Earnings within Tax-Free Savings Accounts (TFSAs) and other tax-deferred plans are, in principle, supposed to grow “tax-free”. However, some taxes can still apply. One such tax is the advantage tax which applies at the rate of 100% of any advantage (as defined in the Income Tax Act). This tax has become one of the CRA’s favourite tools to effectively expropriate what they view as improperly-boosted returns within a TFSA. In our experience, when the CRA assesses an advantage, it imposes a 100% tax on the entire increase in the value of the TFSA in gain years. In loss years, however, CRA gives no credit for the downtick in value.
A new decision of the Tax Court of Canada – Louie v. The Queen – is the first to consider the scope of the advantage tax. This decision significantly undercuts the CRA’s interpretation of the advantage rules.
In Louie, the taxpayer had a self-directed TFSA at a discount brokerage firm. She contributed the initial maximum of $5,000 in 2009. The brokerage firm’s rules permitted her to “swap” publicly-traded securities between her TFSA and her other accounts for a $45 fee. These swaps were not executed through the facilities of the stock exchange. The brokerage firm allowed accountholders to choose any price between the high and the low trading price of the day at which to execute the swaps.
Given the swap parameters set by the brokerage, Ms. Louie adopted a “buy low, sell high” strategy for her TFSA. Towards the end of the trading day, she would swap shares into her TFSA for cash from another of her accounts at the low price of the day and pay the $45 transaction fee. Then, either on the same day or within a short period thereafter, she would swap those shares or others out of her TFSA for cash at the high price for that stock on that day. This proved to be a low-risk (or no-risk) method of systematically increasing the value of her TFSA.
Ms. Louie undertook 71 swap transactions up to October 2009, and her TFSA account value grew substantially in 2009 based at least in part on those swaps. It rose further in value in 2010, declined in 2011, and grew again in 2012. The CRA assessed her for 100% of the increases in value for 2009, 2010 and 2012 – whether realized or not – on the basis that she had received an advantage through her use of TFSA swaps. The CRA gave her no credit or reduction for the “disadvantage” in 2011 when her account declined in value.
The Tax Court upheld the advantage tax assessment for 2009, but overturned the assessments for 2010 and 2012. The Court found that the trades did not occur between parties dealing at arm’s length, and further that they did not reflect transactions that would have occurred in the market. The former because Ms. Louie directed both sides of the transaction, and the latter because of the use of hindsight in selecting the trade price. Furthermore, every trade operated to the disadvantage of Ms. Louie’s other accounts and for the benefit of the TFSA.
In upholding the 2009 assessment, the Tax Court found that the increase in value in 2009 was attributable to the Ms. Louie’s numerous swap transactions. The Court further found that the swap transactions were caught by the advantage rules at the time – even though the Income Tax Act was only amended in October 2009 to specifically capture swap transactions, and Ms. Louie’s swaps all occurred before that date. Justice Lamarre stated, however, that, “I do not consider the increase in FMV to be attributable to each swap transaction taken individually. If the Appellant had made
only one swap transaction or just a few such transactions over a long enough period of time I might have concluded, on the facts, that the increase in value is not attributable to the swap transactions.”
In overturning the 2010 and 2012 assessments, the Tax Court rejected the CRA’s contention that once an account is tainted by an “advantage” then all gains or increases in value thereafter are forever captured by the advantage tax. The Court stated that the gains in 2010 and 2012 arose from market forces, noting the strong market recovery in 2010 (which, in fact, had begun in 2009) and finding that the gains from 2010 onwards were not “directly or indirectly” attributable to the swap transactions. The 2011 loss bolstered the Court’s finding in that regard.
Overall, while there remain some gaps to fill in the interpretation of the advantage tax, this decision provides a sensible result in the face of complex legislation that is being aggressively applied by the CRA.