TFSA red tape at work

National Post

2010-10-02


TFSA overcontributions and the looming penalty some Canadians may be facing has been a hot topic among confused taxpayers who thought they understood how these simple savings vehicles worked.

Introduced in 2009, tax-free savings accounts allow Canadians aged 18 and over to contribute up to $5,000 annually. If you didn't contribute last year, any unused contribution room is automatically carried forward to be used in a future year.

Any withdrawals of TFSA money increase your available TFSA contribution room, but only in the following calendar year. This is the rule that apparently tripped up more than 72,000 Canadians (out of 4.8 million TFSA holders), who received notices from the Canada Revenue Agency last June requesting more information as to why the overcontribution occurred.

Last week, the Canada Revenue Agency shed some light on the issue by releasing information on the overcontribution mess.

Anyone who received a "TFSA return" from the CRA had until Aug. 3 to respond by either signing the return and sending it in with payment or sending the CRA a letter requesting a review of their circumstances with a view to getting the tax waived.

If you received a TFSA return but chose not to respond, the CRA will assess the overcontribution return based on the information it has and issue a TFSA notice of assessment.

Why all this back and forth? Why didn't the CRA simply grant tax relief?

The CRA indicated it is precluded from doing so by the Income Tax Act, which requires that a request for relief be initiated by the taxpayer, who must demonstrate that the overcontribution error was "reasonable" and that "reasonable steps were promptly taken to remove any excess amount from the TFSA," where applicable.

Perhaps most revealing was the CRA's explanation for why re-contributions in the same year are not permitted. According to the CRA, this requirement is to allow an individual's annual contribution room to be determined in a "simple manner."

Since contribution room is affected by a number of determinants, such as contributions, accumulation of unused TFSA room, indexation of the annual contribution limits and withdrawals, absent this rule it would be difficult to verify whether a specific contribution is actually within a contributor's TFSA limit.

Finally, the CRA also confirmed that you can transfer a TFSA from one financial institution to another without violating the overcontribution rules, provided the transfer is done directly by the institution. There is no specific CRA transfer form, since most institutions process transfer requests electronically.

So, to initiate a TFSA transfer, contact your financial institution to ensure the funds are transferred directly, rather than trying to do it yourself via a withdrawal and subsequent re-contribution, which could trigger the penalty tax. Note that a transfer fee might apply.