THE INCREASE IN THE ANNUAL contribution limit for tax-free savings accounts (TFSAs) – to $10,000 from $5,500 – has heightened their importance as an investment and long-term tax planning tool for Canadians.
With the cumulative contribution level now at $41,000, TFSAs now rival RRSPs as the tax-efficient savings/investment vehicle of choice.
TFSAs now are “really the single best tool we have available to us,” says Kevin Sullivan, vice president, portfolio manager and advisor with Toronto-based MacDougall MacDougall & MacTier Inc. Sullivan notes that TFSAs, as a saving and investing tool, have great benefits and flexibility, and these advantages now are magnified by the higher annual contribution limits.
The one caveat, cautions Sullivan, is that many people, and certainly many do-it-yourself investors, equate the TFSA with a savings plan and consequently pay little attention to its importance for sheltering investment gains in the current low interest rate environment. Notes Sullivan: “We really should look at TFSAs in much the same way we do other registered plans, including RRSPs and RRIFs.”
He adds that the financial services sector needs to “make an effort to show investors the importance and potential of TFSAs as an investment and financial planning tool, given the wide range of investments it is possible to hold within these plans.”
Individuals can use TFSAs to hold most the investments eligible for RRSPs: stocks, bonds, mutual funds, exchange-traded funds, guaranteed investment certificates and cash – without any tax consequences on the gains these assets realize.
Recognizing that TFSAs now offer greater planning options, Heather Holjevac, senior wealth advisor with TriDelta Financial Partners Inc. in Oakville, Ont., outlines several ways in which clients may use TFSAs. For example, she suggests using TFSAs during retirement to shelter interest income for high-income retirees. That is, if a client is not expecting his/her tax rate to decline during retirement, then it will be prudent to maximize the use of TFSAs, which will provide tax-free income. (See story, page B4.)
Holjevac also suggests using TFSAs as an accelerated growth strategy by putting high-growth assets that could double in value over a longer period. TFSAs also can be used for income splitting by gifting any unused contribution room to adult children. In the case of income splitting, TFSA rules allow monies to be rolled over to a successor annuitant by Dec. 31 of the year following the year of the annuitant’s death.
Holjevac advises that because contribution room is cumulative, unused room can be used for estate planning and retirement planning: for example, a lump sum realized from the sale of a family home during retirement can be added to the TFSA at a future date to maximize contribution room not previously used.
Sullivan typically considers a differentiated TFSA strategy for his clients. For younger clients in the saving/accumulation phase of their lives, he generally recommends TFSAs together with RRSPs, whenever possible, as the two main savings/investment vehicles.
However, for clients with more investible assets who are further along in the wealth-accumulation process, he says, he “would normally counsel them to ensure every possible contribution has been made to their TFSA and then consider RRSPs or individual pension plans.”
Sullivan also notes that income and withdrawals do not affect government income-tested benefits or credits such as the old-age supplement. TFSAs also are tax-efficient saving and investing tools for clients planning to buy a home or other big-ticket items.
Although the TFSA has many advantages, it cannot be used to carry on a business; that would conflict with the TFSA’s purpose, which is to assist Canadians in saving. From a practical point of view, the prohibition generally is aimed at highly active investment traders, such as day traders. These taxpayers cannot use the TFSA to shelter their winnings.
And the Canada Revenue Agency (CRA) is watching. Highly active traders who use TFSAs face audits from the CRA. The result is that many such traders are being found liable for taxes on their gains.
However, there is little clarity about what is deemed to be “carrying on a business” in a TFSA, although active traders who have amassed a significant buildup in the value of their TFSAs should be prepared for inquiries from the CRA.
The issue remains contentious, and further guidance from the CRA does not appear to be on the horizon. As CRA spokeswoman Mylène Croteau says, “Due to the vast number of multi-faceted investments and arrangements that could exist, it is difficult for the CRA to provide more specific guidance than the significant guidance that already exists in the public domain.”
She suggests that the CRA is committed to providing further guidance as required on the various anti-avoidance rules that apply to TFSAs and she points out that the tax agency has an administrative process in place through which any taxpayer can request an advance ruling on a transaction that the taxpayer is contemplating.
In the absence of specific guidance, the CRA appears to be using the following criteria to determine whether TFSA holders are carrying on a business, says Henry Korenblum, tax manager with Kestenberg Rabinowicz Partners LLP in Markham, Ont.: frequency of transactions; period of ownership; knowledge of securities markets; whether security transactions form part of the taxpayer’s ordinary business; time spent studying the securities markets; advertising to purchase securities; financing securities primarily on margin or by using some form of debt; and the speculative nature of the securities involved.
Thus, for example, Korenblum says: “If the CRA identifies a taxpayer who is making frequent trades and has knowledge of the financial markets, and has accumulated significant gains, the CRA may argue that based on a ‘balance of probabilities,’ the individual is carrying on a business within his/her TFSA.”
The level of activity or dollar value accumulated in a TFSA that will trigger an audit remains unclear. Says Sullivan: “We do know that the main trigger for such investigations and audits is total TFSA value.”
Although there is speculation that a $100,000 value will trigger an audit, Sullivan suggests that there is no certainty that the CRA is using this level. He is aware of cases in which audits are taking place at lower asset levels.
Sullivan believes that other situations also may draw the attention of the CRA, such as large withdrawals from TFSAs that are in excess of original contributions; numerous and frequent trades; the purchase of private-company shares, for which less than perfect information flow may be present and for which share values rise quite rapidly upon further rounds of financing to ever-higher price levels; or when a private company goes public at some multiple of the price when the shares are contributed to the TFSA.
There is growing pressure for better guidance from the CRA. Korenblum notes that the Investment Industry Association of Canada has requested clear guidelines from the CRA that TFSA holders can follow when placing trades so that they are not considered to be carrying on a business in the view of CRA.
Financial services institutions that maintain TFSA trusts also have requested assurances from the Department of Finance and the CRA that they will not be liable for any tax liabilities arising from TFSAs that are found to be used in carrying on a business.
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