If you accidentally overcontribute to your tax-free savings account (

TFSA

), you will face the dreaded overcontribution penalty tax, which is equal to one per cent per month for each month you’re accidentally over the limit. You can request that the

Canada Revenue Agency

waive or cancel the tax, which it has the power to do, if it can be established that the tax arose “as a consequence of a reasonable error” and the overcontribution is withdrawn from the TFSA “without delay.”

But what if by the time you realize that you overcontributed, the fair market value of the investments inside your TFSA has plummeted to such an extent that it’s below the value of the overcontribution you need to withdraw? Will the

monthly penalty tax

ever stop accruing?

A federal court judge, writing in the latest TFSA overcontribution case just released, called this a “perpetual tax trap” for the unfortunate taxpayer, adding that it “appears to be inconsistent with (Parliament’s) intent.” Let’s review the details of this recent case before considering, practically, what a taxpayer might do should they find themselves in such a dilemma.

The taxpayer’s TFSA woes began back in December 2017, when he opened a TFSA with online broker Qtrade. His portfolio consisted largely of penny stocks. In 2018, he also contributed to a separate Sun Life Financial Inc. TFSA. He contributed a total of $183,000 to his TFSA accounts, resulting in a total overcontribution of $131,719. In July 2019, the CRA issued the taxpayer a TFSA Notice of Assessment (NOA) for 2018 resulting in $6,424 of tax, interest and penalties. The taxpayer received this NOA, but claimed that he misunderstood it, believing that it applied to unpaid regular income tax, and therefore simply paid it.

In 2019, the taxpayer contributed an additional $70,562 to his TFSAs when only $6,000 of new room opened up for 2019. Thus, by the end of 2019, he had overcontributed a total $196,281 to his TFSAs. In July 2020, the CRA issued a TFSA NOA for 2019, and assessed him an additional $22,086 in overcontribution tax, interest and penalties. Once again, the taxpayer claimed that he misunderstood the 2019 NOA and thought that it applied to unpaid income tax.

In 2020, the taxpayer contributed a further $33,894 to his TFSAs, such that by the end of 2020, he had overcontributed $224,175 to his TFSAs. In July 2021, the CRA issued a TFSA NOA for the 2020 taxation year, assessing $26,522 in tax on excess TFSA amounts, as well as penalties, interest and a previous unpaid for a total balance owing of $44,114.

According to the taxpayer, it was only after receiving this 2020 NOA, in July 2021, that he understood the nature of the overcontribution issue. By that time, however, the value of his Qtrade account had fallen below the amount necessary to withdraw the excess and therefore, according to him, he could not simply liquidate his portfolio to the required amount.

Notwithstanding the taxpayer’s overcontribution situation, the taxpayer still made further contributions to his TFSAs in 2021, including into yet another TFSA account he opened in July 2021, with Industrial Alliance (IA) Financial Group. The taxpayer said that he had meant to open an RRSP account. He also continued to contribute to his Sun Life TFSA.

In July 2022, the CRA issued a TFSA NOA for 2021 taxation year, assessing $27,364 tax on excess TFSA amounts, which with penalties, interest and a previous unpaid balance brought the total owing to $72,552.

In January 2023, the taxpayer closed his Qtrade account and transferred all its remaining assets to his non-registered account. Although he had deposited a total of $288,500 into this account over time, the value of his TFSA portfolio had plummeted to $21,810. In February 2024, after meeting with his accountant who informed him that his IA account was also a TFSA, the taxpayer closed the IA account as well.

The taxpayer wrote to the CRA requesting a waiver and cancellation of all the taxes, interest and penalties payable resulting from his overcontributions, saying they were “inadvertent” because when he opened the Qtrade account, he had intended to open a regular trading account and did not realize that it was a TFSA.

He further argued that by the time he realized it was a TFSA, because he had invested in penny stocks that went to zero, the overcontributed money no longer existed, making it impossible for him to fully comply with the CRA’s notices to withdraw the entire amount immediately. He argued that it would be unfair for him “to be subject to (overcontribution) tax for the next several decades, which is how long it would take the annual contribution room increases to catch up with the overcontribution.”

The CRA rejected these arguments, which is why the matter ended up in court.

The judge, after a careful review of all the evidence, found that the CRA’s decision not to waive the tax was reasonable. She felt that the taxpayer should have been alerted to his TFSA overcontributions by the NOAs, the first page of which clearly indicates “TFSA NOA,” and the second page which says “you contributed too much to your TFSA.” In addition, the monthly Qtrade statements he had been receiving since December 2017 clearly describe the type of account as a “TFSA.”

In a final comment, the judge did share the taxpayer’s concern that, in certain circumstances, “prolonged and ongoing liability to remedy overcontributions appears to be inconsistent with the legislator’s intent. (The law) as it currently stands, operates as a perpetual tax trap for taxpayers who made a good faith but mistaken overcontribution, even when they acted to unwind it to the best of their ability but cannot do so because the value of their TFSA is no longer sufficient to do so.”

She noted that the CRA had asked the taxpayer repeatedly to close all his TFSA accounts and to provide the CRA with proof of this. While this may not assist the taxpayer with respect to prior years’ taxes and penalties, it may be interpreted as an invitation from the CRA for him to present “a clean record” and seek relief for any future overcontribution tax.

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Taxpayers who find themselves in a similar situation would best be advised to close out their TFSAs, and either seek a waiver from the CRA for future overcontribution tax, or consider

seeking a remission order

.

Jamie Golombek,
FCPA, FCA, CFP, CLU, TEP, is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto.
Jamie.Golombek@cibc.com

.

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