TaxMatters@EY: Family Wealth Edition – July 2023

Gael Melville, Vancouver, and Jennifer Chandrawinata, Toronto

Canadians now have a range of registered programs they can use to save and invest for various purposes, like buying a first home or financing further education. Use of self-directed investment accounts, both registered and non-registered, surged during the pandemic, with many novice investors entering the market.¹

If you’re using registered plans or accounts to invest, it’s critical that you understand the applicable features and restrictions. A recent tax case illustrates an important difference between the tax implications of certain stock trading activities an individual undertakes in a tax-free savings account compared to a registered retirement savings plan or registered retirement income fund.

Rules on carrying on business in a TFSA or RRSP/RRIF

Tax-free savings accounts (TFSAs) were first launched in 2009, offering Canadians a flexible way to save or invest in a tax-sheltered account. Account holders who abide by the TFSA rules and restrictions can benefit from tax-free income and growth in the account, as well as tax-free withdrawals.

There are two important limitations on TFSAs. First, the account must hold only qualified investments: for example, mutual funds and listed securities. Second, a TFSA must also not carry on a business. If a TFSA does hold non-qualified investments or carry on a business, its income from those investments or that business will be taxable.²

Registered retirement savings plans (RRSPs) have similar limitations to TFSAs on the types of investments they can hold and also on carrying on a business, but there are also some differences. In particular, an RRSP that carries on a business that earns income from the disposition of qualified investments is not subject to tax on that income.³ A similar exception exists for a registered retirement income fund (RRIF).⁴

The Canada Revenue Agency’s (CRA’s) administrative position is that day trading in an RRSP or RRIF that is limited to the buying and selling of qualified investments does not cause the income from trading those investments to be taxable as income from carrying on business.⁵

The reason for the differing approach in the taxation of a business of trading qualified investments was not expressly stated in the explanatory materials issued when the TFSA rules were introduced. However, while an RRSP is a tax deferral mechanism and tax is eventually paid on distributions from the plan, a TFSA is funded by after-tax dollars and there is generally no tax on distributions. Therefore, if a large balance is generated in a TFSA, it may be possible to distribute it to the holder without payment of tax.

Activities that constitute carrying on a business

Due to their nature, self-directed or “trusteed” plans or accounts execute trades to acquire and dispose of investments. The Income Tax Act does not set out a specific number of trades that will automatically cause a plan or account to be viewed as carrying on a business of trading, rather than engaging in normal investment behaviour. However, outside the context of registered plans, the courts have developed general criteria to determine when a business is being carried on. The CRA applies these criteria to trading in the context of registered plans, with some exceptions.⁶

The factors most applicable to trading in registered plans are:

• Frequency of transactions
• Period of ownership of securities
• Nature of the investments (for example, whether they are speculative)
• Taxpayer’s knowledge of securities market
• Whether security transactions form part of the taxpayer’s ordinary business
• Time the taxpayer has spent studying the market and investigating potential purchases⁷

In each case it will be a question of fact whether a registered account is being used to carry on a business of trading. However, taxpayers who are experienced investors or who work in the financial markets should take particular care when investing through a TFSA since they already fulfill some of the criteria listed above.

As can be seen from a recent tax case involving an investment advisor, frequent transactions inside a TFSA where securities are owned for short periods may lead to the determination that the TFSA is carrying on a business, and as a result gains on the disposition of securities would become taxable.

Canadian Western Trust case

Canadian Western Trust⁸ is the first decided case that deals with a CRA assessment based on trading in a TFSA. In January 2009, Mr. X, who was a professional investment advisor, opened a trusteed TFSA. Mr. X was the TFSA holder and its beneficiary. In this case, the appellant taxpayer was the TFSA issuer and the trustee.

Mr. X invested a total of $15,000 in his TFSA, making a $5,000 contribution in each of January 2009, 2010 and 2011. Mr. X bought and sold only qualified investments in his TFSA, but the majority of his purchases were short-term, speculative “penny stock” investments in companies operating in the junior mining sector. His trades were very successful, and by the end of 2012 Mr. X’s TFSA was worth over $560,000.

