Tax-free savings accounts (TFSAs): Making the most of them

Transcription

1 Tax-free savings accounts (TFSAs): Making the most of them Helps you maximize the benefits and navigate the complexities of TFSAs. February 28, 2013 Commencing 2013, the annual tax-free savings account (TFSA) contribution limit has increased to $5,500 from $5,000, making this savings vehicle even more attractive. You can use TFSAs to save for any purpose, including retirement, buying a home, starting a small business and taking a vacation. The merits of the TFSA make it a high-priority investment option, in addition to contributing to your registered retirement savings plans (RRSPs) and paying down a mortgage on your principal residence. To make the most of your TFSA it is important to compare your savings options, and avoid the myriad pitfalls and anti-avoidance rules that can apply. This Tax memo 1 discusses the TFSA rules and how a TFSA can benefit you. It covers the following topics: The basics... 1 Why open a TFSA?... 2 Contribution room... 2 Qualifying investments... 3 Death of a TFSA holder... 3 Marital breakdown... 5 Non-residents... 5 U.S. citizens resident in Canada... 5 Comparing saving options... 6 Appendix: Anti-avoidance rules... 8 We can help The basics Canadian residents aged 18 years 2 and older who have a social insurance number can contribute to a TFSA. The annual TFSA contribution limit was $5,000 from 2009 (when TFSAs were introduced) to This limit is indexed (rounded to the nearest $500) and increased to $5,500 in TFSAs are available at banks, insurance companies, credit unions and trust companies. They are generally structured as deposits, annuity contracts or arrangements in trust. The 1. This Tax memo replaces our Tax memo Tax-Free Savings Account A Good Way to Save dated December 18, Some provinces and territories do not allow individuals to enter into a contract (including opening a TFSA) until they are 19. Individuals in these jurisdictions, who would otherwise be eligible to open a TFSA, will accumulate TFSA contribution room for the year they turn 18, which will carry over to the following year. 3. The federal government has proposed to increase the limit to $10,000 when its budget is balanced (scheduled for 2016)

2 2 investments that a TFSA can make are similar to those that can be made by an RRSP. Contributions to a TFSA are not tax-deductible and income (including capital gains) earned in a TFSA is exempt from income tax. Withdrawals (whether from capital or income) are tax-free and will increase your contribution room in future years. Furthermore, if you contribute less than the annual contribution limit ($5,500 for 2013; $5,000 from 2009 to 2012), the unused contribution room can be carried forward indefinitely. Because income earned in a TFSA is exempt from tax, interest on money you borrow to contribute to a TFSA will not be deductible for tax purposes. Why open a TFSA? TFSAs are attractive for several reasons: Tax-free earnings Income earned in a TFSA is not taxable, allowing you to grow funds faster than if invested outside of a TFSA. Contribution room is not lost on withdrawal Amounts withdrawn from your TFSA will be added to your unused contribution room for future years. Income splitting If you give funds to your spouse and/or other adult family members to contribute to a TFSA, the income earned in their TFSAs will not be taxable to you. Post-age 71 contributions You can contribute to a TFSA after you turn 71, even though this is when you must wind up your RRSP. Income-tested benefits Neither earnings in a TFSA nor withdrawals will affect income-tested federal government benefits, such as old age security, the guaranteed income supplement, the working income tax benefit, the GST/HST tax credit, the Canada child tax benefit, the age amount and employment insurance benefits. Loan collateral You can use a TFSA as collateral for a loan or other indebtedness, if certain criteria are met. Contribution room Contributions to your TFSA cannot exceed your contribution room for the year, which is calculated as follows: Table 1 TFSA contribution room A Annual contribution A 1 limit for the year 1 + B Withdrawals B made in the previous year 2 + C Unused contribution C room from the previous year = D Contribution D room for the year 1. The annual contribution limit is $5,500 for 2013; $5,000 for 2009 to The limit is indexed, rounded to the nearest $ For distributions that do not increase your contribution room, see Withdrawals on page 3. Example TFSA contribution room Transactions in taxpayer s TFSA: Start of year Nil $900 $6,000 $1,500 $1,000 Contributions $5,000 $4,600 $5,500 Nil $30,000 Income/(loss) ($3,500) $500 $20,000 ($200) $5,000 N/A Withdrawals ($600) Nil ($30,000) ($300) Nil End of year $900 $6,000 $1,500 $1,000 $36,000 Result: TFSA contribution room: A $5,000 A 1 $5,000 $5,000 $5,000 $5,500 $5, B N/A B $600 Nil $30,000 $300 Nil + C N/A C Nil 2 $1,000 2 $500 2 $35,500 $11,300 = D $5,000 D $5,600 $6,000 $35,500 $41,300 $16, Assumes annual contribution limit remains $5,500 in The unused contribution room from the previous year is: Contribution room (D) $5,000 $5,600 $6,000 $35,500 $41,300 Previous Less: TFSA contributions ($5,000) ($4,600) ($5,500) Nil ($30,000) year s (see above) Unused contribution room (C) Nil $1,000 $500 $35,500 $11,300 You can request your TFSA contribution room from the Canada Revenue Agency. However, you should also maintain your own records about your TFSA transactions. You can set up more than one TFSA; however, your contributions to all of your TFSAs cannot exceed your TFSA contribution room. If you overcontribute to your TFSAs, you will be liable for a monthly 1% penalty tax on the excess contributions (see Table 5 in the Appendix). This tax will apply until the excess contributions are withdrawn or new contribution room earned in subsequent years eliminates the excess contribution.

3 3 Withdrawals As shown in Table 1 on page 2, withdrawals from a TFSA increase the contribution room for the following year. You can replace the amount withdrawn from a TFSA in the year of the withdrawal only to the extent you have available TFSA contribution room for that year (which is increased by the previous year s withdrawals). Any excess re-contribution will be subject to the monthly 1% penalty tax on excess contributions (see Table 5 in the Appendix). However, the TFSA contribution room is not increased for certain distributions, including a direct transfer between: TFSAs of the same holder; or a holder s TFSA and the TFSA of the holder s current or former spouse or common-law partner upon marital breakdown (see Marital breakdown on page 5). Table 5 (footnote 2, third paragraph) in the Appendix lists other distributions that do not increase the contribution room. Services fees The payment of investment counsel, transfer or other fees by a TFSA will not be considered a withdrawal from the TFSA, and therefore will not increase your contribution room. Furthermore, services fees you pay relating to your TFSA are not deductible for tax purposes and will not constitute a contribution to the TFSA. Qualifying investments A TFSA can make essentially the same types of investments as an RRSP. Qualifying investments include: money and deposits; guaranteed investment certificates (GICs); federal, provincial and municipal bonds and debts (those of a Crown corporation also qualify); public company bonds and debts; shares listed on prescribed stock exchanges in Canada or in a foreign country; annuities; units or shares of mutual funds; segregated fund policies; certain mortgages; and certain shares of small business corporations. Although shares listed on prescribed stock exchanges or in a foreign country are qualifying investments for a TFSA, dividends paid on these shares may be subject to foreign withholding tax; treaty relief for the withholding tax is generally not available. Investments that are not qualifying investments are non-qualified investments. In addition, in certain cases, the qualifying investments could be prohibited investments. As discussed in detail in the Appendix, non-qualified investments and prohibited investments are subject to penalties, while taxes apply to the income arising from these investments. In-kind contributions You can make in-kind contributions of qualifying investments to your TFSA. The amount of the contribution will be equal to the fair market value (FMV) of the property at the time of the contribution, and you will be considered to have disposed of the property for this amount. Any resulting gain will generally be taxable, but a capital loss will be disallowed for tax purposes. Death of TFSA holder 4 Whether your TFSA will maintain its tax-exempt status after your death depends on your circumstances, as discussed below. Successor holder and beneficiary designations Most provinces and territories permit an individual to designate outside a will a beneficiary to his or her TFSA in the event of death. That separate designation generally involves filing the appropriate forms with the financial institution where the TFSA 4. The text under Death of a TFSA holder originally appeared in the PricewaterhouseCoopers-authored article, TFSA Always Tax-Free? published in Canadian Tax Highlights, in February 2011, Volume 19, Number 2.

