Thought this was an interesting article copied
When day traders should incorporate
Arthur Drache Printed November 8, 2000
National Post
Judging by the responses we've had to past articles, day trading remains alive and well in Canada notwithstanding the roller-coaster markets. Indeed, it is the very volatility of markets that attracts day traders who think they can reap profits by quick "in and out" forays.
The main focus of day traders from a tax perspective seems to be whether their profits are on income or capital accounts and whether they can guarantee capital treatment through the subsection 39(4) election (National Post, July 25). But a recent ruling letter from the Canada Customs and Revenue Agency confirms that there is a tax planning option available to day traders: incorporation of the operation while treating income as being from active business.
While the ruling letter was replete with the usual caveats ("depends on the facts"), it in effect ruled that where the traditional tests of an active business applied, a corporation carrying on day trading would be considered to be generating active business income. The tests as set include:
- Frequency of transaction: a history of extensive buying and selling of securities or a quick turnover.
- Knowledge of the securities market: The taxpayer has some knowledge of or experience in the securities markets.
- Security transactions form a part of the taxpayer's ordinary business.
- Time spent: A substantial part of the taxpayer's time is spent studying the securities market and investigating potential purchases.
- Financing: Security purchases are financed primarily on margin or some form of debt.
- In the case of shares, their nature -- normally speculative in nature or of a non-dividend type.
These tests are taken from Interpretation Bulletin 479R5 and of course not every one of them must be met to be considered carrying on an active business.
There are some attractive aspects to setting up a company and carrying on active business, providing of course that the activities generate a reasonable flow of income and providing you are prepared to leave part of that income in the company. What are the benefits?
- The company will be taxed at preferential rates on its first $200,000 of active income. The actual rate depends on the province, but ranges from a high of about 21.12% in Saskatchewan to a low of 17.62% in New Brunswick. (These are prospective rates for 2001, but may change and could be lower.) But note that the value of the low rate is lost to the extent that funds are paid out of the company, as they will be subject to tax in the hands of the recipient.
- It is easy to arrange to split income by having a spouse as a director, officer, employee or shareholder.
- Earning funds within a corporation allows flexibility as to how the funds are withdrawn (salary, bonus, dividends and perhaps interest) and the timing of the withdrawal ... allowing a deferral of recognition.
- The shares of the company may be eligible for the $500,000 capital gains deduction.
Against these key benefits are some offsetting issues. The company will have to keep a separate set of books, file its own tax returns and generally keep records. And, of course, there is the cost of incorporating and maintaining corporate status, accounting fees and perhaps legal fees.
Generally, we do not recommend incorporation where the business is likely to be short term, where there may be losses without income against which to offset them, and where the owner-operator "needs" all the annual income for his or her living expenses.
Incorporating a day-trading operation is certainly not for everyone but for those who meet the criteria, it may be an attractive option, especially if capital gains treatment is not available to you now and if you believe that the rates on active business income are likely to drop, not rise, over the next few years.
Arthur Drache, QC, is a partner in the Ottawa law firm of Drache, Burke-Robertson & Buchmayer.; adrache@drache.com
nationalpost.com
Best Regards
WB |
