Published: December 15, 2022
Last Updated: December 15, 2022
Introduction – Tax Penalty and Interest Relief for Overcontributions to a TFSA
As of 2009, Canadian tax residents over 18 years old have been entitled to establish a tax-free savings account (“TFSA”). Unlike a Registered Retirement Savings Plan (“RRSP”), you are not entitled to deduct your contributions to a TFSA against your income. In turn, the withdrawals made from a TFSA will be tax-free. Thus, a Canadian taxpayer does not pay tax on interest, dividends, capital gains or other income that accumulates within a TFSA.
The TFSA is a powerful tax planning tool for families and individuals to begin saving for retirement or significant life purchases, like a family home. Your ability to contribute to a TFSA is not unlimited, however, and is capped by the Canadian Income Tax Act. For each year that a Canadian tax resident has been eligible to establish a TFSA, the dollar limit for contributions increases by roughly $5,000 to $6,000 per year, with rates gradually adjusted for inflation. The dollar limit is cumulative, and so an individual’s contribution room will increase every year, even if a TFSA was never opened by or contributed to by an individual.
Excess contributions above an individual’s TFSA dollar amount can generate significant tax penalties. If, at any time during the year, you make a TFSA contribution that exceeds your TFSA contribution room, subsection 207.02(1) of the Income Tax Act imposes a penalty tax on that excess contributed amount at a rate of 1% per month. You must also file a special tax return reporting the TFSA penalty tax (Form RC243, “Tax-Free Savings Account Return” and Form RC243-SCH-A, “Schedule A – Excess TFSA Amounts”), and you may suffer additional penalties for failing to file this return should you be aware of the overcontributed amounts. The penalty tax is also subject to interest at the prescribed rate.
The Canada Revenue Agency (“CRA”) is granted the power to waive some or all of an individual’s accrued penalties and interest for excess contributions to a TFSA under the Income Tax Act. More specifically, subsection 207.06(1) of the Income Tax Act provides that the CRA may exercise its discretion if the taxpayer establishes that the liability was:
- The consequence of a reasonable error; and
- The excess TFSA amounts are removed from the TFSA without delay.
Both elements of the test must be satisfied before the CRA is entitled to provide relief. The case of Singh v. Canada, 2022 FC 346 (“Singh”) demonstrates that, even if the circumstances a taxpayer faces are sympathetic, that it may not be enough for the CRA to offer discretionary relief from penalties and interest for overcontributions to a TFSA. The taxpayer in Singh escaped the worst of TFSA overcontribution penalties and interest given the amount of money involved. However, had the taxpayer been more diligent with managing her tax affairs, she may have been able to avoid years of litigation. If you are ever in doubt concerning your TFSA contributions or what opportunities may exist under the Income Tax Act to benefit from CRA’s relief programs, you should be proactive and consult an expert Canadian tax lawyer.
The Facts of Singh
The Appellant taxpayer received $41,000 in proceeds from the sale of her house following her divorce from her husband. On the advice of her bank advisor, she moved those funds into her TFSA. However, the taxpayer failed to obtain expert Canadian tax advice and therefore made two crucial errors:
- The taxpayer’s contribution room was well below $41,000 in the year that she moved the funds into her TFSA. The bank advisor had failed to explain to the taxpayer that there was a contribution limit to TFSA accounts.
- Following the sale of her former house, the taxpayer’s husband filed her tax returns. The taxpayer’s husband failed to update her mailing address with the CRA, and the taxpayer never did so herself. She thus missed any letters the CRA had sent her concerning her overcontributions.
The taxpayer continued contributing funds to her TFSA throughout 2016 and 2017. On the taxpayer’s 2017 notice of assessment, she was notified that she owed $3,733.04 in tax, interest and penalties on her excess TFSA contributions. The taxpayer moved to pay the outstanding amount immediately when she had learned of the fact.
The taxpayer applied for relief under CRA’s Taxpayer Relief Program twice in 2019, unsuccessfully. After exhausting CRA’s internal review options, the taxpayer launched a self-represented appeal to the Federal Court for judicial review of the CRA’s decision concerning her second taxpayer relief application. The taxpayer argued that the CRA’s decision to decline awarding relief from penalties and interest was unreasonable.
The Ruling of the Federal Court of Canada
On judicial review, the Canadian tax litigation lawyer for the CRA argued that the taxpayer’s error was not a reasonable error. The Federal Court observed that the applicable standard for judicial review followed from the Supreme Court of Canada’s decision in Canada (Minister of Citizenship and Immigration) v. Vavilov, 2019 SCC 65. Specifically, under the Vavilov framework, a reviewing court must consider whether the CRA’s reasoning process, in light of the experience of its delegate, suffered from a “failure of rationality internal to the reasoning process”, or whether the decision was “untenable in light of the relevant factual and legal constraints.” Absent an exceptional case, a reviewing court will not interfere with the factual findings made by a decision-maker, and the reviewing court must treat the decision made with deference.
