As readers are aware, one of the highlights of the February 26, 2008 Budget was the proposal to introduce a new Tax-Free Savings Account ("TFSA"). Details regarding TFSAs are set out below. Employers who currently offer their employees retirement and other savings vehicles (for example, Group RRSP, defined contribution pension plan, taxable savings account) will need to decide whether (beginning 2009) to complement these vehicles with a TFSA option as well. Relevant considerations include the following:
- Matching company contribution arrangements, similar to those which exist for Group RRSPs, could be made for TFSAs. By permitting the employee to obtain the benefit of a company-matching contribution where the employee contributes to either the Group RRSP or the TFSA, the employee can choose the vehicle best suited to his or her particular circumstances. The attractiveness of a TFSA will depend, in part, on an individual’s income tax bracket and how long the funds are likely to be left in the account. An individual in a lower marginal tax bracket may generally find it more beneficial to contribute to a TFSA before an RRSP, while the reverse would be true for individuals in a higher income tax bracket.
- It should be relatively simple to integrate a TFSA option with the existing savings/retirement arrangements offered by the employer to its employees. For example, the same service providers could be used and the same investment options could be offered.
- As in the case of a Group RRSP, it will be important, from the employer’s perspective, that the written arrangement make clear that the employee has sole responsibility for ensuring that contributions to his or her TFSA do not exceed the income tax limits.
- The employee’s choice as to whether contributions should be to the Group RRSP or to the TFSA will affect the employer’s source withholding obligations. The employer matching contribution is simply additional salary. While salary contributed directly to a RRSP is generally not subject to source withholdings, it can be expected that this would not be the case for salary transferred to a TFSA.
- As TFSAs are tax-assisted, they will likely be considered to be capital accumulation plans ("CAP") and may, therefore, be subject to CAP guidelines developed by the Joint Forum of Financial Market Regulators.
Details of TFSA Rules
Beginning in 2009, any Canadian resident individual who is 18 years of age or older may establish one or more TFSAs. Any income, losses or gains in respect of investments held within a TFSA, as well as amounts withdrawn, will not be
- included in computing income for tax purposes;
- taken into account in determining eligibility for income-tested benefits or credits delivered through the income tax system (i.e., the Canada Child Tax Benefit, the Goods and Services Tax Credit and the Age Credit); or
- taken into account in determining other benefits that are based on the individual’s income level (i.e., Old Age Security benefits, the Guaranteed Income Supplement and Employment Insurance benefits).
Since both the investment income in, and withdrawals from, a TFSA will not be taxable, interest on money borrowed to invest in a TFSA will not be tax deductible.
An individual may make total TFSA contributions up to $5,000 annually. This $5,000 limit will be indexed to inflation and the annual addition to the contribution room will then be rounded to the nearest $500. Unused contribution room may be carried forward for an unlimited number of years. Any amounts withdrawn from a TFSA in a particular year will be added to the individual’s contribution room for the following year. Excess contributions will be subject to a tax of 1% per month. While an individual who becomes a non-resident will be allowed to maintain his or her TFSA and continue to benefit from the exemption from tax on investment income and withdrawals, he or she will not be allowed to contribute while being a non-resident, and no contribution room will accrue for any year throughout which the individual is a non-resident.
Generally, a TFSA will be permitted to hold the same investments as RRSPs. As such, a TFSA may invest in mutual funds, publicly-traded securities, government and corporate bonds, guaranteed investment certificates and, in certain cases, shares of small business corporations. However, a TFSA may not hold investments in any entities with which the account holder does not deal at arm’s length, including an entity of which the account holder is a "specified shareholder" as defined in the Income Tax Act (Canada) or in which the account holder has an analogous interest (generally a 10% or greater interest, together with non-arm’s length persons).
If an individual transfers property to the individual’s spouse or common-law partner, the income tax rules generally treat any income earned on that property as income of the individual (and not of the individual’s spouse or common-law partner). Such "attribution rules" will not apply to income earned in a TFSA.
Financial institutions that are currently allowed to issue RRSPs will also be allowed to issue TFSAs. Such financial institutions would include Canadian trust companies, life insurance companies, banks and credit unions. TFSA issuers will be required to file annual information returns that include the following information: the value of an account’s assets at the beginning and end of the year and the amount of contributions, withdrawals and transfers made in the year.
TFSA contribution room will be determined by the Canada Revenue Agency (the "CRA") for each eligible individual who files an annual income tax return. If an individual has not filed returns for prior years, he or she will be allowed to establish his or her entitlement to contribution room by filing a return for those years or by other means acceptable to the CRA.
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.