In January 2013, the TFSA trust sold its securities and transferred the sale proceeds of $547,789 to Mr. X. The CRA reassessed the appellant in its capacity as trustee of the TFSA for the 2009-12 years on the basis that the TFSA earned income from carrying on a business of trading qualified investments in each of the 2009-12 taxation years and the income was taxable under the Income Tax Act.

When the taxpayer appealed the reassessments to the Tax Court of Canada, the court had to decide whether a TFSA that carries on a business of trading qualified investments is exempt from tax on the income from that business. The taxpayer’s main argument was based on a comparison between the treatment of income earned from a business of trading carried on in an RRSP and a TFSA. The taxpayer argued there would have been no rational legislative purpose for Parliament to have enacted different rules that taxed income from a business of trading qualified investments if it was earned in a TFSA but not if it was earned in an RRSP. The taxpayer also argued that the buying and selling of qualified investments did not constitute carrying on a business for the purposes of subsection 146.2(6).

In its review, the court noted that RRSPs and TFSAs are separate and highlighted the difference between the two. The court reasoned that had Parliament intended to create an exemption for income from a business of trading qualified investments, it would have specified this exception in the legislation, as it had already done for RRSPs.⁹ Parliament chose not to do so, and as such the differing income treatment between TFSAs and RRSPs was intentional. The court also noted that the term “carrying on business” has a large volume of jurisprudence and that trading securities constitutes carrying on business.

The court analyzed the relevant legislative provisions using a textual, contextual and purposive framework and found that the rules for RRSPs and TFSAs were separate and their components could not be interchanged unless the legislation specifically allowed it.

According to the court, Parliament’s primary purpose in creating the TFSA regime was to encourage Canadians to save, with its secondary purpose being to achieve that objective with certain limits. One of those limits was that income a TFSA trust earns from carrying on any kind of business is taxable under the Act.

The Tax Court of Canada dismissed the taxpayer’s appeal. The taxpayer has appealed to the Federal Court of Appeal; at the time of writing that appeal had not yet been heard.

Conclusion

Despite the name, income and gains earned in a TFSA are not always tax free and the Canadian Western Trust case serves as a useful reminder that TFSAs and RRSPs/RRIFs are governed by different rules. Since each case depends on its facts, there is no easy way to determine whether an individual’s pattern of trading activity has crossed over into what the CRA may consider to be a business of trading investments. However, fact patterns that include short holding periods, a high volume of activity and speculative trades should be examined closely. Financial institutions that offer TFSAs report the balances to the CRA each year, so it’s reasonable to expect that large increases in account balances year over year could precipitate further investigation.  

Lucie Champagne, Toronto

The 2023 federal budget, tabled on March 28, 2023, included welcome changes for families with respect to registered education savings plans (RESPs) and registered disability savings plans (RDSPs).¹

Changes to RESPs

Increase in educational assistance payment withdrawal limits

There are two types of payments that may be made from an RESP when an eligible student attends an eligible post-secondary institution. Amounts that were funded with contributions to the RESP — commonly referred to as refunds of contributions — may be withdrawn as a tax-free return of capital. In contrast, educational assistance payments (EAPs) include government grants received and income earned on contributed amounts and government grants. These amounts are taxable to the student in the year of withdrawal.

Under the previous rules, the limit on the amount of EAP that could be withdrawn from an RESP for the first 13 consecutive weeks of enrollment in a 12-month period was limited to $5,000 for full-time students.² For students enrolled in a part-time program, the EAP limit was $2,500 per 13-week period.³ Not surprisingly, these EAP limits were often insufficient to cover the cost of post-secondary education programs for the first semester. The rules do not place a limit on the amount that may be withdrawn as a refund of contributions, and therefore any shortfall may be made up by requesting an additional withdrawal as a refund of contributions. However, in most cases it is generally more desirable to withdraw EAPs from an RESP first.⁴

Effective March 28, 2023, the new withdrawal limit increases to $8,000 in respect of the first 13 consecutive weeks of enrollment in a 12-month period for full-time students, and to $4,000 per 13-week period for students enrolled in part-time programs.⁵

Individuals who have already withdrawn EAPs may be permitted to withdraw an additional amount up to the new limit, subject to the terms of their plan, which may need to be amended by promoters to allow for the new withdrawal limits.

