TaxMatters@EY – October 2021

Alan Roth, Toronto

Canadian residents age 18 and older are eligible to open a Tax Free Savings Account (TFSA) and make contributions up to their available limit each year. Since their inception in 2009, TFSAs have proven to be a popular vehicle through which individuals can benefit from the tax-free growth of investment savings.

There are very specific rules that govern the amount of contributions that may be made, re-contributions of funds withdrawn from a TFSA and the type of investments that can be held in a TFSA. Penalty taxes may be imposed on excess TFSA contributions, on contributions made by nonresidents, and for holding nonqualified or prohibited investments in a TFSA, and on the accrual of certain benefits or advantages from a TFSA.

At the CRA roundtable held at the 2021 Society of Trust and Estate Practitioners (STEP) conference, the CRA commented on the tax implications of a specific scenario where a taxpayer made an overcontribution to their TFSA in 2021 as a result of being a nonresident before the 2021 taxation year, highlighting some aspects of these rules.

Background

Unlike Registered Retirement Savings Plans (RRSPs), contributions to a TFSA are not tax deductible, but there are significant benefits to holding a TFSA, such as:

• Income and capital gains earned on investments held in a TFSA are not taxable, even when withdrawn.¹
• You can make withdrawals at any time and use them for any purpose without attracting any tax.
• Any funds you withdraw from the TFSA — both the income and capital portions — are added to your contribution room in the next year. This means you can recontribute all withdrawals in any subsequent year without affecting your allowable annual contributions. Note that recontribution in the same year will result in an overcontribution if you have no available contribution room for that year. In this case, you would be subject to a penalty tax on the overcontribution.
• You can contribute up to $6,000 annually ($6,000 in each of 2021, 2020 and 2019; $5,500 in 2016, 2017 and 2018; $10,000 in 2015; $5,500 in 2013 and 2014; $5,000 prior to 2013). If you contribute less than the maximum amount in any year, you can carry forward and use that unused contribution room in any subsequent year. The cumulative contribution limit for 2021 is $75,500.

Don’t exceed your annual contribution room limit. In general terms, the maximum TFSA contribution room available to an individual is the sum of three amounts:

• The annual TFSA dollar limit (currently $6,000 as noted above)
• The cumulative unused TFSA contribution room from a previous year
• The total amount of withdrawals made from the TFSA in the previous year²

Certain qualifying transfers and exempt contributions will not result in a TFSA overcontribution.³

The CRA tracks your contribution room and reports it to you annually as part of your income tax notice of assessment. If you overcontribute to your TFSA in a given year by exceeding the maximum contribution room, you will be subject to a 1% penalty tax on the excess amount.⁴ The tax is calculated monthly based on your highest excess TFSA amount for that month. The 1% tax continues to apply for each month the excess TFSA amount remains.

You may take action to correct an overcontribution and minimize the tax by making one or more withdrawals from your TFSA to reduce or eliminate the excess TFSA amount. The CRA may waive or cancel the 1% tax upon request if you promptly withdraw a sufficient amount from your TFSA to eliminate the excess TFSA amount together with any associated income and capital gains and you establish to the CRA’s satisfaction that the overcontribution and resulting penalty tax arose as a consequence of a reasonable error.⁵

As noted above, you must be a Canadian resident to be able to contribute to a TFSA. If you hold a TFSA and become a nonresident of Canada, you will not be taxed in Canada on income earned in the TFSA, although foreign taxes may apply, or on withdrawals from your plan. No contribution room will accrue for any year throughout which you are a nonresident. In the year of your emigration or immigration, the annual dollar contribution limit without proration applies. If you re-establish Canadian residence, any withdrawals made while you were a nonresident will be added back to your TFSA contribution room in the following year. A 1% penalty tax will also apply to any contributions you make to your TFSA while you are a nonresident.

Penalty tax on excess TFSA contributions

At the 2021 STEP conference, the CRA commented (in CRA document 2021-0883221C6) on a specific scenario where a taxpayer moved to Canada in 2021 and then opened a TFSA account. Since he was previously a nonresident of Canada, the taxpayer’s cumulative TFSA contribution room for 2021 was only $6,000 (the contribution limit for the 2021 taxation year).

