Do You Need to File Form T1135?
As a day trader, you don’t need to file a form T1135, also known as a Foreign Income Verification Statement. You only file this form if you have passive foreign investments that are more than $100,000 at any time. You only pay the 50% inclusion rate because these are considered capital gains. Capital gains that aren’t foreign are reported in Schedule 3 of your income tax return, line 12700 and are separate from your foreign exchange gains and losses.
How to Convert USD Trades to CAD
If you trade US securities, the simplest way to convert your funds into CAD is by using Norbert’s Gambit. It’s best used for amounts above $1,000 and only incurs a flat fee, unlike currency conversion.
Norbert’s Gambit works by purchasing an ETF that tracks both the US and the Canadian dollar. You purchase in one currency and sell in the other, so your currency is converted. So, if you’re looking to turn US currency into Canadian, you can do so by purchasing in the US ETF and selling in the CAD translation. It can take between 2 and 4 days for this process to complete, though.
The Section 39(4) Canadian Securities Election
As an investor, it’s important to know the rules of the Income Tax Act. Section 39(4) election allows Canadian taxpayers to elect to treat all of their gains and losses (proceeds of disposition) from capital securities as capital gains and losses rather than ordinary income.
Under section 38, the general inclusion rate for all capital gains, allowable capital losses, and allowance general business losses is 50%. Your T2125 is used when claiming these on your taxes. That said, you don’t have to use them right away either. There are carry-forward and carry-back rules you can use to your advantage, as well as rules for non-capital losses.
As a day trader, though, you’re unable to claim capital gains under the Income Tax Act Section 9. This rule establishes that a taxpayer’s income or loss from business or property for the year equals their net profit or loss from that source.
Provincial Tax Rates for Trading Income
When you earn trading income, you’ll be taxed at your standard income tax rate, both federally and provincially. This standard marginal tax rate is based on your annual income and then charged accordingly.
The annual trading amount that you claim is based on what’s recorded on your T5008 slips, and you’ll receive one for both qualified and non-qualified investments. Depending on how long you’ve been trading, you may be required to follow quarterly installment requirements for your taxes.
Filing with T2125 and NAICS Codes
When you’re doing your taxes and have self-employed business income, you must report the expenses using Form T2125 along with the correct North American Industry Classification System code (NAICS industry code). The code must match your primary activity. In fact, you must report a separate T2125 for each distinct business.
How Day Traders Are Taxed In Canada
When claiming your income on your taxes, it can be slightly complicated on how your day trading capital gains are taxed. Capital gains are the amount you earn when you sell securities for more than you paid. How you calculate the taxes on these depends on whether the capital gains are treated as business or investment income.
Business Income
Whether you can claim the capital gains tax has a lot to do with whether you are your own business or a corporation. If you have your own business (make your income solely or mainly from day-trading), you need to report it as business income. A corporation must also report any day trading income on its tax return. It is also important to report any losses that you incur while investing. While there are some restrictions, these business losses can be used as tax deductions.
If the CRA considers you to be a business, your losses and gains are calculated as business income, and you can claim 100% of them. You can also claim any expenses related to your day trading business, which helps reduce the amount of taxes that you will pay. These can be anything like:
- Computer purchases
- Monthly internet bill
- Educational resources and courses
Investment Income
If you are using investments for passive income rather than running a business, you can report capital gains and losses, which will be taxed based on your income. You can also carry your capital losses to the next year if you don’t report them. When you do report these amounts, be sure to report the adjusted cost base.
Trading fees for investors are not tax-deductible, and your capital losses can only be used to offset or reduce your capital gains. There is also the superficial loss rule to consider, which can cost investors a lot in taxes.
Is Day Trading Considered Capital Gains?
As we mentioned above, whether to pay income tax on day trading income depends on whether the income is considered business or investment income. Your day trading strategies, as well as your income from day trading, will determine which is the case for your federal tax return. So will the trading value you incur when you’re day trading stocks, as well as other online trading. These will all affect your tax burden.
As we mentioned, most investment income is treated as capital gains to take advantage of the lower tax rate. This is because for amounts below $250,000, the capital gains inclusion rate is one-half. So if you earn $100,000 in investment gains, then half this amount is taxed at your marginal tax rate. There are other income sources eligible for capital gains as well, though.
Capital Gains Tax Rates And How To Calculate Them
The capital gains tax rate is based on your income and the tax bracket you fall into. Only 50% of your capital gains are taxed as a regular investor.
To calculate how much you’re paying, you first need to determine what your capital gain is. First, you look at the amount you sold the investment for, and then you deduct any fees. You then subtract the original purchase price, which gives you your capital gain. Cut that amount in half, and that’s what you’ll pay tax on. As a day trader, you’ve likely held that income for less than a year, so it’s subject to normal income rates that are decided based on your annual income. To help further, though, you can also claim capital cost allowance.
Are Futures, Swing Trading, and Options Taxed Any Different?
The CRA doesn’t tax you based on the types of investments that you trade; they tax you based on capital gains. As mentioned above, the capital gains are taxed at 50% for a regular investor at your marginal tax rate.
The CRA’s Rules For Day Trading
When it comes to day trading in Canada, there are fewer rules under the Income Tax Act than under U.S. rules. However, if you are trading American investments, then the U.S. rules still apply. If you are just trading Canadian investments, there are a few rules you need to abide by. It is important to claim your taxes correctly to claim your capital gains and capital losses.
Superficial Loss Rule
If you are already a day trader, you have heard of the superficial loss rule, also known as the “30-day rule.” This is the most important rule for day trading in Canada. The reason this is called the “30-day rule” is that it applies to 30 days from the date of sale and 30 days after. If a capital loss happens during this period of time, they call this a superficial loss, and you are unable to claim it on your taxes. The reason this rule is in place is to prevent the seller from triggering a capital loss after selling and then immediately rebuying.
The superficial loss rule is the rule CRA uses to help determine what capital gains and losses you can claim. The rest depends on your investment income and the tax bracket you fall into. It is also important to remember that while day trading income is allowed to be invested into TFSAs and RRSPs (Registered Retirement Savings Plans) as long as you claim it, depending on how much you invest into those accounts, you do run the risk of the interest earned on those amounts being taxed as well.
Pattern Day Trader Rule
The Pattern Day Trading rule comes into effect if you trade over a certain amount of U.S. stocks. Essentially, if you affect 4 or more stock or equity options in 5 days, you’re considered to be a Pattern Day Trader. Because of this, you will need to maintain a minimum of $25,000 USD to continue trading. This only applies to US stocks, not Canadian stocks. You’re also allowed to keep the funds in CAD as long as they’re equal to $25,000 USD.
The Best Tax Structure For Day Traders
When claiming your taxes as a day trader, there isn’t a ton of difference between investment income and other businesses. Because day traders are considered to have a business, it is important to keep track of their capital gains and losses. It is also possible to claim any capital losses in the next tax year if it makes sense to roll them over.
There isn’t a larger variety of tax structures set up for day traders, so the best option is to gather all your information and discuss it with an accountant. They will help you decide the best way to file your taxes and advise you if you are eligible to claim your capital gains and capital losses.
Can Day Traders Incorporate?
In short, you can incorporate it as a day trader. However, it may not be as beneficial to you as it is for other businesses. It can be cheaper from a tax perspective, but the paperwork involved in day trading is much more complex. It would be best to speak with a tax professional to determine the best option for you.
The process of filing taxes as a sole proprietor and claiming business activity is different from claiming your day trading profits and dividend income as employment income. Not only do you claim any active trading, platform fees and other trading activities. Even if your income as swing traders and day traders is considered business income, it’s more complicated to file if you’re incorporated.
How to Report Day Trading Income in Canada
If you purchase and sell Canadian Securities in Canada, it can be difficult to determine how to report your long-term and short-term profits. Should they be reported as capital gains or should they be reported as income? Well, they really just depend on how much you’ve made and how often you invest in and sell different securities like penny stocks.
If you claim your income as business income, then the amounts you earn are fully taxable. If you invest only occasionally, this income would be treated as capital gains, and only a portion would be taxable. If you are unsure, then you should get tax advice from a tax professional and bring any tax receipts and tax slips with you.
What is a T5008 Slip?
A T5008 slip is also known as a Statement of Securities Transactions. It’s issued by brokerages and financial institutions that report the purchase, sale, and redemption of securities held in a non-registered account. The numbers provided on this slip are reported in Schedule 3 of your income tax return. Capital gains are reported on line 12700. You can also carry back capital losses or choose to claim them.
If you’re claiming capital losses in Canada, then you have a three-year carryback, or you can choose to use them in future years. You have up to 10 years to use them. However, when it comes to capital losses, your Allowable Business Investment Loss is 50% of your total capital losses incurred on the disposition of shares of debt of a small business corporation.
Can the CRA Tax TFSA Trading?
While a Tax-Free Savings Account is meant to earn interest tax-free, it’s only meant for standard passive investing. If you’re a frequent trader, then this is considered to be business income, and you’ll have to pay taxes on the income that you earn, even if your funds are in a TFSA. You don’t pay GST/HST on trading fees, though, because it’s an exempt financial service under the Excise Tax Act.
Often, there will be a CRA audit of TFSA accounts. If a business holds a TFSA, taxes will be charged on the funds held in it. If you make an in-kind contribution to your TFSA, there is a deemed disposition on contributions that were transferred. This means the asset is treated as if you sold it at Fair Market Value on the day of the transfer.
Whenever you’re dealing with any trading, it’s all regulated by the Canadian Investment Regulatory Organization (CIRO). This includes day trading transactions, binary options contracts and other transactions through commodity contracts dealers.
Are Futures a Qualified Investment in a TFSA?
In Canada, futures are not considered to be a qualified investment in a TFSA. The reasons for this include the risk of loss since you can lose more money than you put in, and you aren’t permitted to borrow money or leverage positions in a TFSA.
How to Elect Capital Gains Treatment on Your Day Trading Income
When you day trade in Canada, the CRA treats any earnings as business income. Capital gains are only used on passive investments; they don’t count for inventory-like trading. Anything you earn from day trading will be taxed using your marginal tax rate. Single transactions that are classified as business income but aren’t day trading income are classified as adventure in the nature of the trade. They aren’t for day traders, but still can’t be claimed as capital gains.
Owing Quarterly Installment Payments to the CRA
If you have a net amount of $3,000 owing in taxes for the current year or in either of the two preceding years, you’ll likely have to make quarterly installment payments. This is common for those who are self-employed, own rental properties, hold investments, or have multiple jobs and still owe income tax at the end of the year.
When it comes to how much you owe, there are three calculation options.
No calculation: With this option, it’s recommended that you follow the CRA’s suggested amount based on your last year’s tax amounts, but there’s no set amount.
Prior-year: This provides base payment amounts based on the amount owed in the prior tax year.
Current-year: This provides estimated amounts based on your current-year taxes.
Just like with your standard taxes owing, if the amounts aren’t paid on time, you are going to incur a penalty. An installment interest penalty is charged when the amount owing exceeds $1,000, and the required minimums are not paid.
How Options and Short Sales are Taxed
When it comes to investing in options and short sales, your earnings are either taxed as fully taxable income or capital gains. The tax treatment you receive depends on your trading frequency and intent.
Those who invest casually can claim capital gains and capital losses. For the most part, the inclusion rate remains 50% unless you exceed $250,000. If you are a more active investor, then your earnings will be treated as 100% taxable regular business income. This is known as market-to-market accounting for day traders. However, a facts-and-circumstances determination is often used to determine your exact tax situation.
What Triggers a CRA Audit?
When the CRA determines whom to audit, it uses computerized risk-scoring systems that flag anomalies, discrepancies, or even high-risk filing patterns. Some of these things that they look for include:
- Repeated business losses
- Disproportionate expenses
- A lifestyle that doesn’t correspond with your income
Sometimes you can even be randomly selected for an audit without any audit triggers.
What Happens if You’re Re-assessed by the CRA?
When you’re re-assessed by the Canada Revenue Agency, you’re going to receive a Notice of Re-assessment. This usually means you will receive a refund or owe money. However, just because you’re re-assessed doesn’t mean that you’ve done anything wrong. Many things can trigger a reassessment, including:
- Random checks
- Mismatched income from employers or banks
- Missing income
- Ineligible claims
- Flagged small business deductions
If you don’t agree with the re-assessment, you can start the objection process by filing a formal Notice of Objection within 90 days. If you agree, you can pay any amount you owe in full within 30 days or set up financing arrangements.
