Tax-savvy investors place securities that yield the highest-taxed income in TFSAs—for instance interest-bearing securities, like bonds.
But what if your client wants to shelter a private placement investment inside a TFSA? Here’s how that works.
Wealthy clients should consider holding private company stock in TFSAs, since these investments are generally speculative and can yield huge gains.
The stock has to be shares of a specified small business corporation: generally a Canadian company that uses virtually all of its assets carrying on an active business in Canada.
But this strategy is off the table for any clients who own 10% or more of the company, or do business with it on a non-arm’s-length basis.
CRA defines people as dealing with each other at arm’s length when they’re not related. So people connected by blood relationship, marriage, common-law partnership or adoption are related and are disqualified from this definition.
Tax authorities also consider people who act together and have the same interests, such as those with close business ties, as not dealing with each other at arm’s length.
Recent changes in legislation mean these investments have to continue to meet this requirement the entire time clients own them; otherwise they become prohibited investments.
That would happen if you or any person with whom you do not deal at arm’s length acquire more shares, resulting in ownership of 10% or more of the company’s stock while the shares are in the TFSA. The investment can also become prohibited if the assets of the corporation start to be invested to earn significant passive income (instead of being used to earn active business in the corporation).
If clients want to go down this route, they’ll likely be required to obtain a signed form that attests to the investment’s TFSA-qualified status. The TFSA administrator is responsible for reporting any non-qualified investments acquired within the TFSA to CRA.
So administrators require TFSA holders to obtain an independent opinion as to whether the small business shares qualify and to confirm the value of the shares when they are transferred to the TFSA.
For specific requirements, clients should contact their TFSA administrator to obtain the necessary forms. And these investments need to be monitored to ensure they continue to qualify to avoid potential penalties.
You can also suggest clients join angel or investment groups to gain knowledge about private companies looking to raise capital.
TFSA at a glance
- Canadian residents have to be at least 18 years old to take advantage of TFSAs
- The annual allowable contribution has just risen to $5,500
- The accounts are only tax-free while the holder is alive
- Though the account can be transferred directly to a spouse or common-law partner, joint TFSAs don’t exist
- Money invested in a TFSA can be withdrawn any time
Additional TFSA investment considerations
- Avoid holding U.S. and other foreign securities in a TFSA. Since TFSAs are not strictly considered retirement plans, foreign withholding tax will apply and isn’t recoverable.
- Various taxes and penalties apply to over-contributions. So monitor accounts for non-resident clients. If they contribute to TFSAs, they’ll be hit with a 1% penalty tax per month on that contribution until it’s fully withdrawn from the account.
Stella Gasparro is a partner at MNP in Toronto.