It’s happened again. Yet another taxpayer has been hit with harsh penalty tax for inadvertently overcontributing to his TFSA. And the Canada Revenue Agency isn’t being very nice about forgiving the matter.
Before turning to the facts and circumstances of this most recent case, let’s review the general rule regarding overcontributions. If you overcontribute to your TFSA (or RRSP, for that matter), you will face a penalty tax of one per cent per month for each month the overcontribution remains in the plan. Fortunately, the Income Tax Act gives the CRA the ability to waive the penalty tax if you can demonstrate that the overcontribution occurred because of a reasonable error.
To request a waiver of the penalty tax, an affected taxpayer needs to forward a detailed written request to the TFSA Processing Unit in Sudbury or Winnipeg with all relevant information, explaining “why it would be fair to cancel or waive all or part of the tax.” But just because you ask for relief, doesn’t mean the CRA has to grant it. And if they refuse to grant it, you can take your case to Federal Court, asking a judge to review whether the CRA’s decision to deny relief was reasonable.
That’s exactly what happened in the recent case, decided late last month. The case involved a taxpayer who, in 2016, had a TFSA contribution limit of just over $10,000. On Jan. 8, 2016, he contacted his financial institution by telephone to make a $10,000 TFSA contribution. Ten days later, he phoned back his financial institution to ask if the contribution he had made via telephone had been processed. Unfortunately, the clerk on the phone failed to see that a colleague had already processed the Jan. 8 contribution and proceeded to redo it, resulting in an overcontribution of $10,000.
But things got worse. In June 2016, the taxpayer contacted his financial institution about rumours he had read in the news concerning its demise. The taxpayer was then advised to split his deposits between two separate entities owned by the financial institution to have the benefit of Canada Deposit Insurance Corporation protection. The taxpayer followed this advice and gave directions over the phone to split his accounts. Unfortunately, these directions were mistaken for an order to contribute a further $10,000 to a TFSA rather than transfer $10,000 from one TFSA to another. Thus, the taxpayer ended up with $30,000 of total TFSA contributions in 2016, rather than the $10,000 he intended to contribute.
The $20,000 of excess contributions went undiscovered until July 2017, when the taxpayer received an assessment from the CRA for $1,800 in penalty taxes. The taxpayer immediately withdrew $20,000 from his TFSA, depositing this amount back to his bank account and applied for relief from the CRA from the taxes and penalties caused by the overcontributions.
In September 2017, the CRA denied his request. He then requested a review of this denial. In May 2018, the CRA once again declined the taxpayer’s request, as he was, apparently, in the words of the CRA, “a repeat overcontributor to his TFSA.”
The CRA based this on the fact that in 2014, the taxpayer, who had TFSA contribution room of $5,500, contributed that amount to a TFSA. In June 2016, he withdrew $5,500 from his TFSA and personally deposited that amount in another TFSA account with a different financial institution. Under the Tax Act,however, this is considered to be a withdrawal and contribution.
Withdrawals from a TFSA get added to your available TFSA contribution room, but only in the following calendar year. If you simply walk into your financial institution and withdraw all your TFSA funds and walk across the street to a competitor to make a new contribution, unless you have unused TFSA contribution room, you will be in an overcontribution situation and subject to penalty tax. The right way to do this is via a direct transfer from one financial institution to the other.
In 2015, the CRA assessed the 2014 transactions as two separate contributions, and applied penalty tax and interest totalling $440. The taxpayer objected to this assessment and, ultimately, in June 2016 the CRA waived the tax on the basis that the excess TFSA contribution occurred due to a transfer between financial institutions.
In refusing to grant relief for the 2016 overcontributions, the CRA stated that the taxpayer “continued to make excess contributions to (his) TFSA in 2016, after (he was) notified by the (CRA) about TFSA excess contributions made in 2014.” The CRA thus concluded that the taxpayer was a repeat overcontributor to his TFSA account, which he had been advised of, and that a “clerical error at his financial institution was not a reasonable error.”
The taxpayer felt that the 2016 assessment “was done in a mechanical way, with a purely robotic approach, and no qualitative factors or mitigating circumstances entered into making the decision.”
The judge, sympathizing with the taxpayer, ruled that his inadvertent TFSA overcontribution in 2014 was not connected to the question of whether relief should be granted regarding the 2016 TFSA overcontributions. In the judge’s view, “it was unreasonable for the (CRA) to consider the 2014 overcontributions and the notices received by the (taxpayer) in that regard when assessing whether relief should be granted in respect of the 2016 excess contributions.”
Calling the CRA’s characterization of the taxpayer as a repeat overcontributor “unjustified,” the judge concluded that the CRA’s decision was “unreasonable because it did not fully assess the extent to which the excess contributions resulted from the mistakes of persons other than the taxpayer.”
While the taxpayer had hoped the judge would simply cancel the $1,800 in penalty tax and interest, the judge could not do so. As he wrote, the court “does not have the jurisdiction to order the (CRA) to waive taxes, penalties, and arrears interest. The jurisdiction of the Court is limited to ordering the (CRA) to substantively reconsider (its) decisions.”
The judge therefore concluded that the CRA’s decision was “not reasonable” and should be returned to the CRA for reconsideration by a different officer.