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The taxpayer was a sophisticated investor. In 2009, when the Tax-Free Savings Account (“TFSA”) rules were introduced, she saw a tax planning opportunity. At that time, she had a self-directed RRSP and a direct trading account. Knowing that gains made inside TFSAs are not taxable, she swapped stocks in and out of her RRSP, trading account and newly opened TFSA to take advantage of that. The Federal Court of Appeal (“FCA”) summarized the swap transactions as follows:[1]
7 By May 2009, the appellant wanted to capture the gains she had earned on stocks held in her TFSA and RRSP accounts, and to shelter from tax the possible future gains to be made on stocks held in her trading account. TD Waterhouse, as trustee of the appellant’s TFSA, confirmed to the appellant that it permitted holders of TFSAs to conduct asset swaps between their accounts. Accordingly, the appellant decided to move stocks from her Canadian trading account to her TFSA and RRSP accounts in order to eliminate or defer tax payable on possible future gains.
8 The appellant conducted research to determine which stocks had the most upward price momentum going forward because these stocks would have the greatest probability of earning a gain in the future. Where a stock had upward price momentum, the appellant would benefit from transferring the stock into and sheltering the stock in her TFSA. Similarly, the appellant conducted research to determine if there existed any downside risk in relation to stocks she held in her TFSA. If a risk existed that a stock might drop in value, the appellant’s practice in 2009 was to capture the gain in the TFSA by either selling the stock or exchanging that stock for another existing stock in her RRSP or trading account.
9 The appellant chose which stocks, and how many of them, she would transfer in and out of her TFSA. She also chose the values that would be used and recorded for each stock that was transferred, based on the daily range of their values on the market. For stocks being transferred into the TFSA the appellant chose, and instructed TD Waterhouse to use, the lowest market price that the stock had traded at on that day to the point in time when she gave her instructions to TD Waterhouse. For stocks being transferred out of the TFSA, the appellant chose, and instructed TD Waterhouse to use, the highest market price that the stock had traded at on that date to the point in time when she gave her instructions.
In October 2009, TD Waterhouse advised the taxpayer that swap transactions would no longer be allowed because of proposed amendments to subsection 207.01(1) of the Income Tax Act (“ITA”) to specifically include “swap transactions” in the definition of “advantage”. By then, the taxpayer had already completed 71 swap transactions. After she was no longer allowed to swap, the taxpayer left the stocks in her TFSA untouched, letting market forces dictate their value. From her initial $5,000 contribution in 2009, the market value of the taxpayer’s TFSA increased as follows:
- December 31st, 2009 – $206,615.09 (over 4,000% increase in a single year)
- December 31st, 2010 – $281,826.11
- December 31st, 2011 – $186,267.56
- December 31st, 2012 – $220,485.00
The CRA reassessed the taxpayer’s 2009, 2010 and 2012 taxation years on the basis that she received an “advantage” within the meaning of subsection 207.01(1) ITA. The CRA calculated the advantage as the annual increase in the fair market value (“FMV”) of the taxpayer’s TFSA, minus her initial contribution of $5,000. Therefore, the taxpayer was asked to repay the following amounts:
- For 2009 – $200,795
- For 2010 – $70,841
- For 2012 – $29,217
Even though the FMV of her TFSA was only $220,485 by the end of 2012, she was asked to repay a total of $300,853, excluding interest.
Legislative Provisions
TFSAs were designed to encourage Canadians to save by providing a mechanism to earn investment income tax-free. While gains earned inside a TFSA are generally not taxed, they will be taxed if they fall within one of the exceptions provided for under the ITA. One such exceptions is found at subsection 207.05(1) ITA, which states that a tax is payable for a calendar year if in the year an “advantage” in relation to the TFSA is extended to the holder of the TFSA.
Back in 2009 (before the amendment), “advantage” as defined in the ITA did not specifically refer to “swap transactions”. Therefore, the core issue was whether the swap transactions that the taxpayer entered into were caught in the definition.
Tax Court of Canada
Lucie Lamarre A.C.J. of the Tax Court of Canada (“TCC”) found that the taxpayer received an advantage for 2009, but not for 2010 and 2012.
For 2009, she found that the increase in the FMV of the TFSA was due to the swap transactions. Those swap transactions were part of a series of transactions which would not have occurred in an open market in which prudent, knowledgeable and willing parties dealt with each other at arm’s length. She further found that the main purpose for the swap transactions was to benefit from the Part I tax exemption on the sale of the shares inside the TFSA. While the taxpayer tried to advance “technical arguments”, they were not compelling because the facts did not support those arguments. For example, she argued that the trustee of the accounts, which was TD Waterhouse, was at arm’s length and agreed to the swap transactions. Therefore, the transactions were legitimate and took place between arm’s length parties. However, this argument omits one big factor. The taxpayer was the directing mind behind all the swaps and TD Waterhouse was only executing her orders.
For 2010 and 2012, Lamarre A.C.J. sided with the taxpayer and found that she did not receive any advantages for those years. In making that finding, she adopted a narrow interpretation of the expression “directly or indirectly”. She found that the increase in the FMV of the TFSA in 2010 and 2012 was not due to the swap transactions, but rather to the post-2008 financial recovery.
The dispute did not end at the TCC. The taxpayer appealed the TCC’s decision regarding the 2009 taxation year. The CRA cross-appealed regarding the 2010 and 2012 taxation years.
Federal Court of Appeal
Eleanor R. Dawson J.A. of the FCA dismissed the taxpayer’s appeal and allowed the CRA’s cross-appeal, with costs to the CRA at both the TCC and FCA’s level. In other words, the CRA won all the way.
For 2009, the FCA substantially agreed with the TCC’s reasoning. However, for 2010 and 2012, the FCA disagreed. In essence, the FCA found that there was no support for adopting a narrow interpretation of the expression “directly or indirectly”, which would have let the taxpayer off the hook. The taxpayer would not have earned what she did in 2010 and 2012 had she not entered into the swap transactions in 2009, which allowed her to significantly increase her holdings inside her TFSA. In simple terms, had the taxpayer not entered into the swap transactions in 2009, her initial $5,000 contribution would not have artificially grown to $200,000 in the span of a year. Therefore, for 2010 and later years, her starting point would not have been $200,000. This fact simply cannot be ignored.
Tax planning must be undertaken very carefully. The fact that a provision does not specifically refer to a specific type of transaction (in this case, “swap transactions”) does not mean that the transaction is permitted. Further, the fact that a broker allows a transaction to take place should not be viewed as them corroborating or confirming the legality of the transaction. One bright side for taxpayers who unknowingly break the TFSA rules is that the CRA “may” waive or cancel all or part of the penalties if certain conditions are met. However, even here, the CRA’s decision to waive or cancel the penalties is “discretionary”.
[1] Louie v. Canada, 2019 FCA 255, paras. 7 to 9.