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Chances are that if you invest in the markets outside of your RRSP or RRIF, you treat any profits you realize from your investing activities as capital gains. The obvious advantage is that capital gains are taxed at only 50% of your marginal tax rate. The disadvantage is that any losses incurred can only be applied against other capital gains, not against other sources of income.
Day traders, on the other hand, who make their living by frequently buying and selling securities, often closing out any long positions by the end of the day, are considered to be engaged in the business of buying and selling securities with a view to a profit and, therefore, must generally report any profits as business income, fully taxable at their marginal rate.
While day traders cannot take advantage of the 50% capital gains inclusion rate on their profits, they are able to deduct 100% of any trading losses against other sources of income.
But what about someone who has two accounts: One used exclusively for day-trading activities and the other for long-term investing? Is it possible to report profits on the day-trading account as income, while the profits from the long-term account are 50% taxable capital gains?
That was the question posed to the Canada Revenue Agency, which released its technical interpretation to the public last month.
The whole issue of whether profits from securities trading should be treated as income or capital is not a new one and predates day trading.
In 1984, the CRA revised its bulletin entitled Transactions in Securities, listing several factors to determine whether a taxpayer's activities constitute a "business."
These factors include the frequency of transactions, the period of securities' ownership, investor's knowledge and experience in securities markets, whether the transactions form a part of a taxpayer's ordinary business, as well as the amount of time spent studying the securities markets and investigating potential purchases.
Not surprisingly, the CRA's general position is that given the frequent transactions and short period of ownership associated with day trading, gains or losses from day trading are generally considered to be income and not capital gains.
As for having two separate accounts – one for day trading and one for long-term investing – the CRA acknowledged that it may be possible for the same taxpayer to legitimately hold some securities as an investment and other securities on income account, but that "such situations are rare." The CRA's initial presumption is that any gains or losses on securities transactions by the same taxpayer must be treated consistently.
Nevertheless, the CRA concluded by saying that if an investor wishes to establish otherwise, he or she must be able to demonstrate that each distinct pool of capital is being managed separately – one with a view to producing short-term gains on an income account, and the other with a long-term investing focus.
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