Being an investment professional can influence tax treatment of your own investmentsBy Doug Carroll | May 23 2017 07:00AM
There is a fundamental concept in tax that determines how your investments are treated, being whether you are trading on ‘income account’ or on ‘capital account’.
It’s a concept that can cut both ways. On capital account, only half of gains are taxable, and only once realized; correspondingly, when losses are realized they can only be applied to reduce capital gains. On the other hand, income account treatment means full taxation on a year-to-year basis, while expenses in this arena are fully deductible in the year.
The ideal case for an investor would be to have all gains treated under capital account, and all expenses treated on a current/income account basis. As you might expect though, it’s not a matter of an investor simply choosing, though intention is part of the legal test.
What may surprise many people though, is that who you are – at least in terms of your professional/business profile – can influence how you are treated.
Income Tax Act (ITA) section 248 – Definitions
“business includes a profession, calling, trade, manufacture or undertaking of any kind whatever and … an adventure or concern in the nature of trade …”
Rajchgot v. the Queen, 2004 TCC 548
This is an oft-referenced authority on the legal test for income and capital treatment. The starting point is whether securities giving rise to a loss or gain are part of business activity (trading property) or investment activity (holding property). And the entrée into that analysis begins with ascertaining the taxpayer’s intention at the time of acquiring the securities.
Determining intention is understandably difficult, and is not helped much by a taxpayer’s statements, as those would be almost entirely self-serving. Intention then is derived by inquiring into and observing the taxpayer’s whole course of conduct. The framework for this analysis is arranged under the following headings:
- Frequency of transactions
- Duration of holdings
- Nature and quantity of securities held
- Time spent on the activity
- Particular knowledge possessed by the individual
Foote v. the Queen, 2017 TCC 61 (released April 21, 2017)
According to the case fact summary, Mr. Foote had a sense that the markets had bottomed out in March 2009. Over the course of that year, he carried out 38 purchase transactions with an aggregate value of about $2.5 million, and generated about $3.0 million from 50 sale transactions. His total gain was about 23%. Mr. Foote reported the net result as capital gains in his 2009 income tax return. The Canada Revenue Agency (CRA) reassessed the amount as income, and Mr. Foote appealed to the Tax Court of Canada.
Mr. Foote had been in the investment industry for over 25 years, at the time working as head of institutional trading at a major investment dealer. In his role, he did not directly trade securities, but did oversee others who traded. On a personal level, he testified that his investment strategy had always been to invest in diversified securities he felt had the potential for 30% returns over a reasonable time frame.
The judge reviewed the facts under the Rajchgot heads of analysis. Trade frequency had tripled in 2009 relative to prior years, and hold periods averaged just 50 days, with some securities bought and sold within the same week. Despite not technically being a trader, his position “in common parlance and as generally described in the markets” nonetheless fell into that category. While acknowledging that the activities did not amount to “carrying on a business of trading securities”, the judge found that they handily met the requirements of “an adventure or concern in the nature of trade” under the ITA s.248 definition of business. Accordingly, the appropriate treatment of the gains was held to be income.
- Tax treatment of securities trading can vary based on the subject matter traded, the manner of trading, and the individual carrying out the trades. Frequent trades and short holding periods tend toward full income inclusion, as opposed to capital gains treatment.
- Working within the investment industry does not invariably result in income treatment. For example, being the vice-president of human resources or information technology for a securities dealer would not in itself suffice. However, where a person’s job is integral to the business function of trading securities, that fact is far more influential in arriving at a determination of income treatment. And it is not a sufficient reply to merely show that the individual was not trading on insider-type information.
- Still, it remains possible for even a full-time professional trader to be trading on capital account in his or her personal affairs, if the facts can support that conclusion.