Joint RESP accounts for divorced or separated parents

Under the previous rules, only spouses or common law partners could jointly enter into an agreement with an RESP promoter to open an RESP. If a joint RESP was opened by parents prior to their divorce or separation, the plan could be maintained, but the parents were not permitted to open a new joint account with a different promoter.

Effective March 28, 2023, divorced or separated parents are now permitted to open joint RESPs for one or more of their children, or to move an existing joint RESP to another promoter.⁶

Changes to RDSPs

Qualifying family member 

An RDSP can be established by a person who is eligible for the disability tax credit, their parent (if the eligible person is a minor) or a legal representative (if the eligible person is not contractually competent). Establishing a legal representative can be a lengthy and expensive process.

A temporary measure was introduced in 2012 to allow a qualifying family member — namely a parent, spouse or common-law partner — to become a plan holder of an RDSP for an adult who might not be able to enter into contracts.⁷ This temporary measure was set to expire on December 31, 2023.

The 2023 federal budget extends the temporary measure to December 31, 2026. As such, qualifying family members will continue to be permitted to open an RDSP and be the plan holder for an adult beneficiary whose capacity to enter into an RDSP contract is in doubt and who does not have a recognized legal representative.

A qualifying family member who becomes a plan holder before the end of 2026 may remain the plan holder after 2026.

Siblings as qualifying family members

The definition of qualifying family member has also been broadened to include a brother or sister of an adult beneficiary whose capacity to enter into an RDSP contract is in doubt and who does not have a recognized legal representative. This measure became effective on June 22, 2023 and will remain in effect until December 31, 2026.

A sibling who becomes a qualifying family member before the end of 2026 may remain the plan holder after 2026.

For additional information on RESPs and RDSPs, see chapter 9 of Managing Your Personal Taxes: a Canadian Perspective 2022-23.   

Lucie Champagne, Alan Roth, Yiyun Chen and Candra Anttila, Toronto

We've updated our popular personal tax calculator and rate cards to reflect budget proposals and news releases up to June 1, 2023.

Frequently referred to by financial planning columnists, our mobile-friendly 2023 personal tax calculator lets you compare the combined federal and provincial 2023 personal income tax bill in each province and territory. A second calculator allows you to compare the 2022 combined federal and provincial personal income tax bill.

You'll also find our helpful 2023 and comparative 2022 personal income tax planning tools:

• An RRSP savings calculator showing the tax saving from your contribution
• Personal tax rates and credits by province and territory for all income levels

In addition, our site offers you valuable 2023 and comparative 2022 corporate income tax planning tools:

• Combined federal-provincial corporate income tax rates for small business rate income, manufacturing and processing income, and general rate income
• Provincial corporate income tax rates for small business rate income, manufacturing and processing income, and general rate income
• Corporate income tax rates for investment income earned by Canadian-controlled private corporations and other corporations

You'll find these useful resources and several others — including our latest perspectives, thought leadership, Tax Alerts, our monthly TaxMatters@EY and much more — at ey.com/ca/tax.

Tax Alerts – Canada

Tax Alert 2023 No. 28 – Department of Finance consultation on Canada’s transfer pricing rules – Detailed summary

Tax Alert 2023 No. 27 – 2023 budget implementation bill no. 1 is enacted

Tax Alert 2023 No. 26 – Proposed regulations amending the valuation for duty rules for goods imported into Canada

Tax Alert 2023 No. 25 – Department of Finance consultation on Canada’s transfer pricing rules

Tax Alert 2023 No. 24 – Highlights from the CRA’s 2021 Mutual Agreement Procedure Report