Question
In a recent internal technical interpretation,
the CRA indicated that where common shares of a company are issued to a tax-free savings account (TFSA) of a key employee as part of a freeze, the CRA considers the shares’ FMV increase to be an “advantage” as defined in subsection 207.01(1) of the Income Tax Act
—that is, a benefit taxable to the employee.
What is the basis for this position, and how should the value of this advantage be determined? Can the CRA clarify whether it would attempt to put a value on the new common shares at the time of the transfer, or whether the value must be determined annually on the basis of the future FMV growth? Does it matter whether the issuer is a public company or a private company?
Response
Section 207.05 imposes a special tax if an advantage is extended to the holder of a TFSA, the TFSA itself, or any other person not dealing at arm’s length with the holder. “Advantage” is defined in subsection 207.01(1) to include any increase in the total FMV of property held in connection with a TFSA that can reasonably be considered to be attributable, directly or indirectly, to
- a transaction or event (or a series of transactions or events) that would not have occurred in an open market between arm’s-length parties acting prudently, knowledgeably, and willingly, and one of the main purposes of which is to benefit from the tax-exempt status of the TFSA;
- or a payment received in substitution for either (1) a payment for services rendered by the holder or non-arm’s-length person, or (2) a payment of a return on investment or proceeds of disposition in respect of property held outside the TFSA by the holder or non-arm’s-length person.
In the case of an advantage described above, the amount of tax payable is equal to 100 percent of the increase in FMV of the TFSA property. A separate tax is payable for each advantage, and the liability to pay the tax generally lies with the holder of the TFSA.
We confirm that it remains the CRA’s view that the transactions described in the question would be considered an advantage.
The CRA is also of the view that the words “directly or indirectly” in the definition encompass not only the increase in the FMV of the TFSA resulting from the share issuance, but also all future increases in FMV that are reasonably attributable to the initial advantage. These increases include, for example, any increase in FMV of the TFSA or any other TFSA of the holder that is reasonably attributable to any dividends paid on the shares, any capital appreciation in value on the shares or on any substituted property (whether realized or not), and any income earned on income. Because the advantage tax is required to be remitted annually, it would be necessary to determine the total increases in FMV annually.
The fact that the company might be a public company would not be a relevant factor in determining whether shares issued to a key employee’s TFSA as part of a freeze are subject to the TFSA advantage rules.
We would also like to take this opportunity to discuss several tax-planning schemes involving TFSAs that have come to our attention. These schemes purportedly enable taxpayers to effectively avoid the statutory limit on TFSA contributions and, in some cases, to avoid paying tax on withdrawals from registered retirement savings plans (RRSPs) and other registered plans or on otherwise taxable income.
The Department of Finance announced on October 16, 2009
several measures to address these schemes. Briefly, the proposed measures include a ban on trading activities between a TFSA and the taxpayer’s registered or non-registered accounts. It is also proposed that any income earned on deliberate TFSA overcontributions or prohibited investments will be treated as an advantage and thus as subject to a 100 percent tax.
While these proposed amendments apply on a prospective basis only, the CRA intends to closely review any unusual TFSA transactions that took place before the announcement (as well as those that occur after the announcement) and, in appropriate circumstances, to apply existing anti-avoidance rules to challenge the purported tax benefits being claimed.
The TFSA advantage rules give the CRA significant scope to challenge schemes that are designed to avoid the TFSA statutory contribution limit or to shift taxable income away from a taxpayer and into the shelter of a TFSA. Schemes that rely on unfairly valued transactions, artificial transactions, or transactions that would not reasonably be expected to occur between arm’s-length parties dealing in an open market are clearly caught by the advantage rules and will be challenged by the CRA where appropriate.
The CRA may also challenge the valuation of the transaction or assert that the transaction is not legally effective. In such circumstances, the transaction may be treated as a contribution to the TFSA and thus taken into account in determining the 1 percent per month tax on TFSA overcontributions. Where the transaction involved an RRSP or other registered plan, it may be treated as a taxable withdrawal from the registered plan. The CRA may also, in appropriate circumstances, hold the financial institution that administers the registered plan liable for any unremitted withholding tax and associated penalties.
In addition to tax consequences that may be present under the TFSA-specific rules, the CRA may, in appropriate circumstances, apply the general anti‑avoidance rule (GAAR) to deny the tax benefit that was obtained by virtue of the transaction or assess third‑party penalties or gross negligence penalties.
We wish to remind taxpayers and their advisers that the CRA has a number of compliance tools at its disposal to challenge TFSA schemes, up to and including criminal prosecution for the most egregious cases. We encourage any taxpayers who were involved in these schemes to avail themselves of the CRA’s voluntary disclosure program.
