Woman who used swaps to run up TFSA suffers triple loss in court appeal
Most Canadians use TFSAs as intended — as general-purpose savings or investment vehicles to grow funds, tax-free, for future use. And, unlike an RRSP or RRIF, when funds are withdrawn from a TFSA, they are also tax-free.
But, in rare situations, tax can be levied on a TFSA if it’s determined by the Canada Revenue Agency that a TFSA account holder has received an “advantage” from their TFSA. The penalty for receiving an advantage is severe — it’s a 100 per cent penalty tax on the fair market value of the advantage.
One of the situations that could lead to the 100 per cent penalty tax involves what are known as “swap transactions” in which investments (typically, securities for cash) are transferred between the TFSA and its owner, regardless of whether such a swap was done at fair market value. As the CRA states in its published Income Tax Folio: “The advantage tax will nonetheless apply in respect of any future increases in the total FMV of the property held in connection with the plan that are reasonably attributable, directly or indirectly, to the swap transaction.
When the TFSA was first launched back in 2009, swap transactions were not originally part of the TFSA advantage rules but legislative amendments were introduced on Oct. 17, 2009, a mere ten months after the introduction of the TFSA, in response to stories that some shrewd investors had already built up six-figure TFSAs via opportunistically swapping of securities back and forth among their accounts.
Last week, the Federal Court of Appeal released its decision in the tax case of a B.C. taxpayer who engaged in numerous swap transactions in 2009, prior to the legislative amendments that would effectively halt all TFSA swap activity.
The taxpayer was described as “a sophisticated investor with extensive knowledge of the stock market … (who) proved to be highly knowledgeable about her trading activities.” She had three accounts with her discount brokerage: a non-registered direct trading account, a self-directed RRSP and a self-directed TFSA. From May 15 until Oct. 17, 2009, the taxpayer engaged in 71 swap transactions. The swaps involved transferring listed shares between her TFSA and her non-registered and RRSP accounts.
The taxpayer explained that each swap transaction required that the assets swapped be of equal value. Her brokerage’s swap valuation rules stated that if the stock she was swapping had traded that day, she could select “any price between the high and low of the day.” The taxpayer acknowledged “that, in following these guidelines, she was at liberty to pick the price of the day that would be most advantageous to her when swapping in or swapping out shares.”
For all of the swap transactions, the price selected for the shares swapped out of her TFSA was the highest price at which they had traded during the day up to the time of the swap. Conversely, for the shares swapped into her TFSA, the price chosen was the lowest at which they had traded.
As the Federal Court of Appeal observed, “the result of the (taxpayer’s) strategy was to inflate the value of the TFSA so as to benefit from a tax-free distribution from her TFSA (as opposed to a taxable withdrawal from her RRSP or a taxable gain within her Canadian trading account).”
Indeed, by the end of 2009, the taxpayer’s initial TFSA contribution of $5,000 was worth $205,795. For the years 2010 and 2012, the increase in FMV was $70,841 and $29,217 respectively. (Her TFSA decreased in value in 2011.)
The issue in the case was whether the taxpayer was liable to pay the 100 per cent advantage tax for the increase in fair market values in each of 2009, 2010, and 2012 resulting from her swap activity.
While a swap was not specifically listed as an “advantage” prior to Oct. 17, 2009, an increase in fair market value that was either directly or indirectly attributable to transactions “that 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 that was intended to benefit from the TFSA’s tax exemption was considered to constitute an advantage under the Income Tax Act.
The CRA argued in Tax Court that the taxpayer was able to shift value from her RRSP and non-registered account to her TFSA by selecting the price of the swapped shares “a posteriori.” Because these trades took place off-market and because parties dealing at arm’s length would not have agreed to set prices that would constantly disadvantage the holders of the RRSP and the non-registered account, the CRA felt that the taxpayer’s actions resulted in an advantage under the tax law.
The Tax Court agreed and in a 2018 decision, concluded that the advantage tax ($200,795, representing the increase in value from $5,000), should apply for 2009 but not for 2010 nor 2012. It concluded that the increase in the value of the shares in 2010 and 2012 was attributable to what happened in the market and was “neither a direct nor an indirect consequence of the swap transactions.”
The taxpayer appealed the Tax Court’s decision to impose the advantage tax for 2009 while the CRA cross-appealed the lower court’s decision not to impose the advantage tax to the increases in fair market value in 2010 and 2012.
Last week, in a double (or perhaps triple) loss for the taxpayer, the Federal Court of Appeal found the advantage tax to be applicable in 2009, 2010 and 2012. As the appellate court explained, “For each taxation year under consideration the question is how much of the fair market value increase in the TFSA is attributable directly or indirectly to impugned transactions.”
In upholding the advantage tax for 2010 and 2012 and reversing the Tax Court’s decision, the appellate court determined the increases in the fair market value of the TFSA in 2010 and 2012 were indeed “indirectly attributable” to the swap transactions undertaken in 2009.