4 4 was opened: the holder can change the designation at any time. Although a TFSA could be created as early as 2009, some provinces and territories were slow to introduce measures to permit direct successor holder and beneficiary designations to be made for a TFSA that was not an insurance product. For example, the relevant provisions in Ontario did not come into effect until May 28, 2009; therefore, an Ontario-resident individual who had already opened a TFSA before this date should ensure that any designation is not dated earlier than May 28, 2009, to avoid unanticipated tax consequences on death. In Quebec, a beneficiary designation can be made only through a will. Because only a spouse or common-law partner can be designated as a TFSA s successor holder, tax issues may arise because of differences between that designation and a beneficiary designation. Surviving spouse designated as successor holder A surviving spouse or common-law partner (referred to as surviving spouse or survivor ) may be designated as the TFSA s successor holder on the former TFSA holder s death. If the surviving spouse acquires all the same rights as the deceased TFSA holder plus the unconditional right to revoke any previous beneficiary designations made by the deceased, the survivor becomes the TFSA holder and suffers no related income tax consequences. Any income earned or capital appreciation inside the TFSA continues to be tax-free. Alternatively, the TFSA s assets can be transferred to the survivor s TFSA, regardless of whether the survivor has contribution room, if the transfer occurs before the end of the first calendar year after the year of death. Surviving spouse not designated as successor holder A TFSA holder who has not designated a successor holder can designate his or her spouse as a beneficiary of the TFSA under his or her will. The surviving spouse can then make an exempt contribution to his or her TFSA if four conditions are met: the contribution is made to the survivor s TFSA by the end of the first calendar year after the year of death (the rollover period); a payment (a survivor payment) is made directly or indirectly out of the former TFSA to the survivor during the rollover period and as a consequence of the individual s death; within 30 days of making the contribution, the survivor designates it by filing the prescribed form in the prescribed manner with the CRA; 5 and the contribution is generally no more than the least of: the total survivor payment; the FMV of the assets in the deceased s TFSA immediately before death; and nil, if the deceased had an excess TFSA amount immediately before his or her death or if survivor payments are made to more than one survivor. An exempt contribution does not trigger any tax liability and has no effect on the survivor s TFSA contribution room, but all the TFSA s earnings and appreciation that arose after the TFSA holder s death are taxable to the surviving spouse and/or other beneficiaries. If permitted in the province or territory of residence, it is more tax-efficient to make a successor holder designation in prescribed form and manner. Surviving spouse and surviving adult child A beneficiary designation made under the original TFSA holder s will may divide the TFSA assets equally between a surviving adult child and the 5. Draft legislative proposals released on December 21, 2012, allow the Minister to extend the time for the survivor to make this designation.

5 5 surviving spouse. In that case, the TFSA a trust generally retains its tax-exempt status until the earlier of the date on which the trust ceases to exist and the end of the calendar year following the year of death (the exemption-end time). Any TFSA value accrued before death may be distributed tax-free to the plan s designated beneficiaries, but only the surviving spouse not an adult child can make an exempt contribution of funds received to his or her TFSA. The adult child can contribute the funds received to his or her TFSA only if he or she has contribution room. Income earned and appreciation that arises after the TFSA holder s death may be taxable to the beneficiaries. No surviving spouse If there is no surviving spouse, the TFSA generally retains its tax-exempt status for the period described above. TFSA value accrued before the holder s death may be distributed tax-free to a beneficiary designated for the TFSA or named under a will. The beneficiary can make a contribution of the receipt to his or her TFSA if he or she has contribution room, but not as an exempt contribution. Income earned or appreciation that arises after the TFSA holder s death may be taxable to the recipient. No surviving spouse and TFSA continues to exist after exemption period In this case, the TFSA trust becomes a taxable trust if it continues to exist after the end of the calendar year following the year of death. Any income earned or appreciation that arises from the date of death to the exemption-end time is taxable in the trust s first taxation year, which begins after that time, in the trust s hands unless the trustees allocate or distribute it to the former TFSA trust beneficiaries under regular trust rules. Donation of TFSA funds If a registered charity or other qualified donee under the Income Tax Act was named as a beneficiary of the deceased s TFSA, the transfer of funds to the donee must generally occur within 36 months after the date of death. The charitable donation tax credit can be claimed on the deceased s tax return for the donation. Marital breakdown Generally, upon marital breakdown, TFSA property can be transferred tax-free to the TFSA of a spouse or common-law partner or of a former spouse or common-law partner, without affecting the transferor s or transferee s TFSA contribution room. Non-residents If you become a non-resident of Canada, you can maintain your TFSA. There is no tax upon emigration or immigration. Further, you will not be taxed in Canada on any earnings in the TFSA or on withdrawals. Any withdrawals will be added to your unused TFSA contribution room in the following year, but will not be available until you resume Canadian residence. As a non-resident, you cannot contribute to a TFSA and no contribution room will accrue for any year throughout which you are non-resident. If you contribute to a TFSA while you are non-resident, you will be subject to a tax of 1% per month on the contribution (exceptions apply) until the contribution is withdrawn or you resume Canadian residence (whichever is earlier). See the Table 5 in the Appendix for details. You can contribute to a TFSA up to the date you become a non-resident. The annual contribution limit ($5,500 for 2013) is not pro-rated in the year of emigration or immigration. Depending on your country of residence, income earned in your TFSA may be taxable in that country in the year it is earned. U.S. citizens resident in Canada Depending upon their personal circumstances, U.S. citizens and U.S. green card holders who file U.S. resident tax returns may not benefit from a TFSA. It

6 6 appears that income earned in a TFSA will be taxable for U.S. purposes in the year it is earned. In addition, a U.S. citizen or U.S. green card holder that invests in a TFSA should ensure all U.S. reporting requirements are complied with. Comparing saving options Canadians have several vehicles to save money for retirement or other future use. Tables 2 and 3 compare RRSPs, TFSAs and ordinary investments. A brief discussion follows. TFSA versus ordinary investments You can simply invest funds, for example in GICs, the stock market or mutual funds. These investments give rise to annual investment income that is subject to income tax at your marginal tax rate. If you fund investments for the benefit of your spouse, the income earned on those investments generally will be taxable to you, eliminating the ability to have the income taxed at your spouse s lower tax rate. Table 2 Comparison of RRSP, TFSA and ordinary investments RRSP TFSA Ordinary investments Contributions tax deductible? Yes No Investment income taxed? No No see Table 3 Yes see Table 3 Withdrawals taxed? Yes see Table 3 No Maximum contribution per year Lesser of 18% of earned income and $23,820 for 2013 (subsequently indexed for inflation) $5,500 for 2013 (subsequently indexed to inflation) No maximum Effect of withdrawals On contribution room On incometested benefits and credits Once funds have been withdrawn from an RRSP, the funds cannot be recontributed unless the plan holder has generated additional contribution room Withdrawals increase taxable income and therefore may decrease incometested benefits and credits, such as old age security and the age credit Funds withdrawn from a TFSA may be recontributed to a TFSA. After a withdrawal, contribution room for the next year is increased by the amount withdrawn No effect N/A None for withdrawals but, investment income will increase taxable income and therefore may decrease income-tested benefits and credits. Deemed disposition on death resulting in income tax Yes the full balance of the RRSP is subject to tax at taxpayer s marginal rates, unless the RRSP is transferred to spouse or, in certain circumstances, to a child No but, see Death of TFSA holder on page 3 Yes accrued capital gains are subject to tax unless investments are transferred to the spouse Transferable to spouse on death on a tax-deferred basis? Yes Penalty on overcontributions 1% per month on excess contributions over $2,000 1% per month on excess contributions see Table 5 N/A Table 3 Tax treatment of investment income RRSP 1 TFSA Ordinary investments 1 Interest Fully taxable; taxable at up to 50% Fully taxable at withdrawal Tax-free Capital gains 50% tax-free; taxable at up to 25% Capital losses In effect, fully deductible Not tax deductible 50% is tax deductible against capital gains Canadian Eligible Fully taxable at withdrawal, but Tax-free, but dividend tax Taxable at up to 36% dividends Non-eligible dividend tax credits are lost 2 credits are lost 2 Taxable at up to 41% 1. Tax rate depends on income level and jurisdiction of residence. 2. Tax credits are higher for eligible dividends.

