Principal Issues: Whether foreign currency trading is permitted in a trust governed by a tax-free savings account.
Position: General comments provided.
Reasons: Application of the provisions of the Act.
XXXXXXXXXX 2010-038103 Gillian Godson 613) 957-8982 January 5, 2011
Dear XXXXXXXXXX ,
Re: Tax-Free Savings Account ("TFSA") - Foreign Exchange Trading
This is in response to your email of September 7, 2010 wherein you requested information regarding whether the trading of foreign currency on a foreign exchange market is permitted in a trust governed by a TFSA.
Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request. For more information concerning advance income tax rulings, please refer to Information Circular 70-6R5 dated May 17, 2002. Where the particular transactions are completed, the enquiry should be addressed to the relevant Tax Services Office. We are, however, prepared to provide the following general comments which may be of assistance.
Foreign exchange trading, also referred to as "Forex" trading, encompasses a number of financial instruments which range from simply holding foreign currency to entering into various foreign exchange contracts such as spots, futures, forwards, swaps and options. With respect to a TFSA, there are several income tax rules that may restrict foreign exchange trading.
TFSA trusts are required to limit their investments to qualified investments. Pursuant to the definition "qualified investment" in section 204 of the Income Tax Act (the "Act"), which is incorporated by reference into the TFSA qualified investment definition in 207.01(1) of the Act, money is a qualified investment whether Canadian or foreign denominated. However, money that is held for numismatic value or money the fair market value of which exceeds its stated value as legal tender in the country of issuance is excluded from the definition.
The definition "qualified investment" in section 204 of the Act also includes securities (other than futures contracts or other derivative instruments in respect of which the holder's risk of loss may exceed the holder's cost) that are listed on a designated stock exchange. This could include, for example, foreign currency options listed on a designated stock exchange.
Foreign exchange contracts that trade on the over-the-counter market, such as spot or futures contracts, are not a qualified investment. These contracts do not constitute money, nor is the over-the-counter market a designated stock exchange. In addition, foreign exchange contracts that are listed on a designated stock exchange would not be a qualified investment if the risk of loss exceeds the cost of the contract. This would include, for example, foreign currency futures contracts.
In the event that a TFSA trust holds a non-qualified investment, section 207.04 of the Act will apply and the holder of the TFSA will be liable for a special tax equal to 50% of the fair market value of the non-qualified investment. In addition, subsection 146.2(6) of the Act provides that the TFSA trust is taxable on the income from the non-qualified investment.
It should also be noted that subsection 146.2(6) of the Act provides that a TFSA trust is taxable on any business income earned by the trust. A TFSA trust that engages in foreign currency trades that are speculative in nature may be considered to be carrying on a business and thus taxable on the income earned in connection with such activities. The determination of whether a particular taxpayer carries on a business is a question of fact that can only be determined following an assessment of all of the facts relating to the taxpayer's particular circumstances.
In addition, the TFSA advantage rules in section 207.05 of the Act could have application if a TFSA trust were to enter into certain foreign exchange contracts. This would be the case, for example, where the counterparty to the contract does not deal at arm's length with the TFSA holder or where the contract does not reflect commercial terms the result of which is to artificially shift value into the TFSA. If a transaction were found to be an advantage under these rules, any increase in the fair market value of the TFSA property that is reasonably attributable to the advantage would be subject to a special 100% tax.
We trust the above comments will be of assistance.
Yours truly,
Mary Pat Baldwin, CA
for Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch