$400m Tesla Loss? Strategies for What Could Have Been Done
There was a wild story last week. A man from B.C. who grew his investment account from $88K into $415m over the course of a few years using options (see here and here) is now suing RBC and Grant Thornton after losing it all. He alleges that they did not provide proper financial and tax advice.
I read the complaint (here) and summarized the advice that was provided and why at certain dates in the complaint. I then give my opinion of what should have or shouldn’t have been done.
Just to preface this, I am not a lawyer and obviously won’t comment on the merits of the case, but it just goes to highlight whether you are a tax advisor, financial planner or lawyer, the need to keep detailed notes after speaking with clients. The notes could help in the event you get sued for something to dispute the lawsuit.
There is also something to be said about the psychological affect of loss aversion. People feel financial losses twice as much as if they were to feel a financial gain. In these types of situations, you should realize your regret of loss is going to be much greater than your regret of greed. With that said let’s look at what happened.
Timeline
December 31, 2019 – FMV of Tesla position $88K
The articles and complaint don’t describe whether this investment was done personally at first in a non-registered account or TFSA but I will assume it was in a non-registered account.
July and August, 2020 – FMV of Tesla stock $50m
Advice provided
Roll securities portfolio into corporation using Section 85 of the Income Tax Act. Accumulate as many shares as possible and hold them for as long as possible in order for CRA to view the newly incorporated company as an investment holding company and taxed on a capital gain basis of 27% and not an active trading business with shorter term transactions (as was being done personally), being taxed at 53.5% in BC.
Explanation of advice provided
A Section 85 rollover allows individuals or corporations to transfer certain assets into a corporation on a tax deferred basis. Certain legal agreements and tax forms need to be signed and completed to do this. Assuming his cost base is $88K and the current FMV was $50m at this time, he is sitting on a $49.9 capital gain. By rolling this position into a corporation, it defers that capital gain until he sells it in the corporation, which then the corporation will pay the taxes. Rolling the investment into a corporation gives him more flexibility in terms of controlling his personal income from corporate distributions.
The loan provided allows him to access the large gain in the investment without having to sell it. The banks will usually lend less than 100% of the FMV amount to protect their position if the stock starts falling.
The reason why he was advised to accumulate as many shares as possible once the portfolio was rolled into the corporation is because CRA can go and look at what he did in his personal account and classify him as a day trader. This would mean that the large gain he deferred into his corporation would be considered business income personally, because his business is day trading. This would be taxed at the highest marginal rate in BC of 53% and there would be no capital gain effective tax rate of 27%. If that $49.9m gain is taxed as business income, that is a $26m tax bill vs a $13.5m tax bill.
There is no specific rule or law that CRA looks at when determining a day trader vs investor. But they look at different sets of factors like how long the stock was held for, market knowledge, transaction frequency, time spent trading and intention regarding their trades.
My advice
I would advise deferring most of the capital gain as well by using Section 85 and rolling the investment portfolio into the corporation. This allows you to control the type of income as well as timing of income from the corporation when he eventually sold. However, from a financial planning perspective, I would have advised to take a $1m or $2m gain to lock it in and have that money for good when doing the corporate rollover. Although it is always great to defer as much tax for as long as possible, trading options is a risky strategy and if you have a chance to lock in some gain it’d have been prudent to take some risk off.
I would have instructed him to get a corporate will as well in the event that something happened to him. This would allow his corporation to bypass probate. Assuming 1.4% probate fees in BC, he would avoid $700K probate fees ($50m x 1.4%) at this time.
Dec. 2020 to April 2021- FMV/Net Worth $186m
Advice provided
Provide RBC’s own charity with 8.5m charitable donation. Margin loans were also provided against the stock position.
Explanation of advice provided
Usually when you gift an asset (such as a stock) you are deemed to have sold it at fair market value which would then be taxed at your 50% (66.7% now since June 2024) capital gain inclusion rate. However, by donating publicly traded securities, your inclusion rate is bumped down to 0. Which means you owe no tax on the gift. Better yet, the charity you donate to then issues you a charitable donation tax receipt for 100% of the fair market value of the gift. So he would have received an 8.5m tax deduction that can be used in the current year or carried forward 5 years that could shield up to 75% of the company’s net income. When you donate personally and not through a corporation, the donation is treated as a tax credit and not tax deduction.
The margin loans provide interest expense that could be deducted against any income, provided that the amount borrowed was used for property or business income. When you borrow to invest in the stock market, for the interest to be deductible, the stocks you buy must either pay dividends or not have the company state they will never pay a dividend. This would result in the purpose test being met and interest deductibility to be allowed.
My advice
I would have advised to sell half of the position and let the other half play out. He is sitting on generational wealth that he can lock in. Even if there is a capital gain (186m – 88K) of $185.9m, of which $46m of taxes would be owing, selling 50% of the position gives you $140m in the bank. He could have then paid out personally from his capital dividend account $92m to himself tax-free. Or he could have then invested in other businesses to grow his wealth.
If he really wanted to have a margin loan, I would advise to keep it a small part of the total portfolio. Something like 10%-20%. This gives the benefit of having the interest deducted as well as if there is a decrease in the equity value, you are not potentially wiped out.
Nov. 2021 to Dec. 2021 - FMV/Net worth of $415m
Provide RBC charity with 17m charitable donation
Advice provided
The only real advice the lawsuit claims at this time was that a $17m donation of securities was given to the RBC charity
Explanation of advice provided
As explained above, the corporation will get a $17m charitable donation tax deduction to be used for up to 5 years on any income.
My advice
I would have recommended selling another 50% of the position and locking in some of the gain. By selling 50% on each huge swing up, it allows you to trim the position and manage risk.
The donation of securities is a good recommendation provided that there is taxable income to shield. It doesn’t seem like there were any sales or if there were any they were just rolled into another option position.
October 1, 2024 - FMV/Net Worth is 0
Lawsuit filed, FMV 0 as Tesla stock declined in 2022
Aftermath
Of course it is easy to say all of this looking back. Other advice could have been given if we had known more about his family situation such as if it would have made sense to use a trust, some type of life insurance vehicle for estate planning, transfer of some investments to tax advantaged accounts, flow-through share purchases and so forth. But given what was just in the complaint I went with what I had. This is a case that I will be keeping my eye on. I’d be curious if anyone else would have provided some other type of advice.
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