7 7 Because investment income earned in a TFSA is not subject to income tax, your savings will increase more quickly within a TFSA than for investments held personally, assuming the same pre-tax rate of return. For example, if you contribute $5,500 per year to a TFSA for 20 years, you will have approximately $13,000 more in savings than if you contributed the same amount to a regular savings account, the income from which is taxed annually, assuming a rate of return of 2% per year, federal and provincial tax rate of 46% and the taxes are paid from the investment account. (The savings increases to approximately $44,000 if a 5% per year return is assumed.) You can further benefit by holding in your TFSA, rather than personally, investments that would yield highly taxed income (e.g., investments that pay interest income and securities that pay foreign dividends; although foreign withholding tax may apply to the foreign source income). TFSA versus paying down mortgage on a principal residence Another form of investment is to pay down the mortgage on your principal residence. Although you are not acquiring an asset that can produce investment income, reducing non-tax deductible interest is a valid investment option. As well, gains generated on your principal residence are not subject to tax, making home ownership a taxeffective method of saving for Canadians. Both mortgage repayments and contributions to a TFSA are made with after-tax dollars. Because income earned in a TFSA is not subject to tax, the comparison of the potential rate of return earned in a TFSA relative to the interest rate on the mortgage will be a key consideration when deciding between these alternatives. Whether you use excess funds to pay down your mortgage or to make another investment depends on your specific situation. In particular, the relative merits of paying down your mortgage on a principal residence versus contributing to an RRSP have been long debated and the introduction of the TFSA complicates the issue. TFSA versus contributing to an RRSP If you contribute to an RRSP you will be entitled to deduct the contribution from income, reducing your tax payable for the year as well as the effective cost of the contribution (i.e., amount contributed less the tax savings). Investment income accumulates taxfree within the RRSP, but RRSP withdrawals are subject to tax at your marginal tax rate. You can make tax deductible contributions to a spousal RRSP, which allows for income splitting with your spouse when the funds are eventually withdrawn from the RRSP. However, the significance of the spousal RRSP is reduced by the pension-splitting rules. Both a TFSA and an RRSP allow your investment to grow tax-free as long as the funds remain in the plan. With an RRSP, the contributions are taxdeductible, reducing the upfront cost of the investment. Investment income earned in an RRSP loses its character, so that when the income is withdrawn from the RRSP, the income is taxed as ordinary income, rather than at the preferential tax rates for capital gains or dividends. Contributions to a TFSA are not deductible for income tax purposes; however, the original TFSA contributions and the related investment income are not taxed, even when the funds are withdrawn. In addition, when you withdraw funds from an RRSP, the contribution room is lost, and the funds cannot be recontributed to an RRSP unless you generate additional RRSP contribution room. Funds withdrawn from your TFSA can be recontributed at any time after the end of the year, while you are resident in Canada. TFSAs can also be a good supplement to RRSPs. You can continue to contribute to TFSAs after the age of 71, when RRSPs must be collapsed and any payments from a TFSA will not affect your eligibility for federal government assistance programs such as old age security. Further, you should compare your RRSP and TFSA contribution limits. For example, an individual with earned income (i.e., from employment) of $25,000 a year who is not a member of a company pension

8 8 plan, will have a RRSP contribution limit of $4,500 ($25,000 x 18%), which is less than the TFSA contribution limit. Given the differences in the tax treatment of RRSPs and TFSAs, the decision of whether to invest in an RRSP or TFSA must be made case by case. There is no one-size-fits-all solution. If you have contributed to both a TFSA and an RRSP, after retirement you should consider first withdrawing funds from your TFSA. In this way, the funds in your RRSP can continue to grow before having to be withdrawn on a taxable basis. TFSA versus direct corporate share ownership A significant planning opportunity may exist if you and persons not dealing at arm s length with you, together own less than 10% of a specified small business corporation. Generally, a specified small business corporation is a Canadian-controlled corporation in which substantially all of the FMV of the corporation s assets is attributable to assets that are: used principally in an active business carried on primarily in Canada; or shares or debt of specified small business corporations that are connected to the corporation. If these criteria are met, you can hold your shares in the corporation in your TFSA. This would exempt the dividends and capital gains from income tax when earned by the TFSA and when withdrawn