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Taxes  

Generally, all TFSA contributions, withdrawals, and all income (dividends, interest, capital gains) earned within a TFSA are not taxable.

 

 

However under certain circumstances a TFSA account holder may be required to pay taxes in connection with contributions and the investments held within the TFSA account.

In general, any tax payable in connection with a TFSA is the result of an individual violating the Canada Revenue Agency (CRA) rules governing TFSA accounts. While the vast majority of Canadians will never need to worry about paying tax in connection with their TFSA accounts, the following types of TFSA taxes are imposed in the event an individual violates the CRA TFSA rules, and are outlined in more detail below:

  • Excess contributions tax
  • Non-qualified investments tax
  • Prohibited investments tax
  • Non-resident contributions tax
  • Foreign withholding tax

Excess contributions tax

Your TFSA is considered to hold excess contributions, at any time during a year, if the total of all your TFSA contributions exceeds the total your TFSA contribution room.

If, at any time in a calendar month, you have an excess contribution amount in your TFSA account, the CRA will assess a tax equal to 1.0% of the excess amount, per month. The 1.0% will be assessed on the highest excess amount in that month and each subsequent month until the excess amounts have been withdrawn or your earned TFSA contribution room has absorbed it.

Because the 1.0% penalty tax is calculated using the highest excess amount for a given month, even if the excess was deposited and withdrawn in the same month, a penalty tax is incurred.

In addition, under legislative changes proposed in October 2009, any income earned by excess TFSA contributions will be taxed at a rate of 100%. This would be in addition to the monthly 1.0% tax imposed on excess contributions.

For any year that you have excess TFSA contributions, you are required to complete and file an RC243, Tax-Free Savings Account (TFSA) Return 20, and form RC243-SCH-A, Schedule A – Excess TFSA Amounts.

Non-qualified investments tax

Contributions to a TFSA and the income earned within the account can only be invested in Qualified Investments. The list of qualified investments for a TFSA is essentially the same as for a Registered Retirement Savings Plan (RRSP) and a Registered Retirement Income Fund (RRIF).

If, at any time in a calendar month, a TFSA account acquires or holds a non-qualified investment, the CRA will assess a penalty tax. The penalty tax applies equally to acquired non-qualifying assets and to previously qualified investments that become non-qualified investments.

For an account holding non-qualified investments, a one-time penalty tax is imposed by CRA. The penalty tax is equal to 50.0% of the non-qualified investment’s fair market value at the time it was acquired or it became a non-qualified investment.

In addition, under legislative changes proposed in October 2009, any income earned by non-qualified investments will be taxed at regular income tax rates.

An individual that holds a non-qualified investment, at any time in a calendar month, is required to complete and file an RC243, Tax Free Savings Account (TFSA) Return 20.

Prohibited investments tax

Contributions to a TFSA and the income earned within the account can only be invested in Qualified Investments. The list of qualified investments for a TFSA is essentially the same as for a Registered Retirement Savings Plan (RRSP) and a Registered Retirement Income Fund (RRIF).

 A Prohibited Investment is an investment that the TFSA holder is closely connected. Prohibited investments include:

  • a debt of the TFSA holder
  • a debt or equity investment in an entity in which the holder has a 10% or greater ownership interest
  • a debt or equity investment in an entity with which the holder does not deal at arm’s length 

Note: Prohibited investments do not include, however, a mortgage loan insured by Canada Mortgage and Housing Corporation (CMHIC) or an approved private mortgage insurer.

If, at any time in a calendar month, a TFSA account acquires or holds a prohibited investment, the CRA will assess a penalty tax. This also includes the instance where a previously acquired investment becomes a prohibited investment at a later date.

If a TFSA holds a prohibited investment, the TFSA holder will be subject to two separate penalty taxes:

  • The first is a one-time penalty tax that equals as 50% of the prohibited investment’s fair market value at the time it was acquired or became prohibited.
  • The second tax penalty, as a result of legislative changes proposed in October 2009, any income earned by prohibited investments will be taxed at a rate of 100%.

A TFSA holder that becomes subject to the above income tax penalties is required to complete and file an RC243, Tax-Free Savings Account (TFSA) Return.

Non-resident contributions tax

If you become a non-resident of Canada, you are permitted to continue holding a TFSA account, but you will not be entitled to make contributions nor accumulate TFSA contribution room for the period of your non-residency.

However, if you do make a contribution while you are a non-resident then you will be subject to a tax penalty. The CRA will assess a tax equal to 1.0% of the contribution amount, per month. The 1.0% will be assessed on the highest non-resident contribution amount in that month and each subsequent month until the contribution amounts have been withdrawn.

To eliminate this tax penalty the full amount of non-resident contributions must be withdrawn. The 1.0% tax penalty is not assessed for the month that the full non-resident contributions are withdrawn.

In addition, if the non-resident contributions created an excess contribution balance, then the excess contribution amount will be assessed a separate 1.0%, per month, penalty tax.

For every year that you made non-resident TFSA contributions, you will be required to complete and file an RC243, Tax-Free Savings Account (TFSA) Return, and a Form RC243-SCH-A, Schedule B – Non-Resident Contributions to a Tax-Free Savings Account (TFSA).

Foreign withholding tax

As with registered accounts, TFSAs are permitted to invest in and hold foreign securities.  A foreign security is an investment in a non-Canadian entity (foreign corporation, foreign government, etc.).

If the foreign investment pays a regular income, the income may be subject to withholding tax, deducted at source, before the income is received by your TFSA account. The foreign withholding tax amount will vary by country and it will be subject to the current income tax treaty with Canada.

Normally, if the foreign investment were held in a taxable account, the foreign withholding tax deducted would be reported in your annual income tax return. This is not so for TFSA accounts where the income earned is tax-free. The foreign withholding tax deducted cannot be claimed in your income 

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