When a tax-free savings account isn’t tax-free

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Your Finances with Stephen Maltby

(Reprinted article by Jamie Golombek, CIBC Wood Gundy)


The Tax Free Savings Account (TFSA) is supposed to be tax-free, as its name implies. Yet, there are several situations in which a TFSA may not live up to its tax-free moniker. Let’s examine three scenarios where this can be the case.

The first scenario is where you accidentally end up “over contributing” to your TFSA. Accidental over contributions are subject to a penalty tax of 1% for each month the over contribution remains in the TFSA while deliberate over contributions are

subject to a penalty tax of 100% of any income or gains resulting from the deliberate over contribution.

How can you innocently over contribute? The answer can often be traced to a misunderstanding of the TFSA withdrawal and recontribution rules.

Unlike an RRSP, if you withdraw funds from a TFSA, an equivalent amount of TFSA contribution room will be reinstated in the following calendar year. But the problem is that if you withdraw funds from a TFSA and then recontribute in the same calendar year without having the necessary contribution room, over contribution penalties could arise.

You can get tripped if you move a TFSA from one financial institution to another and simply withdraw the funds from one financial institution and walk across the street to deposit them at another financial institution the same day. This is considered to be a withdrawal and recontribution and could lead to some penalty tax. Instead, when moving TFSAs, be sure to do so by way of a direct transfer, rather than as a withdrawal and subsequent recontribution.

The second scenario in which you could face some tax on your TFSA income is where you have invested in a foreign stock inside your TFSA. If that stock pays foreign dividends, you may find yourself subject to foreign non-resident withholding tax.

While in a non-registered account, you get a foreign tax credit for the amount of foreign taxes withheld, if the dividends are paid to your TFSA, no foreign tax credit is available and thus the non-resident withholding tax has a direct impact on your net return.

For U.S. stocks, while, there is an exemption from withholding tax under the Canada-U.S. tax treaty for U.S. dividends paid to an RRSP or RRIF, this exemption does not apply to U.S. dividends paid to a TFSA.

Finally, if you are a U.S. citizen, you should likely steer clear of TFSAs altogether. That’s because U.S. citizens, even those living in Canada, are required to file a U.S. tax return and pay tax on their worldwide income annually. The U.S. doesn’t recognize the tax-free nature of the TFSA and thus you could end up paying U.S. tax on the TFSA’s income and gains. Even if you have enough excess foreign tax credits from your other Canadian income to avoid a U.S. tax bill, many tax practitioners consider the TFSA a foreign grantor trust which necessitates onerous and often costly annual U.S. tax reporting, negating

the tax-free benefit of the TFSA all together.


Stephen Maltby is an Investment Adviser and Chartered Accountant with CIBC Wood Gundy. He has been in the financial services industry for more then 30 years and has held various accounting, investment and management positions with several accounting and investment firms over the years. He is in addition to his Advisor role a First Vice-President and Executive Director Atlantic Canada, CIBC Wood Gundy.


Organizations: CIBC Wood Gundy

Geographic location: U.S., Canada

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