CRA Audits & TFSA Penalties
Audits of Tax Free Savings Accounts - Louie v. Canada, 2019 FCA 255 (CanLII)
Tax-Free Savings Accounts (“TFSA”) are regularly audited by the Canada Revenue Agency (“CRA”). One reason being is that there are opportunities to abuse the “tax free” element beyond the intent of the respective legislation. In addition, there are certain prohibited TFSA investments that taxpayers may not be aware of.
Investment gains in a TFSA are tax free, with exceptions. For example, a taxpayer cannot engage in frequent trades using the account. It is meant to be a long-term investment vehicle, not an account to shield day trades from tax. And if you are found to have abused the TFSA, or gained an “advantage”, you will be liable for a 100% tax of the gain.
In addition to disallowed TFSA investment activity there are types of investments that cannot be placed in a TFSA. These “prohibited investments” include a debt or share in a corporation that is non-arm’s length to the TFSA owner. For instance, you cannot place shares of your own corporation in a TFSA. Many taxpayers are unaware of the restrictions but can appeal a related assessment and/or ask CRA for a waiver or cancellation of TFSA penalties.
Key TFSA decisions related to prohibited trading in a TFSA account or gaining an “advantage” include those of the Federal Court of Appeal (“FCA”) and the Tax Court of Canada (“TCC”) in Louie v. Canada, 2019 FCA 255 (CanLII) and Louie v. The Queen, 2018 TCC 225 (CanLII). The taxpayer’s subsequent application for leave to appeal to the Supreme Court of Canada was dismissed.
In Louie, the taxpayer was an investment professional who engaged in swap trading. This involved regularly transferring stock in and out of her TFSA. Ultimately, she accumulated hundreds of thousands of dollars in tax free investment gains in a relatively short period and CRA selected her for in-depth scrutiny.
Pursuant to the Louie FCA and TCC decisions, a finding of abuse of a TFSA was based on a determination whether a taxpayer engaged in a series of transactions that would have not occurred among arm’s length parties in the open market and that resulted in gains or an advantage. The courts ruled against the taxpayer.
Subsection 207.05(1) of the Income Tax Act - "Tax Payable in Respect of an Advantage"
The legislation under consideration in Louie was subsection 207.05(1) of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) which provides, among other things, that a tax is payable for a calendar year in connection with a TFSA if, in the year, “an advantage in relation to the TFSA is extended” to the holder of the TFSA. Advantage is defined as follows in subsection 207.01(1):
(b) a benefit that is an increase in the total fair market value of the property held in connection with the TFSA if it is reasonable to consider, having regard to all the circumstances, that the increase is attributable, directly or indirectly, to …
(i) a transaction or event or a series of transactions or events that
(A) would not have occurred in an open market in which parties deal with each other at arm’s length and act prudently, knowledgeably and willingly, and
(B) had as one of its main purposes to enable a person or a partnership to benefit from the exemption from tax under Part I of any amount in respect of the TFSA…
Swap Trades in a Tax Free Savings Account
In Louie, the taxpayer engaged in swap trades using her TFSA account. The FCA concluded that the swaps were a part of a series of transactions per paragraph 207.01(1)(b). According to subsection of the 248(10) of the Income Tax Act, a series of transactions “shall be deemed to include any related transactions or events completed in contemplation of the series.”
The court relied on the related interpretation in Copthorne Holdings Ltd. v. Canada, 2011 SCC 63 (CanLII),  3 SCR 721, which held that “nothing [in s.248(10)] suggests that the related transaction must be completed in contemplation of a subsequent series…”. A series of transactions does not require uniformity.
The FCA did not agree with the Appellant that she was dealing at arm’s length with her brokerage, trustee of the accounts. The Appellant conceded that the transactions would not have happened in the open market and one of the main purposes was to realize tax free gains.
The FCA’s decision centred on the analysis of “arm’s length” and “single directing mind”. The FCA and TCC chose to rely on three factors referred to in paragraph 62 of the Supreme Court of Canada decision in Canada v. McLarty, 2008 SCC 26 (CanLII),  2 SCR 79, taken from CRA Income Tax Interpretation Bulletin IT-419R2 “Meaning of Arm’s Length” (June 8, 2004):
The following criteria have generally been used by the courts in determining whether parties to a transaction are not dealing at “arm’s length”:
was there a common mind which directs the bargaining for both parties to a transaction;
were the parties to a transaction acting in concert without separate interests; and
was there “de facto” control.
Both courts confirmed that not all factors need apply. The TCC and FCA found that 2 of 3 did apply, which was sufficient to rule against the Appellant.
Challenging a Tax Free Savings Account Penalty
Taxpayer’s should be aware that you can challenge a TFSA assessment with a Notice of Objection and appeal to the Tax Court of Canada. Also, a request for relief from any penalties and interests, a waiver, can be prepared and submitted to CRA for consideration.
Canada v. McLarty, 2008 SCC 26 (CanLII),  2 SCR 79, 374 NR 311, 293 DLR (4th) 659, 46 BLR (4th) 1,  4 CTC 221,  SCJ No 26 (QL), ACS no 26,  DTC 6354
Copthorne Holdings Ltd. v. Canada, 2011 SCC 63 (CanLII),  3 SCR 721, 424 NR 132,  DTC 5006
Louie v. Canada, 2019 FCA 255
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