The discussion below is based on Canadian tax law as well as securities held in a regular trading account and does not include TFSAs, RRSPs, or any other retirement accounts. There are things to watch out for when making trades within your TFSA. We’ll discuss these implications and consequences in another post.
From time to time we are asked whether investment income from trading or holding stocks and securities would be taxed on account of income (fully taxable) or capital gains, half of which is taxable. The answer is, it depends.
Can I ensure being taxed as a capital gain?
You can be guaranteed capital gains treatment by making a subsection 39(4) election by completing and submitting form T123. This election applies to any Canadian securities to and commences from the taxation year the election is filed. Once this election is made, it cannot be rescinded. There are limitations on who can make the election. Generally, if you are a “trader or dealer in securities” or a non-resident, this election is not available to you.
What is a trader?
A “trader or dealer in securities” generally means a person who participates in the promotion or underwriting of a particular issue of securities or a person who holds him/herself out to the public as such. If your prime business activity is trading in securities such as day trading, you are likely a “trader or dealer in securities”. If you have special knowledge of a particular corporation not available to the public and you use that knowledge to realize a quick gain, you will likely be considered a “trader or dealer in securities” for those securities.
Is it income or capital?
If the subsection 39(4) election is not made, or is not available to you, you must determine whether your gain or loss is on account of income or capital. The courts have generally looked at 2 tests in making this determination: 1) “course of conduct” 2) “intention”.
Essentially, the authorities assess the facts and circumstances to determine whether the transactions are of the same kind and carried on in the same way as those of a trader or dealer in securities. Considerations for this assessment include:
- The frequency of transactions and whether you have a history of quick buy/sell transactions;
- How long you held the securities for (traders typically hold securities for a short period of time);
- Your knowledge and experience with securities markets;
- Whether securities transactions form a part of your ordinary business;
- Your time spent studying and analyzing the security and decision to buy/sell,
- Whether the security was financed or bought on margin;
- Whether you have advertised or made it known that you were going to purchase the securities; and
- The nature of the shares and whether the shares are speculative in nature or a non-dividend type.
If the factors above indicate that your course of conduct is akin to a “trader or dealer in securities”, the gain/loss will be treated on account of income and be fully taxable.
This area of tax is almost always fact based, meaning every situation is different. If you’re in this boat, your tax situation is no longer neat and tidy and it’s a really good idea to bring a professional on board who can help you sort through the above analysis.
References: IT-479R; subsections 39(1), 39(4); section 3