Tax free savings account,
one of the most powerful investment accounts
that the government create for Canadians.
As the name suggests,
it offers tax sheltered growth
to flexible tax-free withdrawal,
making them an attractive choice
for many investors.
However, it’s important that you know the rules,
otherwise you’ll end up paying penalties.
In this video,
we will examine 5 case studies
of people who didn’t use their TFSAs correctly
and how it backfired on them.
Welcome back, This is Thomas!
Let’s quickly spend a min to recap
what Tax free savings account is.
One of the most significant benefits of a TFSA is,
not surprisingly,
the tax-free growth of your investments.
This means any income, dividends, or capital gains
earned within the account are not subject to tax,
allowing your investments to grow at
a faster rate compared to a taxable account.
This tax-free growth can make
a substantial difference in your
long-term investment returns,
particularly as your account balance
and investment horizon increase.
A TFSA also allows you to invest in
a wide variety of financial instruments,
such as stocks, bonds, and mutual funds.
This flexibility gives you the freedom
to create a diversified portfolio
that aligns with your financial goals,
risk tolerance, and investment preferences.
Whether you're an experienced investor
or just starting,
a TFSA can accommodate
your investment strategy.
And unlike RRSP,
withdrawals from a TFSA are not subject to tax.
This means that you can access your funds
at any time without incurring
any additional tax liability.
This feature makes TFSAs an attractive option
for those who want to save for
both short-term and long-term financial goals,
such as emergency funds,
home down payments, or even retirement.
Okay so it sounds great! What can go wrong?
Let’s go through 5 cases that the Canadians
actually have to end up paying
more taxes and penalty in TFSA.
They all taken to court to appeal
but most of the time end up losing the case.
For privacy purpose,
I will make up the names
As we know,
if you are unable to maximize your
TFSA contributions in a given year,
one of the great benefits is that
any unused contribution room can be
carried forward indefinitely.
This allows you to catch up on
your contributions in future years.
But that only applies if you are
a resident in Canada during those years.
Jane deposited $63,500 into
her TFSA back in December 2019,
which is the maximum room.
Neither the bank nor adviser know Jane
declared non residency in Canada for 3 years.
Therefore, the TFSA is way smaller than $63,500
The CRA sent her an educational letter
informing her of the overcontribution,
but she did not receive it until July 2021
due to being out of the country
during the global pandemic.
Upon learning about the overcontribution,
the taxpayer immediately
withdrew the excess amount.
However, the CRA said, it’s too late,
jane you over contributed for 2 years.
We are going to penalized you plus interest.
Jane made her appeal,
but the CRA denied her request,
forces jane to appeal to Federal Court.
After going back and forth with the court and CRA,
The judge disagreed with the
CRA's reasons for denying Jane’s appeal stating that
Jane could not withdraw the overcontribution
sooner due to not receiving the letter.
At the end,
The judge ordered an
independent review of the case,
emphasizing that the taxpayer
might still face the same outcome.
Now imagine all the time,
money and brain cell wasted during these 3 years.
And it could be avoided.
Alright, let’s move onto the second case study.
Back in 2011,
There was An investment adviser in Vancouver
helped his client’s TFSA grow
from $15,000 to over $617,000
in just three years by day trading penny stocks.
And when he sold everything in 2013,
he nearly made $550,000 on a tax free basis.
While everyone was busy trying to find out the
name of the advisor and want to hire him to work.
CRA immediately slapped a penalty on the TFSA.
Why? because the CRA said this is
a frequent trading activity.
It’s like conducting a business,
and the income generated within
the TFSA needed subject to income tax.
And the tax bill was around $200,000.
And of coz ,The case went to court.
The judge agreed with the CRA,
stating that there was no doubt the taxpayer was
conducting a day trading business within his TFSA,
based on his trading activity.
The Income Tax Act specifies that a TFSA is
generally exempt from tax on its income,
with two exceptions:
if the TFSA holds non-qualified investments
or carries on a business.
