One topic I’ve been covering a lot lately is Tax-Free Savings Account (TFSA) taxes. That is, taxes that you can end up paying on TFSA investments despite the fact that the TFSA is supposed to be “tax-free.” You can become liable for such taxes by over-contributing, holding unapproved investments, and carrying on a day trading business in your TFSA.
Of all of the above TFSA violations that can result in taxation, day trading is the one that gets the most attention. Basically, if you are day trading full-time in your TFSA and you realize large profits doing it, the Canada Revenue Agency (CRA) may class your trading activity as a business and nullify your TFSA benefits.
This isn’t some theoretical problem: many Canadians have had it happen to them (just look up “TFSA day trader taxed” in Google News)! However, the conditions that can cause you to face this tax are rarer than those that subject you to, say, the over-contribution tax. In this article, I will explore the conditions that lead to Canadians paying the day trading tax and whether you are subject to them.
Profitable day trading
To get taxed by the CRA for day trading, you need to be found conducting a day trading business in your TFSA. The factors that distinguish day trading from regular investing are subtle, but below are some practices that could get the CRA to view you as a professional trader:
- Trading very frequently
- Using special paid research services
- Using expensive trading software (e.g., a Bloomberg terminal)
- Not working a day job
- Having worked as a financial advisor before transitioning to full-time trading.
If you have done any of the above and are realizing very large profits, you may end up being taxed in your TFSA.
Why you probably won’t face the day-trading tax
However, if you meet all of the above criteria and lose money, the CRA won’t think it worth their time to go after you for taxes. What gets these CRA account investigations going in the first place is people achieving TFSA balances that raise suspicion. If you try day trading, you will most likely lose money. Studies say that between 90% and 99% of those who attempt day trading are net losers. Therefore, you’d have to be a statistically very unusual trader to face the day trading tax.
An unusual investment strategy
Day trading is very different from the typical investment strategies followed by Canadians.
Your typical Canadian investor might hold a portfolio full of defensive stocks like Fortis (TSX:FTS) and hold them long term. Canadian index funds typically hold stocks like Fortis, as they have heavy index weighting. Stocks like Fortis offer a lot of dividend income (FTS’s yield is about 4%), which gives the TSX index a fairly high yield. Canadian retirees tend to like dividend income, as it is seen as safe. So, they hold lots of stocks like Fortis and index funds that include them.
It’s very different for day traders. A day trader might decide that Fortis is the stock they want to trade and make various long and short bets on it every day. Making money at this is very hard because it requires profitably betting on short-term stock market fluctuations that are basically statistical noise. Those who try it generally lose at it. But yes, if you try it and make a lot of TFSA income doing it, you can lose your TFSA benefits to the CRA’s day-trading tax.
