Tax Free Savings Account (TFSA) Penalties

CRA Rules for Tax Free Savings Account Investments

The TFSA can be an effective investment and tax savings vehicle. In general, gains in the account remain tax free. However, there are very strict rules regarding what type of investment can be placed in a TFSA and if the rules are contravened there may be TFSA penalties (tax payable) on the investment. Also, if a taxpayer exceeds the annual TFSA contribution room there are penalties. And, if a taxpayer becomes a non-resident of Canada for tax purposes and continues to contribute to the TFSA there will be tax payable. There are further restrictions that will be discussed in a later article.

CRA TFSA Audit

Canada Revenue Agency (“CRA”) regularly audits TFSA and RRSP accounts and if they discover offside investments, TFSA penalties will be applied. Fortunately, you can dispute the penalties with a waiver request and a Notice of Objection.

Types of Investments Allowed in a TFSA

In general, the investments allowed in a TFSA include:

bonds;

cash;

securities listed on a designated stock exchange;

mutual funds;

guaranteed investment certificates; and

certain shares of small business corporations.

TFSA Penalties or Tax Payable on a Prohibited Investment

The tax payable on a prohibited investment is severe: 50% of the investment’s fair market value (“FMV”). Furthermore, there is a 100% penalty for any gain or income from the investment. As is obvious, it is very important that you place allowed investments into your account to avoid TFSA penalties. Nevertheless, there are options to dispute the penalty.

In general, an investment that is closely connected to the taxpayer is prohibited. This includes:

a debt of the holder;

a debt or share of, or an interest in, a corporation, trust or partnership in which the holder has a significant interest (generally a 10% or greater interest, taking into account non arm’s length holdings); and

a debt or share of, or an interest in, a corporation, trust or partnership with which the holder, does not deal at arm’s length.

TFSA Penalties or Tax Payable for Exceeding TFSA Contribution Room

Each year a taxpayer has a specific amount that can be contributed, or their contribution room. If a taxpayer exceeds this amount there is a monthly 1% tax payable on the excess amount.

TFSA Penalties or Tax Payable for Non-Resident Contributions to a TFSA

Only Canadian residents for tax purposes can open and contribute to a TFSA. So, if a Canadian becomes a non-resident, future contributions are not allowed. There is a 1% monthly tax on non-resident contributions.