Records That Must Be Kept by Day Traders for Audits
As a day trader, even after you file your income tax return, you must keep your records for up to 6 years under record-keeping requirements. The documentation that you need to have includes:
- Trading journal documentation
- Real-time tracking from ledgers and journals
- Business expense receipts
- Bank and credit card statements
This six-year record-keeping standard isn’t just for day traders, though. It’s standard for short-selling tax treatment, options premium taxation, and even just your regular income tax return.
Deductible Expenses
Since being a day trader is considered to have your own business, there are many different costs that you can claim on your income tax return. Some of these costs include:
- Accounting fees deductions
- Home office deductions
- Market data fees
- Software subscription costs
- Interest on margin loans
- Brokerage commissions
- Internet
- Computer equipment
- ECN and routing fees
Keep in mind that this is standard for any type of investing considered a business. If you invest passively, then you are more likely to be able to claim capital gains. Often, this is decided using the frequency-of-transactions test.
Ultimately, though, whether you are investing in covered call writing, futures contracts marked to market, or even trading cryptocurrency, the best thing you can learn is record-keeping. What you can claim and what your tax amounts will be depend on this.
Foreign Stocks, W-8BEN, and Withholding Taxes
If you’re a Canadian resident who holds U.S. dividend-paying stocks, you must file a W-8BEN form to reduce the standard US withholding tax on dividends from 30% to 15% due to the Canada-US Tax Convention. However, this only applies if they’re held in a TFSA or a non-registered account. Those held in RRSPs and RRIFs are exempt from US withholding taxes.
When it comes to US currency capital gains and losses, they’re taxable in Canada at the inclusion rate after being converted to CAD. In fact, when claiming any foreign currency, you need to perform a foreign currency conversion in the ACB itofile. This has to be done even if you’re using the average cost method under the identical properties rule.
If you’re investing in another currency, you can also claim the foreign tax credit to recover any foreign withholding taxes that are paid on international investment income. The purpose of this is to prevent being taxed twice.
The exact rules for foreign exchange gains and losses from transactions in securities are outlined in Interpretation Bulletin IT-95R under subsection 9(1) and section 39 of the Income Tax Act.
Tax Court Cases and How They Defined Trader Status
In Canada, professional trader status isn’t determined by one single rule. Specific behavioural and circumstantial tests, including the period-of-ownership test and the frequency-of-transactions test, determine whether it applies.
According to the tax court of Canada rulings, the behavioural considerations include:
- Showing an intention to deal in securities as inventory for profit
- Showing a significant amount of time studying markets
- Having a professional background showing significant knowledge of securities markets
- Showing a pattern of playing the market
- Showing short turnover with a high volume of transactions
When it comes to court cases that defined trader status, two prominent ones are the Foote decision and the Prochuk case.
The Foote decision held that trading in a TFSA was still considered business income and taxed accordingly. This is now something that can be done when the CRA checks on your TFSA.
In the Prochuk case, it was determined that business-like activity conducted within an RRSP is not considered carrying on a business. This means that you’re unable to claim business losses on anything invested within an RRSP.
In Mittal vs. The Queen, the decision determined whether a taxpayer’s stock trading losses qualify as a fully deductible business loss or a restricted business loss. This has now helped make this more determined for current taxpayers.
Final Thoughts
If you’re a day trader or are considering day trading, there are many terms you’re going to want to learn, including:
- Wash trade
- Affiliate person rules
- Sposusal account transfers
- Advantage rule penalty
- Staking rewards income
- Commissions and slippage
- Prop firm payouts
If trading is going to be your main source of income, you may also want to look into self-employment CPP contributions and other aspects of running your own business. It can be complex, and getting some professional advice can help. You may also want to set some realistic goals, like 1% per month to start, when carrying on a business.
However, just because it’s complex doesn’t mean you have to know everything about it before you start. To make sure you’re meeting your annual tax requirements, though, a tax professional can help you structure things properly to make the most of your money.
