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The tax-free savings account (TFSA) was introduced back in 2009 and designed to be a very straightforward savings vehicle. You contribute after-tax dollars to the account and invest them in pretty much anything, with any growth inside the account being tax free. You can withdraw funds whenever you want, for any purpose. If that’s not enough, the full fair market value of whatever you withdraw can be recontributed beginning the following calendar year.
With all these benefits, and the simplicity inherent in the account design, what could possibly go wrong? Quite a lot judging by the number of cases we’ve seen over the past decade since the TFSA’s launch. Some cases involve penalties charged for accidental TFSA overcontributions, while others involved taxpayers who got caught by the TFSA advantage rules.
Let’s look at two recent cases, one involving a taxpayer who overcontributed, and one featuring a taxpayer who challenged the constitutionality of the TFSA’s 100-per-cent advantage tax.
The first case involved an 83-year-old, self-represented Saskatchewan taxpayer who took the Canada Revenue Agency (CRA) to court over his TFSA overcontributions. As a reminder, if you accidentally overcontribute to your TFSA beyond your maximum, you can get hit with an overcontribution penalty tax that is equal to one per cent per month for each month you’re over the limit.
You can ask the CRA to waive or cancel this penalty tax if it can be established that it arose “as a consequence of a reasonable error” and the overcontribution is withdrawn from the TFSA “without delay.” If the CRA refuses to cancel the tax, you can take the matter to federal court, where a judge will determine whether the CRA’s decision not to waive the tax was reasonable. That’s exactly what the taxpayer did in this most recent case.
The taxpayer admitted to unknowingly overcontributing to his TFSA during 2016 and 2017. On Jan. 1, 2016, the taxpayer had TFSA contribution room of approximately $27,500, but contributed $46,500 that year, exceeding his contribution room by $19,000. Consequently, the CRA in July 2017 issued a Notice of Assessment in respect of his TFSA overcontribution for the 2016 taxation year and charged him a penalty tax.
The 2017 TFSA dollar limit was $5,500, so on Jan. 1, 2017, he exceeded his contribution room by $13,500. The CRA in July 2018 issued the taxpayer a second Notice of Assessment in respect of his TFSA overcontribution for the 2017 taxation year, again charging a penalty tax.
For 2018, the TFSA dollar limit was also $5,500, so he exceeded his contribution room by $8,000 on Jan. 1, 2018. In a letter sent in September 2018, the TFSA Processing Unit at the CRA recommended the taxpayer withdraw the excess contributions from his TFSA as soon as possible to stop the monthly one-per-cent penalty tax from continuing, and the taxpayer on Oct. 1, 2018, withdrew $9,000 from his TFSA.
A week later, the taxpayer submitted a first request for taxpayer relief for his TFSA overcontribution, claiming he was not responsible for the error because he was not informed by his bank or the CRA that he was overcontributing. He also claimed he was unaware that withdrawals he made from his TFSA were only added to his contribution room the following calendar year.
In January 2019, the CRA denied his request for relief, so the taxpayer asked for a second-level review, which was again denied in June 2019. In denying the second request, the CRA officer noted the taxpayer didn’t remove the excess contributions from his TFSA for 2016 and 2017 until Oct. 1, 2018, which was not fast enough.
The taxpayer then turned to the Federal Court, asking it to review whether the CRA’s decision denying him relief was reasonable. In court, the taxpayer’s primary argument was that the CRA failed “to administer the income tax system fairly and reasonably.”
He explained he did not immediately withdraw his excess TFSA contributions because he was waiting for responses from the CRA to his questions. He also felt the CRA has “a duty of care to have a system that does not allow overcontribution.”
Notwithstanding these arguments, the judge found the CRA had reasonably responded to his questions. She concluded the CRA officer’s decision to deny penalty tax relief was reasonable. “Although (the taxpayer) was notified of his overcontributions, he did not act without delay to remove the excess contributions from his TFSA,” the judge said.
The second recent case involving the TFSA penalty tax was at the Tax Court and concerned the “advantage rules,” which are a series of anti-avoidance rules in the Income Tax Act designed to prevent abuse and manipulation of all registered plans, including TFSAs. If you find yourself offside these rules, you could face a 100-per-cent penalty tax on the fair market value of any “advantage” you receive that is related to a registered plan.
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In this case, the taxpayer was appealing reassessments by the CRA on his TFSA resulting from the advantage he received regarding the transfer of private company shares to his TFSA. The taxpayer asked the court to determine whether the penalty tax was a penalty or a tax, and whether it should be declared unconstitutional as a consequence of Parliament having improperly delegated the rate-setting element of that tax to the CRA, in contravention of the Constitution Act.
Perhaps not surprisingly, the court, after a lengthy legal analysis, held that the advantage tax is, indeed, a tax and, furthermore, is validly imposed. It also concluded it’s not unconstitutional, since the CRA doesn’t set the tax rate; it merely has the discretion to waive or cancel “all or part of the tax.” As the court wrote, “Whatever delegation of taxation power there may be is merely, ministerial discretion, itself sufficiently constrained to permitted administrative duties.”
The taxpayer has appealed this decision to the Federal Court of Appeal, which will likely hear the case sometime in 2023.
Jamie Golombek, CPA, CA, CFP, CLU, TEP, is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto. Jamie.Golombek@cibc.com
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