When you buy a security and sell it at a profit, you realize a capital gain. For the average Canadian, the taxable capital gain is determined by multiplying the capital gain amount with the year’s inclusion rate; currently, the rate is 50%.
Day traders make a living buying and selling stocks, and because it’s their job, capital gains taxation may not apply.
Defining Day Trading
Day trading refers to the practice of turning over securities quickly, usually in the same day, to profit on small price fluctuations.
These highly liquid stocks are defined by the Investment Industry Regulatory Organization of Canada as securities that trade more than 100 times a day with a trading value of $1 million.
- A day trader is a person who makes his living buying, selling and managing these transactions.
- A person who works in the investment industry and makes frequent short-term investment turnovers, such as a stockbroker, for example, may be considered a day trader as well.
The Canada Revenue Agency looks at several factors to define investment professionals for purposes of taxation. If a taxpayer is using day trading as a way to earn or substantially supplement his income, he is not eligible to claim capital gains, and its advantageous tax rate, on those investment earnings.
Defining Investment Businesses
The CRA looks at several factors to consider if a taxpayer is in the business of buying and selling securities. A professional investor will have many buying and selling transactions, with ownership of securities being of short duration.
- Knowledge and experience with securities markets and transactions and time spent analyzing markets and investments also identify those engaged in investment as a business. Purchases are usually financed on margin or other debt, and the shares purchased generally won’t pay dividends.
- Each securities transaction generates a T5008 slip, which identifies the purchaser by name and social insurance number, so the CRA has an easy trail to match purchases with tax returns.
- Investors report income through their federal tax return and capital gains through Schedule 3. The size of the capital gains claimed may also factor into the determination that the taxpayer invests as a business.
The average Canadian investor generally does not turn over securities quickly, and with the growing popularity of registered retirement savings plans and tax-free savings accounts, the capital gains option is used less. Money in RRSPs and TFSAs grows tax-free, so when taxation occurs, it is as income at time of withdrawal from RRSPs.
TFSAs are purchased with after-tax dollars, without any taxation upon withdrawal. Investment profits inside a TFSA are not declared and not taxed either. If day trading is conducted inside a TFSA, then all of the profits are fully taxed as business income, not capital.
Such an investor will have another source of income, likely outside the investment industry, and the proportion of highly liquid stocks in his portfolio will probably be low.
Claiming Capital Gains
When day-trading profits do qualify as capital gains, the resulting amount is reported annually with your income tax return.
“When declaring capital gains from any disposition of capital properties, you report these earnings using Schedule 3, which also covers other income sources that may not apply to you,” says Brent Allen, regional director, certified financial planner and financial management adviser with Investors Group in London, Ontario.
Schedule 3 totals all income sources eligible for capital gains and losses, and then takes half this amount for entry on line 12700 of your federal tax return.
References & Resources
- Brent Allen, CFP FMA; Investors Group, London, Ontario
- Calculating & Reporting your Capital gains & losses