by you. The rules are complex. Consult your PwC adviser or any of the individuals on page 12 to determine if you can take advantage of this planning opportunity. Appendix: Anti-avoidance rules This Appendix discusses the anti-avoidance rules and penalties intended to deter investments in a TFSA that are not qualifying investments (see Qualifying investments on page 3) and transactions that are considered abusive. Non-qualified investments A non-qualified investment is simply an investment that is not a qualified investment. Non-qualified investments cannot be held by a TFSA and are subject to tax as follows: FMV of non-qualified investments 50% tax is payable by the TFSA holder (see Table 5). Income (including capital gains) on nonqualified investments taxable to the TFSA at the top personal tax rate (see Table 4). Subsequent generation income on non-qualified investments see Specified non-qualified investment income on page 9 and Table 4. Prohibited investments TFSAs are specifically prohibited from investing in certain types of investments, referred to as prohibited investments. These generally include: loans (other than certain loans secured by a mortgage) to the TFSA holder; and shares/units or debt of: i) a corporation, partnership or trust in which the TFSA holder has a significant interest (generally, 10% or more); or ii) a person or partnership that does not deal at arm s length with: (a) the TFSA holder; or (b) a person or partnership described in (i). 6 The TFSA holder is subject to the following taxes on prohibited investments: FMV of prohibited investments 50% tax (see Table 5). Income (including capital gains) on prohibited investments 100% tax under the advantage rules (see Tables 4 and 5). 6. Draft legislative proposals released on December 21, 2012, eliminate criteria (b) after March 22, 2011, in respect of investments acquired at any time.

9 9 Advantage rules An anti-avoidance rule imposes a 100% penalty tax (see Table 5) if you or other non-arm s length persons have an advantage with respect to the TFSA. This tax is intended to prevent transactions that are designed to: artificially shift taxable income away from you into the shelter of a TFSA; or circumvent the TFSA contribution limits. Generally, an advantage is any benefit, loan or debt that depends on the existence of the TFSA and may include an increase in the FMV of the TFSA s property. Exceptions include TFSA withdrawals and benefits from administrative or investment services in connection with the TFSA or from loans and debt on arm s length terms and payments or allocations to the TFSA by the issuer, such as reasonable payments of bonus interest. In particular, the advantage rules will tax an increase in the FMV of property held in the TFSA that is attributable to: a transaction or event (or a series of transactions or events): that would not have occurred in an open market 7 between arm's length parties; and one of the main purposes of which is to enable the holder (or another person or partnership) to benefit from the tax-exempt status of the TFSA; and a payment received in substitution for: services rendered by the holder or a person not at arm's length with the holder; or a return on investment, or proceeds of disposition, for property held outside the TFSA by the holder or a person not dealing at arm's length with the holder. Swap transactions Swap transactions (also called asset-transfer transactions) are caught by the advantage rules too. In general, a swap transaction is a transfer of property (other than a contribution or withdrawal) 7. Draft legislative proposals released on December 21, 2012, replace the reference to an open market with a normal commercial or investment context, retroactive to March 23, between the TFSA and the TFSA holder (or a person with whom the TFSA holder does not deal at arm s length). The increase in the FMV of property that is attributable to the swap transaction is subject to a 100% penalty tax under the advantage rules. See Table 5. Deliberate over-contributions A deliberate over-contribution is a contribution to a TFSA that results in, or increases, an excess contribution. An exception applies if it is reasonable to conclude that the individual neither knew nor should have known that the contribution could result in a liability. The TFSA holder is subject to the following taxes on deliberate over-contributions: 1% per month penalty tax on excess contributions (see Table 5). Income (including capital gains) attributable to deliberate over-contributions 100% tax under the advantage rules (see Tables 4 and 5). Specified non-qualified investment income Specified non-qualified investment income is the income (including capital gains) attributable to an amount that is taxable to a TFSA (e.g., subsequent generation income earned on non-qualified investment income or on income from a business carried on by a TFSA). The Minister may require the specified nonqualified investment income to be distributed within 90 days of receipt by the holder of the notice. If the specified non-qualified investment income has: not been distributed by the TFSA within 90 days after receiving notification from the Minister - 100% tax is payable on the income by the TFSA holder under the advantage rules; or been distributed it is taxable to the holder. See Tables 4 and 5.

