When the TFSA was introduced into the Canadian financial choices in 2009, Canadian’s took notice and got excited very quickly. I mean how couldn’t they when the entire financial rhetoric of middle-class Canadian’s is to work hard and save money for a rainy day. Now you can invest the money inside the TFSA and grow your funds tax-free? It seems like a sure-fire way to shelter taxes from capital gains. Right?

Well sort-of.

You see, the CRA TFSA approach has always rested in grey areas. You call the Canada Revenue Agency and seek clarification on what it is you’re allowed, and what it is you’re not allowed to do, and you rarely will get a clear answer. Normally they direct you to a publication on their website which normally leaves your question unanswered. The reality is, even the CRA doesn’t have a clear mandate on how they view the TFSA’s. After many hours of research, and spending time on the phone with them the CRA TFSA approach comes down to one thing in my interpretation.

What does the pattern of your activity “point” to if you ever get audited?

Essentially, it rests with the CRA Auditor to interpret your intent and use that intent alongside the data to determine if your activities inside of the TFSA are eligible or need to be taxed. So, an easy conclusion to draw is that the CRA TFSA approach will differ from person to person. One person may get an auditor who interprets your information differently than the same audit done with another person. This isn’t a stab at the CRA, but it exposes a real challenge for Canadians making use of their TFSA when accessing the financial markets and asset classes.

What does the CRA TFSA approach mean for investors, traders, and day traders?

I separate the three because they’re vastly different, and while this write-up shouldn’t be quoted as a legal reference, it is meant to help you separate the definition and also provide solutions on how to shelter tax efficiently in other methods if you fall into either category(ies).

How are how investors, traders, and day traders are defined in the CRA TFSA approach?

The most important thing the CRA considers in their approach to the TFSA is the unit of time that has transpired between taking an active position in the stock and exiting such a position. The problem is, the CRA doesn’t define the timeline, and simply relies on its auditors to “assess” what your intent is to decide in which category you fall into. How convenient. Right? Basically, it is the flavour of the day.

As an individual looking to sustainably day-trade, trade, or invest, you need a better answer than the flavour of the day.

FINRA and Wall Street can and in my opinion should be used in determining the standard between the three.  

Investors take multiple long and short positions on CFD’s which fall in line with their intended portfolio. Now the smart person will say, you can’t short stocks in the TFSA, and they’re absolutely right. But nonetheless, it doesn’t undermine the definition. From a time-stance point of view, an investor normally holds the CFD’s or asset classes for a minimum of 60, and sometimes 90 trading days. To put this into context, that translates to 3 to 4 months. So, in regular-joe language, if you intend to "invest" the CRA TFSA consensus would point to holding(s) where the majority of your asset classes are not withdrawn for at least 3-4 months.

Traders introduce the grey area between what defines an investor and what truly defines a trader. By wall street standards, a trader is an individual whose intent is solely meant to generate profits and losses off of price action. Their intent is short by nature, and as a standard, a trade is considered to take place in a time frame that is less than 60 trading days at a time. As in you take a position, long or short, and you exit within 60 trading days or 3 months. The problem is that the entry/exit could be within a few minutes. Which then introduces the next dilemma. What’s the difference between a day-trader and a trader then?

Day Traders are similar in nature to Traders, but their intent is much more short-term. In fact, FINRA which is the regulatory body for the financial industry identifies day-traders on the premise of whether they make more than 4 trades in any given 5 trading-day rolling periods.

So how do you take the vague CRA TFSA approach and apply it to your personal circumstance with all the varying definitions between the three categories?

If you want to be safe, it’s my experience that all activities inside the TFSA should be only of long-term nature. As in 4 months or longer. Why do I say this? Especially with the pandemic, way too many Canadian’s have turned to the stock market and “trading” as a form of both keeping their brain busy and making money. Many are also taking it a step further by doing these activities inside of their TFSA, and when their T5008 form is sent to the government, they probably won’t be happy with all those “Tax-Free” capital gains they thought they were getting away with. An audit request and resultant income tax bill will eventually be slapped on most Canadian’s who actively trade inside their TFSA, and the general CRA TFSA consensus is that they’re coming after you for the money you owe.

