James Pendergast is an Associate Lawyer at Rosen Kirshen Tax Law. James is entering his third and final year at the University of Toronto Faculty of Law. Outside of academics, James is a chair of the Faculty of Law’s Health and Wellness Committee, volunteers with the Law in Action Within Schools (LAWS) program and was an Associate Editor with the University of Toronto Law Review. This year, James competed for the University of Toronto at the 2019 Donald G. H. Bowman National Tax Moot.
Jason Rosen is a founding Partner at Rosen Kirshen Tax Law. Jason provides effective and aggressive representation by taking a proactive, client centered approach for his domestic and international clients alike. Throughout his time in the field, Jason has gained a comprehensive understanding of tax procedures and the dispute resolution process.
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Retail Investing and the Tax Implications in Canada
The COVID-19 pandemic has created novel economic conditions for Canadian investors. Many Canadians were laid off or let go completely from their place of employment. Stay-at-home orders have also resulted in many Canadians spending much of their winter indoors in order to comply with provincial regulations to curb the spread of the disease. The pandemic’s effect on the economy has also created an investment climate where there is tremendous potential upswing for the changing needs of our society. Stocks like Amazon, Shopify and, most notably, Tesla have seen record gains on the stock market leading to significant gains for their shareholders in turn.
These factors have led to many Canadians pursuing income-earning alternatives to try to mitigate financial damage. This has contributed to the increasing popularity of “retail investing” as a potential means of planning for one’s financial future. While retail investing may provide an opportunity for some to supplement their earnings, it is important to consider the tax implications of the addition of investment income to one’s existing income sources.
Some retail investors may believe that sheltering their securities under their Tax-Free Savings Account (TFSA) will protect their earnings from any tax liability. However, there are limitations as to what earnings are protected from inclusion in taxable income, even under a TFSA.
What is Retail Investing?
“Retail investing” is the term for non-professional individuals buying and selling financial instruments or securities. Retail investors open investment accounts and procure securities with or without the direct aid of a broker.
Retail investing is increasingly accessible to Canadians, with a wide range of trading accounts now offered by major Canadian financial institutions. Another arena of growth has been the development low-cost trading applications like Wealthsimple Trade and Questrade that allow for Canadians to purchase securities on the go.
Retail Investing and the Tax Implications
Retail investing can trigger earnings in several ways, all of which are taxable (unless eligibly positioned in a registered savings account that shelters the earnings from taxation, like an RRSP or TFSA). However, the amount of the earnings that is included in a retail investor’s taxable income depends on source of the earnings. With retail investing, earnings usually stem from one of three main sources: interest income, dividend income, or capital gains.
Interest income can be earned on investments that have a rate of return on the principal amounts invested. Typically, this is a low percentage of guaranteed earnings such as the interest return on a savings account principal, bond interest or interest earning from a Guaranteed Investment Certificate (GIC). Any interest income earned during a calendar year is to be included in full in the taxable income of the taxpayer.
Dividend income is earned when a corporation elects to pay out a portion of its profit during a specific time period to its shareholders. These earnings vary depending on the security and are to be included in full in the taxable income of the taxpayer during the taxation year in which they were accrued.
When a security appreciates in value and is sold by a taxpayer, any gains or profit earned by the taxpayer upon the sale of the security are determined to be “capital gains” (with some exceptions, e.g. where the taxpayer meets the definition of a “trader”). Half (50%) of the value of all capital gains earned by the taxpayer during a given taxation year are to be included in the taxpayer’s taxable income during a taxation year.
There is a legitimate means of avoiding taxable income inclusions with respect to earnings from these three sources for the individual: placing the financial instruments in a registered savings account such as a TFSA or RRSP (each with their own set of advantages for savings). However, this sheltering requires careful adhesion to the rules and eligibility criteria for investments to be protected under the registered savings plan.
Retail Investing and the TFSA
A TFSA can be a great tool to avoid income tax inclusions on qualifying earnings of eligible securities. However, there are eligibility requirements for what sort of investment earnings garnered under a TFSA are sheltered from taxation.
A consideration to keep in mind is whether the TFSA account holder has already exceeded his or her TFSA contribution limit. The contribution limit is prescribed by the federal government and additional contribution room has been provided each year since 2009. Contributing in excess of the allowable contribution limit can result in serious penalties levied by the CRA against the taxpayer, so in almost all circumstances it would be unadvisable to exceed this limit.
Another key consideration is the nature of the security being held under the TFSA. Retail investors are able to keep mutual funds, registered stocks, bonds, ETFs and GICs among other types of investments in their TFSA. The eligible placement of these securities will protect the interest income, dividend income and capital gains earned from the securities from inclusion in the taxpayer’s taxable income for that taxation year, so long as several requirements are met.
Even still, earnings from these securities that are eligible for protection under the TFSA may be viewed by Canada Revenue Agency (the CRA) as taxable income depending on the nature of the activity undertaken by the TFSA holder. The key distinction lies with whether or not the earnings stem from “investment income” or “business income” in the eyes of the CRA, the latter of which is not protected from inclusions in taxable income.
If you are concerned about unreported taxable income from your retail investing or wish to carefully plan your investment portfolio to ensure compliance with registered savings plan rules and eligibility requirements, contact a tax professional at Rosen Kirshen Tax Law today!
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.