The “Advantage” Exception to TSFAs’ Tax-Exempt Status
Tax Free Savings Accounts (“TSFA”s) were designed to allow Canadians to increase their savings by earning tax-free investment income. While contributions to a TFSA are not tax‑deductible, gains earned within a TFSA are generally not taxed. There are exceptions to this general principle.
A recent Federal Court of Appeal decision addressed one of the TSFA exceptions.
The taxpayer was described as “a sophisticated investor with extensive knowledge of the stock market”, who had previously maintained a Canadian direct trading account and a self-directed Registered Retirement Savings Plan.
In January 2009, when the TFSA Rules were implemented, the taxpayer opened a TFSA with TD Waterhouse.
By May 2009, the taxpayer wanted to capture the gains she had earned on stocks held in her TFSA and RRSP accounts, and to shelter from tax the possible future gains to be made on stocks held in her trading account.
TD Waterhouse, as trustee of the taxpayer’s TFSA, confirmed that it permitted holders of TFSAs to conduct asset swaps between their accounts. Accordingly, the taxpayer decided to move stocks from her Canadian trading account to her TFSA and RRSP accounts in order to eliminate or defer tax payable on possible future gains.
In 2009 the taxpayer had completed 71 swap transactions relating to her TFSA.
In October 2009, TD Waterhouse advised the taxpayer that it would no longer permit swap transactions because of proposed amendments to subsection 207.01(1) of the Income Tax Act (the “Act”) which contains an exception to the rule that TSFAs are not taxable and provides, among other things, that a tax is payable for a calendar year in connection with a TFSA if, in the year, “an advantage in relation to the TFSA is extended” to the holder of the TFSA.
Subsequently, effective October 17, 2009, the definition of “advantage” was amended to include “swap transactions”. However, that amendment did not apply to the taxpayer’s case because all of her swap transactions occurred before October 17, 2009.
The swap transactions had significantly increased the proportion of the taxpayer’s capital stock held in her TFSA. The transactions also significantly increased the total fair market value of the taxpayer’s TFSA in the 2009 taxation year. She had made an initial contribution of $5,000 to the account in 2009 (the maximum contribution permitted for that year). The market value of her TFSA on December 31, 2009 was $206,615.
The taxpayer also made contributions of $5,000 to her TFSA in 2010, 2011 and 2012. As of December 31, 2010, the market value of her TFSA was $281,826. As of December 31, 2011 and December 31, 2012 the market value of the taxpayer’s TFSA was, respectively, $186,267 and $220,485.
The Minister reassessed the taxpayer in respect of the 2009, 2010 and 2012 taxation years to assess tax related to her TFSA. The Minister assessed the taxpayer on the basis that she had received an advantage within the meaning of that term as used in subsection 207.01(1) of the Act in each relevant taxation year. The advantage said to have been received in each year equalled the annual increase in the fair market value of the taxpayer’s TFSA, minus her contribution of $5,000.
The taxpayer appealed the reassessment to the Tax Court of Canada.
Tax Court of Canada Decision
The Tax Court of Canada dismissed the appeal for the 2009 taxation year, but allowed the appeals for the 2010 and 2012 taxation years.
It found that the taxpayer had received an “advantage” in relation to her TFSA in 2009, but had not received an “advantage” in 2010 and 2012.
Federal Court of Appeal Decision
Regarding the 2009 taxation year, the Federal Court of Appeal concluded that :
“While it is correct that almost none of the shares were sold, so that taxable income was not shifted between trading accounts, the result of the [taxpayer]’s strategy was to inflate the value of the TFSA so as to benefit from a tax-free distribution from her TFSA (as opposed to a taxable withdrawal from her RRSP or a taxable gain within her Canadian trading account).”
It dismissed the taxpayer’s appeal for that year, concluding that she had received an advantage.
Additionally, the court found that the Tax Court of Canada had erred in its interpretation of the definition of “advantage” found in paragraph 207.01(1)(b) of the Act and had erred in failing to find that the increase in the fair market value of the TFSA in 2010 and 2012 was indirectly attributable to the swap transactions undertaken in 2009 so as to fall within the definition of “advantage” in subsection 207.01(1).
As a result, the court allowed the appeal for the years 2010 and 2012, finding that the advantage tax also applied to those years and the taxpayer was liable.
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