If you want more information on the CRA TFSA stance, click here 

Why is it believed the CRA is taking this stance?

The CRA tend to view trading, and specifically day-trading as business revenue and not an investment strategy.

An investment strategy normally is accompanied with the intent to hold CFD’s as part of a good-will strategy to see an investment vehicle through to return on investment.

What the CRA is trying to differentiate are positions of speculative nature, versus investment nature. Although it’s our personal belief and opinion that investment and trading can often be interchanged because they both rely on the “hope” that something works out. But at the end of the day, if the CRA interprets it as trading, you really have no meaningful regulation to fall back on to fight your case. I’ll leave that one up to you to interpret.

So, I promised I would explain a solution for all of this arbitrage so that tax sheltering and efficiency are still possible regardless of whether you’re an Investor, Trader, or Day Trader.

#1 – Start an incorporation

I am of the opinion and belief, that every Canadian who intends to hold any investment vehicle both domestically and internationally, quite quickly should talk to a corporate lawyer, and set their expense structure, investment structure, and retirement structure under an incorporated business that is backed by a holding company. I go into extensive detail about this in my 5-part write-up about Financial Freedom found here. But in layman’s terms, if you are actively working the financial markets the largest tax efficiency will eventually not come from the TFSA. I believe the TFSA should be part of your tax-sheltering strategy, but not in its entirety as many Canadians use it as today. I say this for more reasons than not, but one of the largest reasons being that you are limited by the contribution limit towards a TFSA. Most years you can only contribute $5000-$6000 CAD (depending on the year), and the amount you can truly grow will always be bottlenecked.

On the other hand, inside of an incorporation, you benefit greatly from tax write-offs and business expenses (such as commission fees, or costs associated with trading, investing, etc.).

#2 – Back the incorporation by a holdco

To take the incorporation a step further, when it is backed by a holding company, there exist many options such as tax-deferred dividends that can transfer assets such as cash, to the holding company, and in turn, receive what’s called an RDTOH (Refundable-Tax-Dividend-On-Hand). There are many details on what constitutes the RDTOH, but in basic terms, by paying cash from the incorporation to the holding company, you defer (delay) paying tax on the taxable income, and you can hold the said buying power now in your holding company. Inside of the holding company you can now invest in real estate, stocks, or any asset classes which increases the net worth of your portfolio inside of a tax-sheltered structure. The tax would then later be paid when the taxable dividend is paid out to the shareholder. But in the meantime, while the tax was deferred, its additional buying power can now be used to grow one's net worth in a tax-sheltered setup. What you need is a really good accountant, tax lawyer, and securities lawyer to support this structure. But with those expenses also being a tax write-off among so much else, it quickly becomes evident why anyone working the financial markets, or even invests, should firstly be tax-aware, and secondly be set up efficiently in the structure I just mentioned.

Individual circumstances can obviously deter this being an ideal setup, but if you’re simply someone who wants to trade or day trade, and also wants to hold longer-term investments, the opco with holdco combination is a stronger setup to alleviate the CRA TFSA approach, and it lets you focus more on generating profits and losses systematically both going long and short, inside of a legal framework which keeps you efficient, tax-sheltered, and retains the buying power annually in the hands of your holdco to invest further. 

The reality is most North American’s, especially Canadian’s don’t really know about these methods. Besides, Canadians follow the narrative of “work hard” and “save money for a rainy day” and they normally don't even consider the corporate methods that are available to everyone of them.

# 3 Family Trusts

You can actually take this a step further and look into family trusts so that if you grow your trading business to a company that is one day worth (for example) $5mil, you can then sell that $5mil business and take advantage of the LCGE (Life-time-capital-gains exemption). With trusts, your lawyer can usually set it up as such that if there are 4 family members in the family trust beneficiating from the Holdco, each beneficiary gets to exercise up to approximately $870,000 in capital gains exemption from the sale of this company. Multiply that by 4 family members, and the majority of your $5mil business can be sold in a tax-sheltered format. How does that sound for a retirement?

Why do you think rich families have many kids? 😊

To learn more about this, I have put together a 2-hour free webinar meant to inspire, educate, and show you a better way to look at your finances. If learning to trade and generate sustainable habits towards financial success is something you want my help with, check out my courses after you watch the webinar.