For some Canadians struggling financially in the midst of the COVID-19 crisis, tapping into a TFSA to access tax-free savings to augment available government support has been a helpful strategy. And, knowing that you can recontribute those withdrawn funds back into your TFSA in the future (should you have some extra cash to do so), means that you can make such a move without permanently giving up the potential for tax-free income and growth on those amounts.
When recontributing, however, it’s important to keep in mind that withdrawals from a TFSA only get added to your available TFSA contribution room the following calendar year. Unawareness of this rule can lead to inadvertent TFSA overcontribution problems, which can be costly as there’s a penalty tax of one per cent per month, multiplied by the overcontribution amount, for each month you’re over the limit.
Fortunately, under the Income Tax Act, the Canada Revenue Agency has the power to waive or cancel the overcontribution tax if it can be established that the tax arose “as a consequence of a reasonable error” and the overcontribution is withdrawn from the TFSA “without delay.”
To request a waiver of the penalty tax, an affected taxpayer needs to forward a detailed written request to the TFSA Processing Unit in Sudbury or Winnipeg with all relevant information, explaining “why it would be fair to cancel or waive all or part of the tax.” But just because you ask for relief, doesn’t mean the CRA will grant it.
If the CRA refuses your request for relief, you can take your case to Federal Court, asking a judge to review whether the CRA’s decision to deny relief was reasonable. That’s what happened in a recent case involving a B.C. taxpayer and overcontribution tax assessed by the CRA for the 2017 and 2018 taxation years. The case was heard earlier this month, via teleconference, by a Federal Court judge, sitting in Ottawa.
The taxpayer’s troubles began in 2016, when he contributed a total of $81,000 to his TFSA. Unfortunately, his TFSA contribution room for 2016 was only $44,592, resulting in an excess contribution amount as at Dec. 31, 2016. Consequently, the taxpayer had no available contribution room for 2017. Notwithstanding this, in March 2017, the taxpayer deposited $10,000 to his TFSA. In April 2017, he withdrew the entire balance from his TFSA.
On June 1, 2017, the CRA sent him a letter informing him of his excess 2016 TFSA contributions. The letter indicated, in part, that if he continued to make excess contributions “in the future,” he could be subject to a one per cent tax for each month the excess remained in the TFSA.
In September 2017, the taxpayer contributed a further $35,000 to his TFSA, resulting in an excess contribution amount of $35,000 as at Dec. 31, 2017. This excess contribution remained in his TFSA until August 2018, when he withdrew the excess amount.
The CRA issued TFSA tax assessments for the 2017 and 2018 taxation years, each of which set out the excess TFSA amount in the account by month, and the calculation of the tax, interest and penalties imposed on the TFSA excess amounts.
In April 2019, the taxpayer wrote to the CRA requesting a waiver of the overcontribution tax, interest and penalties, arguing that he should not be charged the overcontribution tax for months prior to July 2017 since the June 2017 CRA letter stated that if he continued to make excess TFSA contributions, he could be liable for overcontribution tax “in the future.” Indeed, the taxpayer accepted “full responsibility” for the overcontribution tax related to his overcontributions after June 2017 and admitted that he incorrectly deposited $35,000 to his TFSA in September 2017 because he was unaware that he was required to wait until 2018 to make any further TFSA contributions.
On July 15, 2019, the CRA refused the taxpayer’s first relief request, based on the fact that the taxpayer made another overcontribution in September 2017, despite having received a warning letter from the CRA in June 2017.
A week later, the taxpayer sent a second relief request to the CRA, emphasizing that he had removed all of the funds in his TFSA (in April 2017) and that between then and August 2017, the balance in his TFSA was, actually, zero. He acknowledged his September 2017 TFSA contribution of $35,000, but felt that the CRA should “nonetheless exercise the discretion contemplated by the (Act) to cancel all of the (overcontribution) tax reflected in the 2017 and 2018 TFSA assessments.” The taxpayer also noted that the dispute with the CRA was “causing stress that was unfortunate in light of his ill health.”
Having reviewed the information submitted and the facts of the case, the CRA concluded that the taxpayer “continued to make contributions to his TFSA in 2017, after he was notified of his excess 2016 contributions by the CRA’s June 2017 Letter.” The CRA went on to say “that there were no circumstances that would support the cancellation of the tax levied on the excess TFSA amounts for 2017 and 2018, and that the CRA’s initial assessment was correct.”
The sole issue before the Federal Court judge was not whether the overcontribution tax was correctly charged or calculated; rather, it was whether the CRA’s decision not to waive the overcontribution tax was reasonable. As the judge explained, “My role is not to substitute my own decision for that of the (CRA’s), nor am I to review the (CRA’s) Decision against a standard of perfection.”
The judge found that the reasons given by the CRA for denying relief “contain fundamental gaps.” While the CRA isn’t required to “draft lengthy reasons … it does require an analysis, which may be brief, of the applicable legal framework, significant evidence, and submissions in the record that permits the reader to understand the (CRA’s) rationale for the outcome of the case.”
The judge felt the CRA’s letter denying the taxpayer’s relief did not adequately explain the CRA’s reasoning for denying relief. Specifically, the CRA seems to have viewed the taxpayer’s September 2017 overcontribution “as colouring all of his actions, pre- and post-letter, placing him in the category of repeat over-contributor.”
In ordering the matter to be returned to the CRA for reconsideration by another officer, the judge concluded that the CRA’s decision “does not reflect a coherent assessment of the relevant law and significant facts and submissions from the record and that the (CRA’s) refusal to exercise their discretion was not intelligible or justified.”
Will the CRA show mercy upon a third review? Stay tuned.