With CRA and TFSA rules, ignorance not an excuse for overcontributions

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As we wade through tax season anxiously awaiting those final few T5 and T3 slips for 2023 to arrive, we should ensure we’ve taken full advantage of the contribution room available to us in all the various registered plans in order to minimize the amount of taxable investment income we’ll need to report in future years.

With the cumulative tax-free savings account (TFSA) contribution room potentially as high as $95,000 in 2024 (assuming you were 18 and a resident of Canada since 2009), and this year’s annual dollar limit set at $7,000, there’s really no excuse for anyone to have any non-registered taxable investments if you haven’t fully maximized your cumulative TFSA contributions.

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You can check your TFSA contribution limit online by logging on to the Canada Revenue Agency’s online portal for individuals called My Account. But keep in mind your TFSA contribution and withdrawal information is not updated in real time and may be out of date. Check the “as of” date posted online alongside your TFSA room.

The reason for vigilance is to avoid the overcontribution penalty tax, which is equal to one per cent per month for each month you’re over your limit. A one per cent tax doesn’t seem like a lot, but the tax is one per cent per month for each month you’re over the limit until the overcontribution is withdrawn — that’s 12 per cent per year.

If you do get hit with a TFSA penalty tax, you can request the CRA to waive or cancel it, which the agency has the power to do if it can be established the tax arose “as a consequence of a reasonable error,” and the overcontribution is withdrawn from the TFSA “without delay.” If the CRA refuses to cancel the tax, you can take the matter to Federal Court, where a judge will determine whether the CRA’s decision not to waive the tax was “reasonable.”

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The most recent decision involving a TFSA overcontribution concerned a taxpayer who was assessed nearly $11,000 in penalty taxes, plus a late-filing penalty and arrears interest.

The taxpayer first opened a TFSA account in 2010, but only really started to “use it” in 2020. She testified that due to the onset of COVID-19, she had to take time off work to care for her daughter. Around that time, she decided to do some investing inside her TFSA and used her savings and some money lent to her from family members.

As of Jan. 1, 2020, the taxpayer’s TFSA contribution limit was $68,113. During 2020, she contributed $396,400 and made withdrawals totalling $299,296. As a result, given her limit of $68,113 at the beginning of 2020, she had overcontributed by $28,990 by the end of the year.

The CRA in July 2021 issued the taxpayer a TFSA Notice of Assessment (NOA) for the 2020 taxation year indicating she owed $10,815 in penalty tax based on her excess contributions to her TFSA for 2020, plus a late-filing penalty charge and arrears interest.

The taxpayer in January 2022 formally requested the CRA cancel the tax assessed on her excess TFSA contributions, noting that she “did not have sufficient information regarding the rules governing the use of TFSAs, and that she thought that a TFSA operated in the same manner as a regular savings account.” She added that she called the CRA to obtain further information once she became aware of her excess contribution.

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The CRA denied the taxpayer’s initial request for relief, noting that a “lack of knowledge of taxation rules cannot be considered beyond a taxpayer’s control as information is readily available on (the CRA’s) website and through (its) general inquiries telephone line.”

The CRA officer further noted “it is the responsibility of the taxpayer to be aware of the rules governing the administration of their TFSA,” and pointed out the taxpayer had held the TFSA for more than a decade before the overcontribution in 2020 occurred.

The CRA in July 2022 sent the taxpayer a second TFSA NOA, this time for the 2021 taxation year, notifying her she now owed $14,748 in connection with her remaining excess TFSA contributions from 2020, some of which remained unwithdrawn in 2021, plus additional interest and penalties.

The following month, the taxpayer wrote to the CRA requesting it to review its initial decision to deny her relief, reiterating she was “unaware of the rules, but had sought to correct her error.” She said she had contacted the CRA in connection with the NOA, but was advised to withdraw only the excess amount by the end of the year.

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Meanwhile, interest on the original amount owed was continuing to accrue. She added that she had lost the money invested through her TFSA, was on maternity leave, had not returned to the workplace for child-care and pandemic-related reasons, and did not have the ability to pay.

Fast forward to February 2023 when her case was reviewed by a second CRA officer, who again denied the taxpayer’s request to cancel the penalty tax, citing several reasons. The first was that the taxpayer had held her TFSA since 2010 and should have been familiarized with the rules.

In addition, her lack of knowledge of the rules cannot be considered as something “beyond her control” because such information and resources are widely available. The officer also noted the taxpayer was advised of the overcontribution in July of 2021, but only took steps to withdraw the excess amounts in 2022. This was not, in the view of the CRA, “within a reasonable time frame.”

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After being denied relief for the second time, the taxpayer appealed to the Federal Court seeking a judicial review of the CRA’s decision not to forgive the penalty tax. In these cases, the court’s role is to determine whether the CRA officer’s decision was reasonable.

In this case, the judge concluded it was. “A taxpayer’s lack of knowledge or misunderstanding does not render a CRA’s discretionary decision to not grant tax relief … (to be) unreasonable,” she said.

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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