10 10 TFSA income subject to tax The taxation of TFSA income is outlined in Table 4. Table 4 Taxation of TFSA income Treatment for tax purposes qualifying investments Exempt from tax Income on prohibited investments 1 deliberate over-contributions 100% tax as an advantage see Table 5 Specified non-qualified not distributed investment income 2 distributed Income excess contributions distributed on 3 non-resident contributions Taxable at holder s marginal income tax rate Distribution of an advantange 3 Income not excess contributions distributed on 4 non-resident contributions 100% tax as an advantage see Table 5 non-qualified investments 1 The TFSA trust is taxed at the top personal income tax rate. Who pays tax N/A TFSA holder Income from carrying on a business 5 Income subject to tax from these investments includes: capital dividends (these are fully taxable); and the full amount of capital gains, net of capital losses (the 50% inclusion rate does not apply). 1. An investment that is both non-qualified and prohibited will be deemed to be a prohibited investment only. 2. The advantage rules apply to specified non-qualified investment income that has not been distributed by the TFSA within 90 days after receiving notification from the Minister. If the income is distributed, it will be taxable to the TFSA holder. 3. The distribution is taxable to the TFSA holder if the Minister waives the 1% per month tax on the excess contribution, the 1% per month tax on the non-resident contribution or the 100% tax on the advantage, as applicable. See Table Assuming the excess or non-resident contribution is created by a deliberate over-contribution, income on the deliberate overcontribution will be subject to the 100% tax under the advantage rules. 5. The tax effectively prevents a TFSA from carrying on a business. TFSA

11 11 TFSA penalty taxes Table 5 summarizes the penalty taxes that can apply to TFSAs Table 5 TFSA penalty taxes 1 Excess contributions 2 Non-resident contributions 2 Non-qualified investments Prohibited investments Income on prohibited investments 4 Income on deliberate over-contributions Specified non-qualified investment income 5 TFSA holder has an advantage Swap transactions Penalty tax Explanations When Minister may waive the tax This tax applies to the highest excess contribution in each month. It is similar to the penalty tax on excess RRSP contributions. However, while a $2,000 margin for error is permitted for RRSP excess contributions, every dollar of 1% per month TFSA excess contributions will be penalized. on excess contributions You will be subject to the 1% per month tax until the excess contributions are withdrawn or new contribution room earned in subsequent years eliminates the excess contribution. Deliberate over-contributions increase or create excess contributions. 1% per month on contributions made by non-residents 50% of FMV of non-qualified or prohibited property 3 100% tax on income as an advantage 100% tax on FMV on the advantage or on amount of loan or debt 100% of increase in FMV taxable as an advantage You will be subject to the 1% per month tax until the contributions are withdrawn or you resume Canadian residence (whichever is earlier). This is a one-time tax that becomes payable when the TFSA acquires the prohibited or non-qualified investment or a previously acquired investment becomes prohibited or non-qualified. The income that is subject to the penalty tax includes: the actual amount of dividends received (the dividend tax credit rules do not apply); capital dividends (these are fully taxable); and the full amount of capital gains, net of capital losses (the 50% inclusion rate does not apply). The amount of tax is equal to the: FMV of the benefit; amount of the loan or indebtedness; and/or increase in the FMV of the property as a result of the advantage. The tax applies on the increase in the FMV of property that is attributable to the swap transaction. If the contributions arose because of a reasonable error and you withdraw them without delay. The distribution cannot be less than the full amount of the: excess contribution and income (including capital gains) attributable to it; and/or non-resident contribution and income (including capital gains) attributable to it. If it is just and equitable to waive the tax having regard to all the circumstances, including: whether the tax arose as a consequence of reasonable error; the extent to which the transaction that gave rise to the tax also gave rise to another tax; and the extent to which payments have been made from the TFSA. Effective March 23, 2011, draft legislative proposals released on December 21, 2012: add the third bullet above; and repeal the requirement that a waiver for tax in respect of an advantage could be obtained only if one or more payments are made without delay from the TFSA and the total payment is not less than the tax liability that is waived. 