TFSA to make sure they are playing the rules.
How to Avoid a TFSA Audit
The CRA has two ways of auditing you: random selection, which can happen to anyone, and targeted selection. To avoid becoming a CRA target there are somethings you can avoid doing in your TFSA.
- Trade frequently. If you are making multiple trades inside your TFSA every day, the CRA might see this as you running a business.
- Use debt. If you are borrowing money to trade securities inside the TFSA the CRA might see this as business activity and ask for specifics of what you are doing.
- Being cash liquid at the end of each day. The CRA may also take issue if at the end of each trading day your investments are sold and held in cash.
- Be an investment expert. This may be hard to avoid if it’s your profession. But, someone who works in the investment industry might come under more scrutiny as they have knowledge and experience with the market.
- Speculative trading. If you are making a number of high-risk trades, like penny stocks or options, the CRA may want to know more about the nature of your investments
The CRA Is Taking a Closer Look
To call the CRA audits on healthy TFSA accounts a “crackdown” is an exaggeration; there are a very small number of people who are being looked at. Reports say some of these individuals have been able to take the $31,000 contribution so far and grow it 10 times over. Some TFSA holders being looked at by the CRA are being asked to not withdraw money out of the account until the CRA is done with their investigation. The CRA wants to look at those it thinks are running businesses and using this registered savings vehicle to shelter their gains.
As it is with any registered account, the CRA has a right to ask questions. But generally speaking, if you have seen significant gains in your TFSA, as many have in the spectacular bull market that we have just experienced, and you have not been participating in the risky behaviour listed above, you should have no problem showing the CRA you are not running a business.
Are you concerned about the CRA's involvement with TFSAs? Tell us in a comment below.