Canada: Budget 2015: Tax-Free Savings Accounts – A Welcome Contribution Limit Increase, But "Prohibited Investment" Rules Remain A Concern

Last Updated: April 29 2015
Article by Todd Miller

The Tax-Free Savings Account ("TFSA") is a flexible, registered, savings vehicle that allows Canadians to earn tax-free investment income. Originally introduced in 2009, the TFSA complements traditional registered savings plans, such as Registered Retirement Savings Plans ("RRSPs") and Registered Education Savings Plans ("RESPs"). In contrast to RRSPs, TFSA contributions are not tax deductible; however, withdrawals need not be included in the holder's income.

Budget 2015 proposes to increase the TFSA annual contribution limit from $5,500 to $10,000, with effect from January 1, 2015. The TFSA annual contribution limit will no longer be indexed to inflation.

Unfortunately, Budget 2015 contained no changes with respect to the so called "prohibited investment" rules ("Prohibited Investment Rules"), which serve to restrict the scope of investments for TFSA purposes, and which continue to present potential traps for the unwary, including, for example, investment fund managers seeking to hold units of the funds they manage.

Prohibited Investment Rule Overview

In very general terms, a "prohibited investment" in respect of a TFSA (as well as certain other registered plans such as RRSPs) is defined in subsection 207.01(1) of the Income Tax Act (Canada) (the "Tax Act") to include:

  1. a debt of the TFSA holder (other than certain insured mortgages);1
  2. a share or debt of, or interest in, a corporation, trust or partnership in which the TFSA holder has a "significant interest";
  3. a share or debt of, or an interest in, a person or partnership with which the TFSA holder does not deal at "arm's length" (the "Arm's Length Test");
  4. an interest in, or right to acquire, a share, interest or debt described in paragraphs (a) through (c) above; and
  5. certain "prescribed property".

A key factor in determining whether an investment by a TFSA in a particular entity is a "prohibited investment" is whether the holder of the TFSA is considered to have a "significant interest" in the particular entity.

Generally, an individual will have a "significant interest" in a trust or partnership if she, either alone or together with persons or partnerships with whom she does not deal at "arm's length", holds interests as a member of the partnership or as a beneficiary under the trust that have a fair market value of 10% or more of the fair market value of the interests of all members of the partnership or beneficiaries under the trust, respectively.

An individual will be considered to have a "significant interest" in a corporation if she is a "specified shareholder"2 of the corporation. Generally, a person is considered to be a specified shareholder of a corporation if she owns, directly or indirectly, at any time in the relevant year, 10% or more of the issued shares of any class of the capital stock of the corporation or of any other corporation that is "related" to the corporation.3

Penalty Regime

Under section 207.04, a TFSA holder will be liable for a penalty tax where his TFSA acquires a property that is a "prohibited investment" (or where property held by the TFSA becomes a "prohibited investment"). The penalty tax is equal to 50% of the fair market value of the prohibited investment at the time it is acquired (or at the time the subject property becomes a "prohibited investment") and is refundable if the "prohibited investment" is disposed of by the TFSA by the end of the year following the year in which the tax applied or such later time as the Minister of National Revenue (the "Minister") determines, unless it is reasonable to consider that the holder knew, or ought to have known, at the time the investment was acquired by the TFSA, that it was, or would become, a prohibited investment.4 Furthermore, the Minister is granted the discretion, under subsection 207.06(2), to waive this penalty tax where it is "just and equitable to do so" having regard to all the circumstances, including (i) whether the penalty tax arose as a consequence of reasonable error, or (ii) the extent to which the transaction in question that gave rise to the penalty tax also gave rise to another tax under Part XI.01 of the Tax Act.5

In addition to the penalty tax discussed above, any income (including capital gains) derived, directly or indirectly by a TFSA in respect of the "prohibited investment" will be considered an "advantage"6 in relation to the TFSA, and will subject the relevant holder to a penalty tax equal to 100% of the value of that "advantage".7 Once again, the Minister is authorized, under subsection 207.06(2), to waive this penalty tax where it is "just and equitable to do so".

Continuing Concerns with Prohibited Investment Rules

A number of concerns have been raised over the years with respect to the application of the Prohibited Investment Rules to TFSAs, including the ambit of the "prohibited investment" definition, along with uncertainties associated with the application of the Non Arm's Length Test.8

For instance, in determining whether a particular individual has a "significant interest" in any entity, it is necessary to look not only at the investment assets held by the particular individual, but also to investments held by any person who, for purposes of the Tax Act, does not deal, or is deemed not to deal, at "arm's length" with the individual. Accordingly, it is possible that an individual could unknowingly hold a "significant interest" in an entity as a result, for example, of the holdings of other family members, family trusts, or personal holding companies. Indeed, this could be the case in circumstances where the holdings in the TFSA are exceptionally modest or where the holder has little direct connection to the subject entity.

The ambit of the "prohibited investment" definition is further expanded by the Arm's Length Test. While the application of the Arm's Length Test may be relatively straightforward with respect to TFSA holders who are deemed, for purposes of the Tax Act, to be "related" to a particular entity (and therefore not to deal at arm's length with the particular entity),9 the application of the test becomes trickier when considering whether a TFSA holder, in fact, deals at arm's length with the particular entity for the purposes of paragraph 251(1)(c). This type of factual analysis may arise, for instance, in respect of TFSA holders who act as officers or directors of a corporation and who wish to hold shares of the corporation in their TFSA (or other registered savings plans). Another example in the investment fund context would be where an advisory agreement gives a fund manager significant decision making powers with respect to the day-to-day operations of the fund. Although it will, in many cases, be difficult for the Canada Revenue Agency to successfully assert that such situations in and of themselves give rise to a non arm's length relationship, such a determination is ultimately a question of fact and may be a matter of some uncertainty, even in cases where the shareholdings or partnership holdings (as the case may be) are minimal.


While the TFSA contribution limit increase announced in Budget 2015 is clearly a welcome development, taxpayers should continue to be mindful of the potential restrictions and challenges posed by the Prohibited Investment Rules, which are complex and may give rise to punitive taxes and penalties in unexpected circumstances.


1 Section 5000 and paragraph 4900(1)(j.1) of the Income Tax Regulations (the "Regulations") provide an exemption for certain insured debt obligations (or interests therein) secured by mortgages in respect of real property situated in Canada.

2 As defined in subsection 248(1).

3 For this purpose, a particular person is deemed to own (i) all of the shares of any corporation owned by persons with whom he/she does not deal at arm's length, and (ii) a portion of any shares owned by a trust or partnership in which the particular person has an interest, based on the relative fair market value of the particular person's proportionate interest in the trust or partnership (except where the trust is a discretionary trust, in which case the particular person is deemed to own all of the shares of the corporation owned by the trust). In addition, in some circumstances, a person can be deemed to be a "specified shareholder" of a corporation where he/she performs certain services on behalf of the corporation – see paragraph (d) of the definition of a "specified shareholder" in subsection 248(1).

4 Subsections 207.04(2) and (4).

5 A Canada Revenue Agency ("CRA") technical interpretation letter (CRA Document No. 2011 0430141E5, dated February 3, 2012) provides examples of circumstances in which the CRA will consider waiving the penalty tax and contains a statement of the CRA's intention to "administer the waiver proposition in a fair and flexible manner in order to promote voluntary compliance".

6 As defined in subsection 207.01(1).

7 Section 207.05.

8 In contrast to the relatively "bright line" requirements of the "significant interest" definition.

9 For example, by virtue of subsection 251(2).

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

© McMillan LLP 2015

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.