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Ottawa, October 16, 2009
Archived - Government of Canada Proposes Technical Changes Concerning Tax-Free Savings Accounts
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The Honourable Jim Flaherty, Minister of Finance, today proposed amendments to the Income Tax Act to strengthen the rules applicable to Tax-Free Savings Accounts (TFSAs).
The TFSA was introduced in Budget 2008. Since January 1, 2009, Canadian residents who are 18 years of age or older are eligible to contribute up to $5,000 annually to a TFSA. The TFSA is a flexible, registered, general purpose account that allows Canadians to maximize their savings by earning tax-free investment income. Contributions to a TFSA are not tax-deductible, but investment income earned in a TFSA, as well as TFSA withdrawals, are tax-free.
The proposed amendments respond to recent concerns that have arisen regarding the use of TFSAs in tax-planning schemes.
The proposed amendments would:
- Make any income attributable to deliberate overcontributions and prohibited investments subject to existing anti-avoidance rules in the Income Tax Act.
- Make any income attributable to non-qualified investments taxable at regular income tax rates.
- Ensure that withdrawals of deliberate overcontributions, prohibited investments, non-qualified investments or amounts attributable to swap transactions, or of related investment income, from a TFSA do not create additional TFSA contribution room.
- Effectively prohibit asset transfer transactions between TFSAs and other accounts.
"These proposals will ensure that the TFSA remains viable and strong for Canadians today and in the future and the use of inappropriate transactions to draw excessive benefits are avoided," said Minister Flaherty.
As with the existing TFSA legislation, the Minister of National Revenue will maintain, in appropriate circumstances, the discretion to waive or cancel all or part of any tax that would otherwise be payable because of the application of today's proposals.
Given the clear intent of the TFSA concept, Minister Flaherty has asked the Honourable Jean-Pierre Blackburn, Minister of National Revenue, to ensure that the Canada Revenue Agency closely examines any unusual TFSA transactions that have occurred to date, and to apply the existing TFSA rules to challenge aggressive tax planning where appropriate.
The proposed amendments are to apply to transactions that occur after today. The Government will introduce legislation at an early opportunity.
For further information, media may contact:
Office of the Minister of Finance
Department of Finance
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The Tax-Free Savings Account (TFSA) was introduced in Budget 2008. Since January 1, 2009, Canadian residents who are 18 years of age or older are eligible to contribute up to $5,000 annually to a TFSA. The TFSA is a flexible, registered, general purpose account that allows Canadians to maximize their savings by earning tax-free investment income. Contributions to a TFSA are not tax-deductible, but investment income earned in a TFSA, as well as TFSA withdrawals, are tax-free. Any amounts withdrawn from an individual's TFSA in a year will be added to the individual's contribution room for the following year.
The proposals announced today contemplate a number of amendments to the tax framework applicable to TFSAs. These amendments seek to address concerns regarding the use of TFSAs in tax-planning schemes.
Asset Transfer Transactions
"Asset transfer transactions" (sometimes known as "swap transactions"), in this context, refer to transfers of property (other than cash) for cash or other property between accounts (for example, a Registered Retirement Savings Plan (RRSP) and another registered account) that are generally not treated as a withdrawal and re-contribution, but instead as a straightforward purchase and sale. Subject to the application of existing anti-avoidance rules in the Income Tax Act, these transfers, when performed on a frequent basis with a view to exploiting small changes in asset value, 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 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.
TFSA amounts that may reasonably be attributed to asset transfer transactions will be subject to the advantage rules in Part XI.01 of the Income Tax Act. The advantage rules are anti-avoidance rules that are applicable to transactions or events that would not have occurred in an open market in which parties deal with each other at arm's length and act prudently, knowledgeably and willingly. Where these rules apply, TFSA amounts reasonably attributable to asset transfer transactions will be taxable at 100%.
In circumstances where an asset transfer transaction were to occur inadvertently, after today, between a taxpayer's TFSA (or the TFSA of an individual with whom the taxpayer does not deal at arm's length) and another account, and the taxpayer promptly rectifies the situation by restoring each account to its position before the asset transfer transaction occurred, the Minister of National Revenue will have 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 such a case, the proposed amendment would provide for any investment income attributable to the asset transfer transaction to be taxed as regular income.
The TFSA rules allow a holder to contribute, for 2009, a maximum of $5,000. Contributions and associated earnings may accrue tax-free in the TFSA and may be withdrawn at any time without any adverse tax consequences. Contributions in excess of the contribution limit are subject to a tax of 1% per month on the highest amount of excess contributions for the month. This tax is generally sufficient to neutralize the tax benefit of overcontributions. The Government of Canada 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 overcontributions over a short period of time sufficient to outweigh the cost of the 1% tax. On its introduction, it was not anticipated that the TFSA would be subject to this type of deliberate overcontribution.
Under the proposed amendments, any income reasonably attributable to deliberate overcontributions will be made subject to the existing advantage rules (as described above) 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.
Prohibited Investments and Non-Qualified Investments
A similar concern exists in relation to investment income related to prohibited investments and non-qualified investments held in TFSAs generally. The qualified investment regime sets out the basic investment framework for TFSAs (which is similar to the rules for RRSPs) and includes, for example, debt obligations issued by public corporations as well as publicly listed securities. The prohibited investment rules in respect of TFSAs are intended to guard against, for example, self-dealing opportunities for the holder. 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, where 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, or such later time as the Minister of National Revenue considers reasonable), except in circumstances where the holder knew or ought to have known that the investment was non-qualified or prohibited. All or part of the tax may also be waived or cancelled at the discretion of the Minister of National Revenue where that Minister considers it just and equitable to do so having regard to the circumstances. Prohibited investments also trigger an additional income tax for the TFSA holder (equivalent to 150% of Part I tax in order to provide a proxy for the combined federal-provincial income tax rate) applicable to investment income earned on the prohibited investments. With respect to non-qualified investments, the trust governed by the TFSA is liable for income tax at regular federal/provincial rates on any investment income earned on non-qualified investments held inside the TFSA. The Income Tax Act does not provide for a similar Ministerial discretion to waive or cancel these additional taxes.
While the current TFSA regime applicable to prohibited investments and non-qualified investments provides for serious tax consequences for holding such investments, the investment income associated with the investments may remain tax-sheltered in the TFSA, resulting in an unintended permanent increase in TFSA savings and contribution room.
Under the proposed amendments, the existing prohibited investment tax framework will be modified so that any income reasonably attributable to prohibited investments will be considered an "advantage" and taxed accordingly, i.e. at 100%. The existing taxes on prohibited investment income will be repealed.
Further, any income reasonably attributable to non-qualified investments will also be taxable at regular federal/provincial income tax rates. That is, income earned on income that was earned on non-qualified investments will also be taxable. Under the existing rules, only the investment income on non-qualified investments is taxable as regular income and there is no obligation to remove these amounts. The proposed amendments ensure that the TFSA does not allow for the tax-sheltering of this ancillary income derived from non-qualified investments.
The proposed amendments will also include rules to ensure that the withdrawal of amounts in respect of deliberate overcontributions, prohibited investments, non-qualified investments, asset transfer transactions and income related to those amounts do not constitute distributions for TFSA purposes and thus do not create additional TFSA contribution room.
It is proposed that these measures apply to transactions undertaken after today's date. Withdrawals of amounts related to transactions occurring on or before today's date will be governed by the existing rules.