Nevertheless, due to a misunderstanding of the rules, the taxpayer contributed $18,000 to his TFSA and invested the entire amount in shares of one company. Before he had a chance to withdraw the $12,000 overcontribution, the company went bankrupt. The fair market value of the investment held in the TFSA was now zero.

The CRA was asked whether there was any way it could waive the 1% penalty tax, or if there was any other way the tax could cease to apply, notwithstanding that it was not possible to withdraw the excess contributions since the value of the shares held in the plan was nil.

The CRA responded that since it was not possible to withdraw any amounts from the TFSA in this scenario, subsection 207.06(1) did not apply and the CRA had no authority to waive or cancel the penalty tax. Only new TFSA contribution room that would become available to the taxpayer in future years would serve to reduce the excess TFSA amount.

Therefore, assuming that no additional contributions would be made in 2021, 2022 or 2023, and the annual contribution limit were to remain the same at $6,000 per year, the $12,000 overcontribution would be reduced to $6,000 on January 1, 2022 and fully eliminated on January 1, 2023. The taxpayer would be subject to the 1% penalty tax in 2021 and 2022 and would need to complete Form RC243, Tax-Free Savings Account (TFSA) Return, and remit the penalty tax for each year. The taxpayer could begin making TFSA contributions again in 2024.

The CRA did not comment on the calculation of the total penalty tax amount in this scenario. Although it’s not mentioned in the CRA document, assume that in this scenario the taxpayer became a resident of Canada in July 2021 and made his $18,000 TFSA contribution on September 1, 2021. Although the taxpayer was only a resident of Canada for half of 2021, his TFSA dollar contribution limit for 2021 is $6,000 since the limit is not prorated for the year of immigration.

The penalty tax for 2021 is $480, calculated as the $12,000 overcontribution x 4 (months) x 1%. For 2022, the total penalty tax is $720, calculated as the $6,000 overcontribution x 12 (months) x 1%. In addition to the penalty tax, interest will also be assessed at the prescribed rate plus 4% and will apply from the time the penalty tax is assessed to the time it is paid.⁶

Conclusion

The CRA’s comments illustrate the importance of complying with the rules pertaining to TFSA contribution limits and the adverse tax consequences associated with not complying with those rules. They also serve as a reminder that contribution room does not accumulate during the period that a taxpayer is a nonresident of Canada.

In addition, it should be noted that the CRA can only waive the penalty on overcontributions if certain conditions are met as noted above. In particular, the CRA is not empowered to grant a waiver where the overcontribution cannot be withdrawn from the account.

Gael Melville, Vancouver, Winnie Szeto, Toronto, and Jonathan Ip, Calgary

This case deals with the issue of what recourse a taxpayer has when it has filed an amended tax return that the Canada Revenue Agency (CRA) has not processed. Although the taxpayer was successful in its application for judicial review in this case, the result arguably did not move the taxpayer much closer to its goal of securing reassessments to reflect its amended filing position.

Assessments and reassessments

When a taxpayer files an income tax return, the CRA must assess the return “with all due dispatch” and issue an assessment. An assessment is considered valid and binding, but the taxpayer can object to the assessment and appeal it to the Tax Court of Canada.

However, in the case of an amended return, the CRA may issue a reassessment, generally within the normal reassessment period, which varies according to the circumstances. Although a taxpayer can request an adjustment to a previously filed tax return by filing an amended return, there is no mechanism to compel the CRA to accept amendments to a return and to reassess.¹ This is an important distinction, since without an assessment or reassessment, the taxpayer has no ability to object or appeal to the Tax Court.

Facts of the case

The facts in this case are complex because it was related to other cases involving related individuals and entities in a corporate structure. Overall, there was a series of tax disputes spanning several years, and the central issue was whether certain payments from overseas entities that flowed through an Alberta trust were taxable in the hands of the taxpayer corporation or its principal shareholder, Mr. X.

The taxpayer was a Canadian holding corporation that filed initial returns that reported payments received from an Alberta trust as taxable income. The CRA assessed these initial returns as filed. After discovering that the amounts had been mischaracterized, the taxpayer later filed amended returns and reported the amounts as non-taxable voluntary payments. Based on the amended returns, the taxpayer was thus entitled to tax refunds totalling approximately $3 million for the 2008-11 taxation years.

