The rules relating to Tax-free savings accounts are relatively complex and a failure to abide by these tax rules can result in significant income taxes owing. CRA has also implemented special tax audit projects that specifically target TFSAs, especially those that have accumulated large balances, which further increases the likelihood that technical non-compliance with the TFSA provisions in the Income Tax Act will be detected and correspondingly penalized and/or taxed by CRA. Section 207.02 the Income Tax Act imposes a tax on over-contributions to a TFSA, and section 207.03 taxes contributions made by non-residents. These taxes are punitive in nature and if the contribution(s) which lead to their having been assessed go uncorrected for a lengthy period, the tax amounts owing can be significant. Subsection 207.06(1) of the Canadian Income Tax Act gives the Canada Revenue Agency the discretion to cancel or waive taxes payable under sections 207.02 and 207.03, but only under very specific circumstances. Speak with one of our Canadian tax lawyers to determine if you are eligible for relief on taxes assessed against you due to over-contributions or non-resident contributions made to a Tax-free savings account.
Tax on Over-contributions and Non-resident Contributions to TFSAs
As the name implies, income earned in a tax-free savings account is sheltered from Canadian income tax. For that reason there are strict limits on how much money can be validly contributed to a TFSA. The annual contribution limit was $5,000 for 2009 through 2012, $5,500 for 2013 and 2014 and $10,000 for 2015. The contribution limit has been reduced to $5,500 for 2016 and is to be indexed to inflation and rounded to the nearest $500 moving forward. Therefore, an individual who has made the maximum contribution every year since 2009 will have deposited $46,500 into their TFSA as of 2016. Section 207.02 assesses a tax on over-contributions made to a TFSA equal to 1% of the maximum amount of the over-contribution during the month, for every month the over-contributed amount remains in the TFSA. For instance, If an individual had $5,000 of contribution room in their TFSA and then deposited $20,000 in January of that year and did not rectify the issue by the end of that year, they would be assessed under section 207.01 of the Tax Act for $1,800 (1% of $15,000x12), in addition to any applicable penalties and interest.
Only resident Canadians are entitled to the benefits of tax-free savings accounts and all contributions made to TFSAs by non-residents are subject to tax under section 207.03 of the Income Tax Act. As with over-contributions, non-resident contributions to a TFSA are subject to tax equal to 1% of the maximum amount of the non-resident contribution during the month, for every month the non-resident contribution amount remains in the TFSA. In fact, it is CRA practice to assess non-resident contributions under both 207.02, as an over-contribution, as well as a non-resident contribution, resulting in a double-penalty being charged. Our Toronto tax lawyers are experts on the Income Tax Act and can make sure your tax planning strategies stay onside the TFSA contribution rules.
TFSA Income Tax Relief
For anyone who has received a tax assessment for taxes payable as a result of an over-contribution or a non-resident contribution to a TFSA, income tax relief is available under subsection 207.06(1) of the Income Tax Act. Subsection 207.06(1) allows CRA to cancel or waive taxes assessed against a taxpayer under either section 207.02 or 207.03 if the taxpayer satisfies CRA that he or she ran afoul of the TFSA contribution rules as a result of a reasonable error, and if the taxpayer rectifies the error forthwith by withdrawing the over-contribution or non-resident contribution, in addition to any income earned.
"Reasonable error" is not defined in the Income Tax Act and whether or not income tax relief will be given will likely depend on the unique circumstances of each case. Complete disregard for the TFSA contribution rules, for instance if a taxpayer were to recklessly contribute $250,000 to a TFSA without getting tax advice, will almost certainly not warrant tax relief. However, as mentioned above, the rules regarding TFSAs are complex and an innocent mistake that puts a taxpayer offside the tax rules should warrant tax relief under subsection 207.06(1) of the Tax Act if the facts are presented properly. For instance, contribution room that is "freed up" by a withdrawal in a given year is not credited to a taxpayer's "contribution room" until the following year. For example, if a taxpayer had $25,000 of contribution room on January 1 and decided to contribute the full $25,000 to his or her TFSA, then subsequently withdrew the $25,000 to finance a family emergency, before re-contributing the $25,000 in February of the same year, the final $25,000 contribution would be an over-contribution and subject to a 1% tax for every month it remains in the TFSA, until January 1 of the next year when the previous withdrawal will be credited to the taxpayer's contribution room. In a case such as this, our Toronto tax lawyers can make submissions to CRA on your behalf for tax relief and explain that the over-contribution error was the result of a misunderstanding of the TFSA contribution rules.
In the event CRA does not agree with a taxpayer's request for tax relief, they are able to have a Canadian tax lawyer apply to the Federal Court of Canada to have the decision of CRA to deny relief subjected to judicial review by a Federal Court judge. The power of CRA to give relief for taxes imposed by sections 207.02 and 207.03 of the Income Tax Act is discretionary, and taxpayers applying to Federal Court to challenge CRA's decision to deny relief therefore face a high bar to success because the Court will typically afford discretionary decisions significant deference. Our Canadian tax lawyers routinely apply for judicial review to challenge wrong tax decisions of CRA and can evaluate a taxpayer's circumstances to formulate a plan that maximizes the chances of receiving tax relief for TFSA taxes imposed by Revenue Canada.
Tax-free savings accounts are an excellent tool to save on income tax, but they are heavily regulated and consistently subject to tax audits by CRA. Over-contributions and non-resident contributions are subject to significant taxes thereon which function as penalties. Relief for taxes assessed on over-contributions and non-resident contributions to TFSAs is available, but whether or not tax relief will be granted is in the sole discretion of CRA. Our Toronto tax lawyers make detailed submissions to CRA on a daily basis and can give you the best chance of having the Canada Revenue Agency exercise discretion to offer relief for taxes assessed due to misunderstanding of the TFSA contribution rules.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.