TaxMatters@EY - November 2014

Active trading in an RRSP is not evidence of a trading business

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Prochuk v The Queen, 2014 TCC 17 (T.C.C.)
Dalia Hamdy, Toronto and Allison Blackler, Vancouver

In this decision, the Tax Court of Canada considered whether a person actively trading investments inside his registered retirement savings plan (RRSP) can be considered to be carrying on a trading business outside of his RRSP. The Court concluded that trading inside an RRSP cannot itself be a business, nor can it provide evidence of a trading business carried on outside of an RRSP.

Facts

The taxpayer worked in the financial industry for approximately 13 years, until he decided to leave the business and take care of his own investments. From that time onwards, he made his livelihood from gains made within his RRSP and in fact increased the balance in his RRSP by a factor of eight. The taxpayer reported his RRSP withdrawals as income, but did not report any amounts as income from business or property.

In 2005, using funds withdrawn from his RRSP, he invested $250,000 in an offshore foreign exchange currency fund, which promised a return of 17.52% a year. Under the subscription terms, the taxpayer’s investment would be locked in for more than two years and would yield guaranteed payments twice a year. While he did receive some initial return on his investment, the fund turned out to be fraudulent and he lost $186,250 of his original investment.

The taxpayer claimed a business loss in respect of this amount on his 2007 income tax return on the basis that he was either in the business of trading or that his investment in the fraudulent fund was an “adventure or concern in the nature of trade.” The Minister of National Revenue reassessed the taxpayer on the basis that the loss was a capital loss. The taxpayer appealed to the Tax Court of Canada, but his appeal was dismissed.

The Tax Court of Canada decision

In determining whether the taxpayer’s investment in the fund was on account of income or capital, the Court reasoned that although property that yields income is, generally speaking, a capital asset, such property can also be inventory of a business, depending on the circumstances. Accordingly, the Court evaluated the taxpayer’s particular circumstances to determine whether he was in the business of trading and if not whether his investment in the fund could constitute an “adventure or concern in the nature of trade.”

The taxpayer was not a trader

In determining whether the taxpayer was in the business of trading investments, the Court considered the business activity factors identified in The Queen v Vancouver Art Metal Works Ltd. ([1993] 2 FC 179 (F.C.A.)):

  • The frequency of the investment transactions
  • The length of time the investments were held
  • The taxpayer’s intention to acquire investments for resale at a profit
  • The nature and quantity of the investments
  • The time the taxpayer spent on investing

The Court determined that the taxpayer had only made one investment outside his RRSP since 2000, namely his investment in the fund. The taxpayer held the investment in the fund for an extended period, as it was locked in for a period of 28 months and could not be sold before that date. The taxpayer intended to hold the investment for the long term to earn income from it and to make a profit. In the Court’s view, the taxpayer was merely a passive participant with respect to the investment in the fund and did little or nothing to receive a return on his investment.

The taxpayer had suggested that his significant gains in his RRSP demonstrated that he was an active trader carrying on a trading business. However, citing Deep v The Queen (2006 TCC 315 (T.C.C.)) as authority, the Court declined to draw any conclusions from the taxpayer’s RRSP-related trading. 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. Further, and more important in this case, because the Act treats an individual who trades within his RRSP differently from an individual who is in the business of trading, any trading within an RRSP is not relevant to a determination of whether an individual is in the business of trading outside of an RRSP.

On this basis, the Court concluded that the taxpayer was not a trader.

The taxpayer was not engaged in an “adventure or concern in the nature of trade”

The Court then turned to the question of whether the taxpayer’s activities could be considered “an adventure or concern in the nature of trade.” The Court outlined the relevant criteria set out in Canada Safeway Ltd. v The Queen (2008 FCA 24 (F.C.A.)) for determining if a person is engaged in an “adventure or concern in the nature of trade”:

  • Whether the taxpayer dealt with the property in the same way as a dealer would ordinarily deal with such property
  • Whether the nature and quantity of the property dictated whether it could be disposed of as capital or as a trading asset
  • Whether evidence of the taxpayer’s intention was consistent with a trading motivation

The Court concluded that the taxpayer’s investment did not meet any of the criteria and therefore he was not engaged in an “adventure or concern in the nature of trade.” In the Court’s view, the taxpayer was a passive investor intending to hold the property on a long-term basis and to passively receive a return on his investment. He was not an active businessman intending to promptly resell the investment for a profit. As a result, the taxpayer was not entitled to claim a non-capital loss in his 2007 taxation year, and his appeal was dismissed.

Lessons learned

The Court’s comments that trading activity within an RRSP cannot constitute a business were incidental to the main decision, and therefore are not considered binding. However, they acknowledge that taxpayers can and do actively trade investments in their RRSPs (and arguably, in other tax-sheltered investment vehicles).