Feds look to shut down certain TFSA practices

By Mark Noble | October 19, 2009 | Last updated on October 19, 2009
3 min read

Advisors who think they’ve found a great tax-loophole in the tax-free savings account (TFSA) rules, may want to revisit their strategy. On Friday, Canada’s Minister of Finance, Jim Flaherty, proposed amendments to the Income Tax Act to bulk-up certain restrictions on the use of TFSAs.

Essentially, the government would clarify certain features of the TFSA that have spawned an increase in some questionable tax planning. The proposed amendments respond to recent concerns that have arisen regarding the use of TFSAs in tax-planning schemes, that use strategies such as deliberate over-contribution and asset transfer transactions between TFSA’s and other accounts.

Deliberate over-contributions

Contributions in excess of the annual $5000 contribution limit are subject to a tax of 1% per month on the highest amount of excess contributions for the month. The government says it has become aware that in certain situations, and subject to the existing anti-avoidance rules in the Income Tax Act, some TFSA holders are attempting to generate a rate of return on deliberate over-contributions over a short period of time sufficient to outweigh the cost of the 1% tax.

Under the proposed amendments, any income “reasonably attributable” to deliberate over-contributions will be made subject to the existing advantage rules and taxed accordingly. Pursuant to the advantage rules, the tax payable on the income will be 100%.

“The Minister of National Revenue will maintain the discretion to waive or cancel all or part of the tax payable and the authority to adjust the taxpayer’s TFSA contribution room accordingly in appropriate circumstances,” the backgrounder to the legislation says.

Asset transfer transactions

The government wants more scrutiny on asset transfer transactions – sometimes known as “swap transactions”. Asset transfer transaction usually are transfers of property (other than cash) for cash or other property between accounts for example, a RRSP and another registered account. These transactions are generally not treated as a withdrawal and re-contribution, but instead as a straightforward purchase and sale, the backgrounder says.

When performed on a frequent basis with a view to exploiting small changes in asset value, the government says these transfers could potentially be used to shift value from, for example, an RRSP to a TFSA without paying tax, in the absence of any real intention to dispose of the asset.

The government’s proposed amendments would effectively prohibit asset transfer transactions between registered or non-registered accounts and TFSAs. “The prohibition would apply to transfers effected between accounts of the same taxpayer or that of the taxpayer and an individual with whom the taxpayer does not deal at arm’s length,” the backgrounder says. “Where these rules apply, TFSA amounts reasonably attributable to asset transfer transactions will be taxable at 100%.

Prohibited investments and non-qualified investments

Like RRSPs, only certain investment are TFSA eligible, and include for example, debt obligations issued by public corporations as well as publicly listed securities. Prohibited investments include, for example, shares of the capital stock of a corporation in which the holder has a significant (10% or greater) interest and investments in entities with which the holder does not deal at arm’s length. Non-qualified investments include, for example, land and general partnership units.

Under the current rules, when a TFSA holds a non-qualified investment or a prohibited investment, the holder of the TFSA is subject to a tax equivalent to 50% of the fair market value of the property. This tax is refundable to the holder if the investment is promptly disposed of from the account by the end of the year following the year in which the tax arose.

The government points out that while the current TFSA regime provides for serious tax consequences for holding prohibited or non-qualified investments, the investment income associated with the investments can remain tax-sheltered in the TFSA, resulting in an unintended permanent increase in TFSA savings and contribution room.

Under the proposed amendments, any income reasonably attributable to prohibited investments will be considered an “advantage” and taxed accordingly at 100%.


Advisors should also be aware that withdrawal of amounts in from either deliberate over-contributions, prohibited investments, non-qualified investments, asset transfer transactions do not constitute distributions for TFSA purposes and thus do not create additional TFSA contribution room.

For full information on the government’s proposed changes can be read at http://www.fin.gc.ca/n08/09-099-eng.asp


Mark Noble