In applying the Vavilov framework, the Federal Court found that the CRA’s decision to deny relief was reasonable. The taxpayer argued that she had not made the mistakes purposefully, and that the wrongful advice of her bank advisor combined with her husband’s failure to update her mailing address prevented her from receiving the letters from the CRA advising her of her TFSA contributions, which would have prompted her to correct the matter. The Federal Court concluded, however, that the CRA acted reasonably in finding that the taxpayer was ultimately responsible for meeting her obligations under the law. The assessment of a reasonable error falls on an objective view of a taxpayer’s circumstances. Specifically, the issue concerning her bank advisor’s failure to communicate TFSA contribution limit rules to her was an issue solely between herself and her bank. Further, the CRA is only obligated to show that notice is sent to the latest address of a taxpayer, and not receipt of notice, to hold a taxpayer accountable for taxes owing. The nature of Canada’s self-assessment system for taxes required that taxpayers act diligently in reporting to CRA and acting in response to CRA’s communications. Intent may be a factor that can be considered by CRA in finding whether an error was reasonable or not, but is unlikely to constitute a reasonable error in of itself.
Pro Tax Tip: Keep Your Information with the Canada Revenue Agency Up-To-Date
As discussed above, the CRA’s power to waive penalty tax on TFSA overcontributions is largely a discretionary power. Although the CRA is required to view every situation holistically and on its own facts, it has expressed that an error is more likely to be viewed as reasonable where it was the result of extraordinary circumstances beyond a taxpayer’s control. More specifically, this might include cases where a taxpayer is facing a serious illness, or where the actions of the CRA itself resulted in the error.
The CRA has consistently taken the position that ignorance of law alone will not constitute a reasonable error. A lack of awareness concerning a taxpayer’s TFSA contribution room therefore may not meet the threshold of reasonable error. And as can be seen in the case of the taxpayer in Singh, the failure to update your mailing address to receive letters on-time from CRA is also not a reasonable error. It is your responsibility to remove over-contributions from your TFSA account as soon as you are aware of the error. The CRA will treat any letter that it sends to a taxpayer as effective notice of their over-contributions. It is absolutely crucial that you ensure your information with CRA is up-to-date and current so that you do not miss any letters. Your mailing address provided to CRA is not a declaration of your residence status and is only an administrative matter used to ensure that you receive communications from the CRA. Should you receive a letter from the CRA about over-contributions to your TFSA account, you should immediately speak with one of our expert Canadian tax lawyers to discuss your options for applying for relief from TFSA overcontribution penalty tax.
FAQs
What are the TFSA over-contribution rules?
Excess contributions to your tax-free savings account result in a TFSA penalty tax. If, at any time during the year, you make a TFSA contribution that exceeds your TFSA contribution room, you incur an TFSA penalty tax on the excess amount at a rate of 1% per month. You must also file a special tax return reporting the TFSA penalty tax (Form RC243, “Tax-Free Savings Account Return” and Form RC243-SCH-A, “Schedule A – Excess TFSA Amounts”), and you may suffer an additional penalty for failing to file this return. The penalty tax is also subject to interest at the prescribed rate.
What are the conditions for obtaining relief from TFSA overcontribution penalties and interest under the Income Tax Act?
The Canada Revenue Agency (“CRA”) is granted the power to waive some or all of an individual’s accrued penalties and interest for excess contributions to a TFSA under the Income Tax Act. More specifically, subsection 207.06(1) of the Income Tax Act provides that the CRA may exercise its discretion if the taxpayer establishes that the liability was:
- The consequence of a reasonable error; and
- The excess TFSA amounts are removed from the TFSA without delay.
Both elements of the test must be satisfied before the CRA is entitled to provide relief.
What was the Federal Court’s judgement in Singh v. Canada, 2022 FC 346?
The Federal Court found that the CRA had acted reasonably in denying the taxpayer relief from TFSA over-contribution penalty tax. The taxpayer had failed to update her mailing address after moving from her family home and had received erroneous advice from her bank advisor about TFSA contribution limits. The CRA found that her ignorance of the tax law was not a reasonable error, and that it was her responsibility to update her mailing address to receive communications from the CRA notifying her of her over-contributions. Although the taxpayer never intended to over-contribute, the Federal Court found the CRA was justified in concluding that the over-contributions were not the result of a reasonable error.
Disclaimer:
"This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a lawyer."
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