For the 2014 and 2015 taxation years, the taxpayer filed returns on the basis that the distributions were not taxable income, and the Minister reassessed the returns. Notices of Objection were filed for those taxation years.

In correspondence with the taxpayer, the CRA stated that their requests for refunds and amended returns would be postponed “until a final and unappealable determination had been made/reached on the issue of the taxability” of the distributions from the trust. The CRA also put forth alternative assessing positions under subsection 9(1) and 56(2), noting that it would pursue both positions until a resolution could be reached through the objections and appeals process.

In 2018, as part of a separate audit of Mr. X, the CRA issued reassessments under which it included in Mr. X’s income payments from the overseas entities to the Canadian structures under subsection 56(2) of the Income Tax Act. Mr. X filed notices of objection to these reassessments and appealed to the Tax Court. Essentially, the CRA was applying alternative assessing positions regarding Mr. X and the taxpayer, seemingly intending to treat the tax positions as mutually exclusive once the common issue had been resolved.

Following the issuance of the Mr. X reassessments, the CRA wrote to the taxpayer’s representative advising that a decision regarding the processing of the amended returns would be postponed until a final determination had been made on the common issue.

The taxpayer found the CRA’s position to be unsatisfactory because it wanted the CRA to process the amended returns and issue notices of reassessment so that it could object to the reassessment and have the Tax Court resolve the issue by way of an appeal. The taxpayer then applied for a court order to compel the CRA to process the amended returns. The CRA later issued a decision, part of which read as follows:

“Given the ongoing dispute, the CRA had initially agreed, to the benefit of [the taxpayer], to postpone its final decision on the issue of the Amended Returns until a final resolution of all related tax matters had been determined, however given the application for a mandamus order,² the CRA decided to make a final decision on the Amended Returns, that is, not to reassess [the taxpayer]. Accordingly, the CRA will not accept the Amended Returns, and the initial assessment of [the taxpayer] will not be changed.”

The taxpayer then applied to the Federal Court for judicial review of the decision. The parties agreed to put the earlier application for a court order on hold until the judicial review application had been decided.

Federal Court decision

The Federal Court had to decide whether or not the CRA’s decision was reasonable.

Although the taxpayer raised two arguments before the Court, the Court only considered the first one because that was sufficient to decide the case. Under this first argument, the taxpayer asserted that even though the CRA claimed that its decision not to process the amended returns was final, in fact it was not, because the CRA intended to process them once the Tax Court had determined the appropriate tax treatment of the various payments, as part of Mr. X’s appeal of his own reassessments.

The Court examined the decision and found that it was capable of two different interpretations. The decision could be read as either:

• A final decision not to reassess the taxpayer in line with the amended returns because the CRA disagreed with the taxpayer’s revised filing position, or
• The firming up of an earlier CRA proposal to postpone processing the taxpayer’s refund requests until the common issue had been resolved.

The Court concluded that because the decision could be interpreted in two different ways, it was neither transparent nor intelligible, so it was not reasonable. As a result, the Court set the decision aside, and rather than sending the matter back to the CRA for redetermination left the parties to resolve the matter. The Court did provide some guidance to the parties, noting (among other things) that if the CRA were to issue a clear decision that it was formally exercising its discretion not to reassess the taxpayer, then the Court would expect the CRA to explain its approach to the alternative assessing positions, particularly in light of its administrative policy.

Lessons learned

This case serves as a reminder that the CRA cannot generally be compelled to assess an amended return. In fact, the taxpayer in this case had already pursued various means to try and have reassessments issued for the relevant years, including its application for judicial review, but none were fruitful. Once the judicial review application concluded, the taxpayer remained in a position where it had paid tax based on its original assessing position and had not been able to recover those amounts from the CRA.

The case also underscores the importance of the CRA’s decision record in a judicial review application. In this case, the Federal Court found that the CRA’s arguments were in direct contradiction with the deciding officer’s reasons in his affidavit and testimony on cross examination, which led to the second interpretation of the decision and a finding that the CRA’s decision was not reasonable.

Tax Alerts – Canada

Tax Alert 2021 No. 29 – DIPs required to request information by 15 October
A Distributed Investment Plan (DIP), which as defined generally includes mutual fund trusts and certain partnerships, that is a selected listed financial institution is required to make a written request to obtain certain information from its investors by 15 October 2021.