Taxpayer hit with TFSA overcontribution penalty takes CRA to courtroom

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Regardless of the pliability of the tax-free financial savings account (TFSA), now and again, some taxpayers get confused when monitoring their contribution restrict, and find yourself placing in an excessive amount of, solely to get hit with the dreaded overcontribution penalty tax, which is the same as one per cent per 30 days for every month you’re over your restrict.

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As a reminder, you possibly can contribute $6,000 to your TFSA for 2022. Relying in your age, your restrict may very well be as excessive as $81,500 if you happen to’ve by no means made a TFSA contribution earlier than, since unused room mechanically carries ahead from one calendar yr to the subsequent. You may as well recontribute any TFSA withdrawals again into your TFSA starting the calendar yr following the yr of withdrawal.

Should you do get hit with an overcontribution tax, you possibly can request the Canada Income Company to waive or cancel it, which it has the ability to do if it may be established that the tax arose “as a consequence of an inexpensive error” and the overcontribution is withdrawn from the TFSA “immediately.”

A case that was determined earlier this month involved a taxpayer who was hit with the TFSA penalty tax that the CRA in the end refused to waive. He took the matter to federal courtroom.

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The taxpayer’s troubles started in 2018 when the taxpayer, who had $42,500 of TFSA room obtainable, contributed $52,500 to his TFSA, leading to an overcontribution of $10,000. On Could 9, 2018, the taxpayer deposited an additional $20,000 to his TFSA, however then withdrew it the identical day.

On Jan. 1, 2019, new TFSA room of $6,000 was created for the 2019 tax yr, mechanically decreasing the overcontributed quantity to $4,000. However, on Feb. 19, 2019, the taxpayer went forward and contributed one other $6,000 to his TFSA.

The 2018 overcontribution was quickly found by the CRA, which in July 2019 assessed him the TFSA overcontribution penalty tax. At the moment, the CRA suggested him that if there was nonetheless any extra quantity in his TFSA, he ought to withdraw it instantly to restrict any future penalty tax.

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Shortly after being assessed the penalty tax, the taxpayer wrote to the CRA requesting it cancel the tax on the surplus TFSA contributions for each the 2018 and 2019 years. The request was made on the idea that the preliminary deposit was a results of misinformation he had acquired from his financial institution, and the $20,000 quantity that was deposited and withdrawn on the identical day was a switch between his accounts that was made by mistake.

In October 2019, the CRA granted his request for aid, however just for the 2018 taxation yr. The taxpayer additionally took steps that month to withdraw the surplus contribution of $10,000 from his TFSA.

In August 2020, the taxpayer once more wrote to the CRA requesting the company additionally cancel the TFSA overcontribution request for the 2019 taxation yr. The CRA denied this aid. The taxpayer requested a second-level assessment, which was carried out in October 2020, however aid was additionally denied. The taxpayer then turned to the courtroom to find out whether or not the CRA’s resolution to disclaim him aid was “affordable.”

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The federal courtroom, in making use of what’s referred to as “the reasonableness customary,” doesn’t ask what resolution it will have made rather than the CRA, nor does it conduct any new evaluation to find out the “appropriate” resolution to the issue. Moderately, the function of the courtroom is to find out whether or not the CRA’s resolution to disclaim the taxpayer’s request for aid of the penalty tax for 2019 on his extra TFSA contributions was affordable.

In his defence, the taxpayer argued that his extra TFSA contribution in 2019 was “an sincere mistake, which he rectified instantly upon being notified of it.” He additional contended that the CRA’s resolution to disclaim him aid for 2019 “flies within the face of the choice in 2018, as it’s the similar $10,000 quantity that’s in query.” He was merely requesting consistency within the CRA’s resolution from 2018 (wherein it cancelled the penalty tax) to 2019.

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The decide, nevertheless, disagreed that the 2019 overcontribution was “the identical $10,000.” On the finish of 2018, the taxpayer’s whole overcontribution quantity was $10,000. It was then lowered to $4,000 as a result of 2019 annual contribution restrict improve of $6,000. The taxpayer then proceeded to contribute $6,000 for 2019, however this residue created a brand new overcontribution of $10,000, which the decide concluded was not “the identical $10,000” as in 2018.

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Moreover, the CRA famous that whereas the taxpayer was notified of his TFSA overcontribution in July 2019, he solely withdrew the surplus quantity on the finish of Oct. 2019, which it decided was an “unreasonable delay.” The CRA additionally acknowledged that though the taxpayer’s TFSA extra contributions had been “unintentional, misinterpretation of the TFSA contribution restrict is just not thought-about an inexpensive error.” This conclusion is according to prior selections regarding TFSA overcontributions.

The decide then turned to the wording of the Earnings Tax Act, which states the CRA can train its discretion to waive the penalty tax if the taxpayer can show the tax legal responsibility arose “as a consequence of an inexpensive error and the surplus TFSA quantities are faraway from the TFSA immediately.” Prior jurisprudence has discovered that “each prongs” of the take a look at “have to be established to the satisfaction of the (CRA) earlier than a taxpayer will likely be thought-about for aid. Even when each prongs are met, the discretion to waive stays with the (CRA.)”

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The decide was sympathetic to the taxpayer’s argument, however she discovered the evaluation within the CRA’s resolution to disclaim the taxpayer aid was “internally coherent and rational,” and, subsequently, affordable. The taxpayer’s software was dismissed, and the TFSA overcontribution tax was successfully upheld.

Jamie Golombek, CPA, CA, CFP, CLU, TEP is the managing director, Tax & Property Planning with CIBC Non-public Wealth in Toronto. [email protected]

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