How should I report my online trading income?
February 27, 2017
If you’re into online trading and watching the market everyday, you’re part of a growing number of Canadians who are managing their own investment portfolios. If investing is starting to become more lucrative than your full-time gig, you might be opting to work from home and have turn it into your new occupation. If this is the case, things can get confusing when tax time rolls around. You might be wondering if you should be reporting your securities transactions as business income, instead of capital gains or losses? If you go down that road, you could also be weighing how likely is it that the method of reporting you choose could be challenged by the Canada Revenue Agency (CRA).
Whatever method you choose will have a big impact on your taxes. Here’s how both of these methods work:
If you decide to report your profits as capital gains, they’re only 50% taxable.
- If you report them as business income, they’re fully taxable.
- If you incur losses, the tax treatment isn’t as advantageous, since you can only claim capital losses against capital gains. Business losses, on the other hand, are fully deductible against other sources of income.
- Business profits are pensionable for CPP purposes, meaning they might be subject to CPP contributions at the self-employed rate of 9.9%.
Generally, if you’re purchasing securities as an investment, you should report the transactions on a capital account. On the other hand, if you’re buying and selling only with a view to making a profit, and you conduct yourself similarly to a trader or dealer in securities, your transactions should be reported as business income. For example, day-traders, who make all their trading transactions within the same day, should report transactions as business income.
How to decide? Determine your pattern of trading.
Factors that determine a trading pattern include the frequency of your transactions, the duration of your holdings, your knowledge and experience of the stock market, and the amount time you spend on the activity. The type of securities you buy is also important. Let’s say you focus mostly on blue chip stocks. These are capable of producing dividends, and that would indicate you’re purchasing them as an investment. If you’re more into penny stocks, those are typically purchased on spec, so those transactions would probably be considered business income. A complete list of factors can be found in the CRA’s Interpretation bulletin IT-479R transactions in securities.
One or more of these factors on their own won’t necessarily determine how you should report your trading income. For example, the fact that you have a high volume of trades won’t mean you’re in business if your long-term intention is to build up a solid portfolio. On the other hand, a single transaction could be considered an adventure in the nature of trade, and therefore business income, especially if it was purely speculative and made in hopes of a quick profit. Collectively, however, they would reveal a pattern of activity that’s consistent with either an investment or trading intention.
How likely is it that my method of reporting will be challenged?
An informal survey of Tax Court of Canada looked at cases after the year 2000, and discovered 10 cases that had security transactions in dispute. Eight of these involved taxpayers who had been challenged by the CRA when they claimed their losses as business losses. On the other hand, one of the cases involved a taxpayer who hadn’t reported the transactions under either method, and the CRA assessed the transactions as business income, without giving very much benefit of the doubt.
So, if we look at the number of times that an issue is reviewed by Tax Court as a reflection of how the CRA assesses trading income, it seems like claiming losses from securities transactions as business losses attracts more attention than reporting profits as capital gains. But this isn’t a guarantee, and the CRA could change its focus anytime.
If above all else, you’re just looking for peace of mind when you report your trading income, a special election is available. You can use this to guarantee that the disposition of all Canadian (but not foreign) securities be treated as capital gains or losses. To make this election, track down and fill out Form T123 Election on disposition of Canadian securities. There’s a catch though! Once you make this election, you can’t change it later, so you’re making a lifetime decision. This election isn’t available for trades or dealers in securities and in this context, that would be someone who participates in the promotion or underwriting of securities, or someone who holds themselves out to the public as a dealer of securities.
What else should I know before I decide?
When taking a look through your trades, remember that the CRA always considers the gain or loss on the sale of short sales to be business income unless you made the transaction to hedge your position with respect to identical shares held on capital account. The CRA have also started to audit Tax Free Savings Accounts (TFSA) that they think might be used as shelters for trading transactions. When they’re satisfied that the account is used to generate business income, they’ll then assess tax on the financial institution that the account is registered to. This isn’t an issue with RRSPs, since any income generated within those plan is taxed on withdrawal, regardless of whether it is business or investment income.
Online trading is a great way to build up your investment portfolio and generate some extra income, just remember that anything you earn (or lose) in a year needs to be reported, so make sure you are using the appropriate method.