Punitive TFSA Audits
The Canada Revenue Agency (“CRA”) has recently begun mailing out questionnaires to individuals holding significant amounts in their Tax-Free Savings Accounts (“TFSAs”). This appears to be part of a project audit of TFSAs across the country. A copy of one such questionnaire is provided below.
The CRA has now responded to those who have answered the questionnaire by proposing a “tax” of close to 100% of the value of the TFSA. It seems clear that the CRA is intent on challenging those who have enjoyed significant growth within their TFSA.
TFSAs were established under the Income Tax Act (Canada) (the “Act”) in 2008, with initial contributions permitted as of January 1, 2009. Individuals are allowed to contribute up to $5,000 per year. Investment returns within a TFSA are generally not taxable, and the initial contributions plus returns thereon can generally be withdrawn tax-free. The rules for permissible TFSA investments were initially stricter than for other deferred-income plans such as RRSPs (though recent amendments to the RRSP investment rules now largely eliminate those differences).
The ostensible purpose of the CRA’s questionnaire is to determine whether the growth in the value of the holder’s TFSA is attributable to one or more impermissible “advantages”, with specific reference to “swap transactions”. Swap transactions are essentially defined as a transfer of property (usually of securities) to or from a TFSA by the holder, or another person with whom the holder does not deal at arm’s length (for example, the holder’s RRSP). Swap transactions have been prohibited since October 17, 2009.
If prompted, the CRA will often state that the questionnaire is actually peripheral, and all the CRA official would like to see are the TFSA’s account statements. The reason for this has now become clear: all individuals who have submitted account statements are beginning to receive assessment proposals for each year, equal to the annual growth in value of the TFSA as shown on the account statements.
The proposed assessments (typically made under section 207.05 of the Act) are virtually confiscatory in nature. Apart from allowing the initial contributions of $5,000 per year and (sometimes) an arbitrary, negligible return of 1% on those contributions, the CRA seeks to impose on the holder personally a 100% tax on the value of the assets held by their TFSA. To be clear, this is not an income tax – it is more properly characterized as a penalty tax equal to 100% of the value of the TFSA based on a “mark-to-market” valuation.
The CRA is proceeding on the basis that the entire value of the TFSA (less the contributions and a nominal return thereon) is traceable to an “advantage”, as that term is defined in subsection 207.01(1). Notwithstanding the wording of the questionnaire, the CRA’s assessments appear to have regard only to the year-end value of the assets held within the TFSA, without analyzing whether those assets are attributable to transactions that produced “advantages” as compared to other transactions.
The tax imposed under section 207.05 of the Act has potentially severe ramifications apart from the confiscatory nature of the assessment. Firstly, the tax is imposed directly on the holder of the TFSA, not the TFSA itself. Secondly, the tax is imposed annually based on year-end values. Therefore, if the TFSA distributes all its assets to its holder, or if the TFSA portfolio value falls precipitously, the holder will still be liable for the full amount of the tax. There is no ability to offset portfolio gains arising in one year by losses in another year – that is, only the winning years are valued and taxed; any losing years are ignored. Finally, the TFSA holder’s personal assets are available for collection by the CRA, even if the total value of the TFSA’s assets has declined and the value inside the TFSA is insufficient to cover the tax liability.
If you have received a questionnaire regarding your TFSA, or if you have received a proposed or actual tax assessment with respect to your TFSA, we can help. We believe that in many instances these assessments are ill-founded and may be unsustainable. We have been working with numerous clients since the first set of these questionnaires were sent out, and we have developed several strategies with which to counter the CRA’s course of action.
Contact us if you have received a TFSA questionnaire from the CRA, or if you want to challenge a TFSA tax assessment.