1. Penalty taxes are imposed on the TFSA holder, except for certain cases involving a TFSA advantage, when the TFSA issuer may be liable. You must file Form RC243 E Tax-Free Savings Account (TFSA) Return (and RC243-SCH-A-Excess TFSA Amounts and/or RC243-SCH-B- Non-resident Contributions to a Tax-Free Savings Account (TFA)) and remit the penalty taxes by June 30 of the following year. (Upon royal assent, draft legislative proposals released on December 21, 2012, extend the deadline from 90 days after the calendar year.) If an individual dies before the due date, the deadline will be the later of the normal due date and six months after the date of death. 2. In addition to the 1% per month tax on contributions made while a non-resident, you may also be subject to the 1% per month tax on excess contributions if the non-resident contribution creates an excess contribution. For purposes of the 1% per month tax on excess contributions and the 1% tax on non-resident contributions, contributions exclude: transfers from another TFSA of the TFSA holder; and certain transfers to the TFSA on the TFSA holder s death (see Death of TFSA holder on page 3) on a marriage breakdown (see Marital breakdown page 5). In addition, for purposes of the 1% per month tax on excess contributions, withdrawals exclude: transfers to another TFSA of the TFSA holder; certain transfers from the TFSA on a marriage breakdown (see Marital breakdown page 5); and a distribution of: an advantage (see Advantage rules on page 9); specified non-qualified investment income (see Specified non-qualified investment income on page 9); income that is taxable in a TFSA trust (see Table 4); and income earned on excess contributions or on non-resident contributions that are taxable to the TFSA holder (see Table 4). 3. The Minister can refund the 50% tax on non-qualified investments and prohibited investments if the TFSA disposes (or is deemed to dispose) of the non-qualified or prohibited investment before the end of the calendar year following the calendar year in which the tax arose (or at a later time that the Minister considers reasonable). However, no refund is available if it is reasonable to expect that you knew or should have known that the property was, or would become non-qualified or prohibited. If the investment ceases to be a non-qualified or prohibited investment, the TFSA will have a: deemed disposition of the property immediately before the change in status; and deemed reacquisition immediately after the change in status, for the property s FMV at that time. 4. An investment that is both non-qualified and prohibited will be deemed a prohibited investment only. Therefore, income on the prohibited investment will be subject to the 100% tax as an advantage. For the taxation of income from non-qualified investments, see Table The advantage rules apply to specified non-qualified investment income that has not been distributed by the TFSA within 90 days after receiving notification from the Minister. If the income is distributed, it will be taxable to the TFSA holder (see Table 4).

12 12 We can help For more information about how you can make the most of TFSAs, please contact your PwC adviser or any of the individuals listed below. Calgary Nadja Ibrahim Edmonton Kent Davison Halifax Dean Landry Hamilton Beth Webel London Kevin Robertson Mississauga Jason Safar Montreal Daniel Fortin North York Bruce Harris bruce.harris@ca.pwc.com Ottawa Brenda Belliveau brenda.c.belliveau@ca.pwc.com Quebec City Jean-Francois Drouin jean-francois.drouin@ca.pwc.com Saint John DrDDrouinDrouin Scott Greer scott.a.greer@ca.pwc.com St. John's Darrin Talbot darrin.g.talbot@ca.pwc.com Saskatoon Erick Preciado erick.j.preciado@ca.pwc.com Toronto Ken Griffin ken.griffin@ca.pwc.com Vancouver David Khan david.e.khan@ca.pwc.com Waterloo Mark Walters mark.g.walters@ca.pwc.com Windsor Giancarlo Di Maio giancarlo.dimaio@ca.pwc.com Winnipeg Dave Loewen dave.loewen@ca.pwc.com York Region, Ontario Wilson and Partners LLP 2 Susan Farina susan.farina@ca.pwc.com Jillian Welch 1 Manjit Singh Member of PwC's Canadian National Tax Services (see 2. A law firm affiliated with PwC Canada (see jillian.m.welch@ca.pwc.com manjit.x.singh@ca.pwc.com How much tax do you owe? Use our Income Tax Calculator for Individuals to estimate your 2012 tax bill and marginal tax rates: PricewaterhouseCoopers LLP, an Ontario limited liability partnership. All rights reserved. PwC refers to the Canadian member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisers.