Wednesday, January 26, 2000

When a day trader isn't a day trader. Gains from active investing shouldn't be taxed as income

Arthur Drache

In November, I speculated about the possibility of changes to the current capital gains rules in the upcoming budget. One of the rationales that had been floated as trial balloon by a tax expert was that day traders were not investors and thus their gains should not receive special tax treatment and should be treated as income.

I received more than a few missives from people identifying themselves as day traders saying that Revenue Canada -- now know as the Canada Customs and Revenue Agency -- treated them as being in business and thus they did not get capital treatment for gains and losses.

But few, if any, of them seemed to be aware of the provision of the Income Tax Act that guarantees capital gains treatment.

Subsection 39(4) of the act says a taxpayer may elect at any time by filing form (T123) to treat all his or her Canadian securities as being a capital account. (Note that this is a permanent decision.) In plain English, this means you can get capital gains treatment on both gains and losses.

The rule applies only to Canadian securities, so that day traders and others who buy and sell U.S. and other foreign securities will not get the benefit of the election respect of the gains and losses on foreign securities.

And while the term "Canadian security" is a defined phrase, the fact of the matter is that included within this term are stocks, bonds and mutual fund units "issued by a person resident in Canada."

For all intents and purposes, if it is listed on a prescribed Canadian exchange -- those recognized by the tax department, which includes the Canadian Exchange, created last year by the merger of the Vancouver and Alberta stock exchanges -- it qualifies, subject to some comparatively esoteric exceptions.

There is another hurdle to cross: Certain persons are not eligible to make the election, and this category includes "a trader or dealer in securities."

Many day traders probably believe that this description fits them. But it is worth looking at Revenue Canada's Interpretation Bulletin IT-479R, which deals with capital gains and losses and with the provisions relating to the "guaranteed capital gains election."

For the purposes of the election, the tax department interprets the term "trader or dealer in securities" to mean a taxpayer who "participates in the promotion or underwriting of a particular issue of shares, bonds or other securities or a taxpayer who holds himself out to the public as a dealer in shares, bonds or other securities."

This means, we believe, that so-called day traders are not traders as the term is interpreted by the tax department.

It is not only day traders who should familiarize themselves with the guaranteed capital gains provision. Many who are frequent, but by no means daily, traders have come to see the provision as offering a degree of security vis-a-vis the tax department.

The first step for anybody who wants to use this provision is to get hold of and read the Interpretation Bulletin. If you want to proceed based on the information provided, fill in the form and get it to your nearest Canada Customs and Revenue Agency office.

For most, it simply reinforces the status quo but it may offer a bit of a security blanket which allows sounder sleep for active investors.