How can small business investments be permitted in a TFSA?

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In the February 2017 MEI Viewpoint, Youri Chassin, Montreal Economic Institute (MEI) research director asked “Should Small Business Investments Be Permitted in a TFSA?” The answer is resoundingly yes. What he didn’t address is what needs to be done to make this happen.

Chassin wrote that the flexibility of TFSAs does not extend to permitted investments – limited to those for RRSPs: chiefly mutual funds, exchange-traded shares, bonds, and GICs. His point that big businesses are advantaged over start-ups, and arguments for permitting small business investments into a TFSA, are reasonable and balanced.

The problem is that investment in Canada perches on a wobbly four-legged stool: its legs are the Department of Finance (Finance), the Canada Revenue Agency (CRA), the provincial securities commissions, and financial institutions. Finance’s role is to implement good economic, fiscal, and tax policies; the CRA administers the Income Tax Act (ITA); commissions are responsible for investor protection and capital formation; financial institutions must cope operationally with TFSA rules. What to do?

Finance officials, while responsible for tax provisions encouraging growth, worry that taxpayers not take advantage of the tax system. What the government has not done regarding TFSAs is to enact recommendations to limit activity they believe inconsistent with the spirit of TFSA rules and a risk to tax revenue.

The solution: The easiest way to limit the loss of future tax revenue in those – let’s agree – proportionally few cases of small businesses that really take off is a cap on TFSA value.

The CRA must apply the ITA fairly, but there’s evidence the CRA is tilting just to collecting more tax. Starting May 2013, the CRA was asked to alert taxpayers to the potential negative tax consequences of ‘carrying on a business’ in a TFSA. A February 18, 2015 Investment Industry Association of Canada letter to the CRA appended a recommended alert to taxpayers of the tax risk they might be incurring in their TFSAs. Six CRA helpline staff, in calls recorded by investors, showed CRA staff agreed investors had no tax risk in what they were doing. Escalated to the ministerial level, taxpayer concerns were not addressed and Canadians were not alerted to potential risk. Instead, CRA staff were retrained – reprehensible given the CRA’s sixth Taxpayer Right: “You have the right to complete, accurate, clear, and timely information”.

The solution: The CRA would have to train tax auditors not to apply section (h) of Interpretation Bulletin IT-479R – Transactions in Securities (archived 2013, not yet replaced) – referring to “…shares, … normally speculative in nature or of a non-dividend type” – so taxpayers putting start-up shares in their TFSA aren’t deemed to be carrying on a business subject to tax.

The securities commissions are to protect investors and foster efficient capital markets. For years, commissions’ primary focus has been investor protection, through growing regulation and limiting investors’ ability – unless wealthier “accredited” individuals – to invest in “risky” start-up offerings.

The solution: Until recent regulatory permission for crowd-funding, this problem would be a major obstacle for non-related investors interested in start-ups. Commissions would need to allow crowd-funding in all provinces and raise investment limits.

Often last thought of when it comes to taxes, financial institutions have the first and most contact with taxpayers. While the Viewpoint said it isn’t necessary to precisely measure the fair market value of shares for tax compliance, financial institutions must report TFSA value annually to the CRA.

The solution: Financial institutions should be involved in discussions to ensure proposals can be implemented. This may be easiest solved, but financial institution and investor tax-related admin costs of trusteed accounts such as TFSAs, may add costs.

Barb Amsden is principal of PQbd. These are the views of the author and not necessarily those of

Transcontinental Media G.P.