If either exception applies,
the TFSA must pay tax on its taxable income.
So end up the taxpayer lose the case
and have to pay the fine.
In short, avoid frequent trading in the TFSA.
The CRA considers factors such as
transaction frequency, holding duration,
intention to acquire securities for resale at a profit,
the nature and quantity of the securities,
and time spent on the activity when determining
whether gains from securities constitute
carrying on a business.
Okay, onto the third scenario where Henry tried
to buy private company shares in his TFSA.
Henry later was reassessed by the CRA for
receiving an "advantage" from the transfer
of private company shares to his TFSA.
He argued that the 100% penalty tax was not right,
as you can have a company’s share
in a TFSA and he took it to the court.
And, what’s the result?
First, Henry lost the case as the court said
the intention of those private company’s share
is very questionable and thus not eligible
to be withhold in a tfsa for tax advantage.
Henry did appeal the decision to the Federal Court,
which is likely to hear the case in 2023.
It's crucial to be aware of
what you are buying in your TFSA.
If it’s something not widely accepted,
then please triple check
with all the professional parties.
This Case involves the information from the
CRA My Account section while trying to
determine TFSA contribution limit.
Back in January,
Mary from British Columbia wants to contribute to
her TFSA but she forgot how much TFSA room she has.
So she went to CRA online and check her room.
The problem, however,
that CRA online is not updated in real time.
And usually, this numbers don’t get updated
until April or May.
So, when Mary log in January,
she thought she could still contribute 20,000
where in fact she could only do 6,000.
Therefore, CRA send her a letter and send her a fine
and later in the year,
they also denied Mary’s appeal.
Now Mary was pissed and took the matter to court.
So how did it go?
When it went to court, the judge acknowledged
the taxpayer's argument of making a reasonable error,
but ultimately concluded that the CRA's decision
not to waive the penalty tax was reasonable.
The judge stated that under the Canadian tax system,
taxpayers are responsible for understanding
their TFSA accounts and their limits.
The judge's decision upheld the penalty tax.
This case serves as a reminder for all of us to be
diligent when managing our TFSA contributions.
The Canadian tax system relies on us to
understand and comply with the Income Tax Act.
Again, always double-check your
TFSA contribution limits and be cautious
when relying on the CRA's My Account section,
as the information displayed
may not be updated in real-time.
The last case is about
John found himself in a challenging situation
after overcontributing to his TFSA in both
2018 and 2019 resulting in penalties.
So how did that happen?
Back in 2018,
John had $42,500 of TFSA room available,
so he maxed out the TFSA.
And in mid 2018,
he took out some money from his TFSA for his project.
The project did not go through,
so he contributed it back to the TFSA.
Guess what?
Because he already maxed out
his contribution in that year,
any additional deposit will consider over contribution
regardless if you took out the money or not.
The room does not reset until the following year.
And same thing happened in 2019,
John made another $6,000 contribution to his TFSA,
which further increased the overcontribution.
So the CRA said, that’s it. We are going to penalized you.
And John took the matter to federal court as well.
And as expected,
The court agree with the CRA's decision,
and john needs to pay the fine right away.
This case serves as another reminder that it's crucial
to understand your TFSA contribution limits
and to monitor your contributions carefully.
So what can you learn from these 5 examples?
Don’t do frequent trading
CRA online is not updated real time
Be mindful if you going to withdraw
and deposit it in the same year
Pick an investment that is widely acknowledge
And lastly, don’t try to outsmart the CRA.
Coz 99% of the time you can’t.
and for the remaining 1%,
CRA will find ways to get you back.
So to avoid costly penalties and legal battles,
be proactive in understanding your
TFSA contribution limits and tracking your contributions.
A little extra effort now can save you time,
money, and stress in the long run.
Alright! If you like me to go over more cases like this!
Please give me a thumbs up and make a comment!!
This is Thomas!
Thanks so much for watching!
And I will see you in the next video!