Overview of the Tax-Free Savings Account (“TFSA”)

In order to encourage Canadians to increase their savings, in 2009 Finance Canada and Canada Revenue Agency ("CRA") introduced a new type of savings vehicle: the Tax-Free Savings Account ("TFSA"). Any interest, capital gains and other investment income that you earn in your TFSA is exempt from income tax both while it stays in the TFSA as well as when you withdraw the income from your account.

Every Canadian resident, who is at least 18 years old, and has a Social Insurance Number, is eligible to open a TFSA, and can contribute up to $5,000 per calendar year. You can accumulate contribution room if you don't contribute the full amount in a year, meaning that if you have not used your full contribution room in previous years, you can carryforward the unused amount to future years.

Most banks now offer a savings account product that qualifies as a TFSA. However, the TFSA program is not limited to bank accounts - certain mutual funds and brokerage accounts also qualify.

Difference between TFSAs and RRSPs

TFSAs and RRSPs both shelter your investments from tax while they are held in the account. However, the treatment of contributions and withdrawals differs.

RRSP contributions come from before-tax dollars, because these contributions reduce your taxable income in the year of the contribution. Furthermore, when you withdraw contributions and investment income from your RRSP, your withdrawals are fully taxable as income in the year of withdrawal. For example: in 2011, your net income is $50,000. If you contribute $5,000 to your RRSP, your taxable income is reduced to $45,000. Further assume that by 2021 your $5,000 RRSP investment has grown to $7,000. If you withdraw the $7,000 in 2021, the full amount of $7,000 will be added to your taxable income in 2021.

In contrast, TFSA contributions are made with after-tax dollars, and do not reduce your taxable income in the year of the contribution. However, when you withdraw contributions and investment income from your TFSA, the withdrawals do not increase your taxable income – in other words, TFSA withdrawals are tax-free. For example: in 2011, your net income is $50,000. You contribute $5,000 to your TFSA. Your taxable income is unaffected, and remains at $50,000. Assuming that in 2021 your $5,000 TFSA investment has grown to $7,000, and you withdraw the $7,000 in 2021, the full amount of $7,000 will be tax-free to you in 2021.

We can assist you in deciding between investing in an RRSP or a TFSA.

Over-Contributions to TFSA

As noted earlier, you are allowed to contribute up to $5,000 to your TFSA in each year. However, withdrawals from your TFSA do not affect your contribution limit within the same year. For example, let's say you contributed $5,000 to your TFSA in June 2009, and then withdrew $2,000 in September 2009. Although you would only be left with a balance of $3,000 in your TFSA, you would still have used up your $5,000 contribution room for 2009. If you were to redeposit the $2,000 in October 2009, you would have contributed a total of $7,000 in the 2009 taxation year, even though your TFSA account balance would then be sitting at $5,000. While withdrawals do not make space for additional contributions within the same year, your contribution room is corrected for withdrawals in the following year. In the situation described here, CRA would consider you to have made an over-contribution of $2,000, and would charge you a penalty tax. CRA strictly enforces the penalty taxes for over-contribution. This penalty tax is calculated based upon the highest excess balance in the TFSA in each month, and the penalty is 1% of this amount each month. As such, it is very important to keep track of your contributions in a year, and ensure that they do not exceed the contribution room you have available.

After you file a tax return, your Notice of Assessment issued by CRA will state the amount of TFSA contribution room available to you as of the date of the assessment, and this amount should be adjusted to compensate for any withdrawals made in the previous year.

Transfers between TFSAs

It is possible to transfer amounts between two TFSAs held by the same taxpayer, without affecting the taxpayer’s TFSA contribution room.  However, in order to avoid over-contribution penalties, these transfers must be made directly from TFSA #1 to TFSA #2.  If you withdraw from TFSA #1 into your chequing account, and then transfer from your chequing account into TFSA #2, this transfer will be considered to be a new TFSA contribution.  If you have already used up your contribution room for the year, this will then constitute an over-contribution and attract penalties.

It is also possible to transfer amounts between the TFSAs of separated/former spouses, without affecting the spouses’ TFSA contribution room.  This is only permitted if the spouses are living apart, and the transfer is pursuant to a court order or a written separation agreement.  This transfer must also be made directly from one TFSA to the other.  If the transfer is made indirectly, via non-TFSA accounts, the spouses’ contribution room will be affected, and the transfer may attract penalty tax.

Conclusion

If you have not yet opened a TFSA, you should have $20,000 in available contribution room for 2012.  This is a great opportunity to earn interest or investment income tax-free. 

If you have any questions regarding compliance with the TFSA rules, feel free to contact us by clicking here.

The GST is a tax that applies to the supply of most property and services in Canada. The provinces of Nova Scotia, New Brunswick, and Newfoundland and Labrador, referred to as the participating provinces, harmonized their provincial sales tax with the GST to create the HST. Generally, the HST applies to the same base of property and services as the GST. In some participating provinces, there are point-of-sale rebates equivalent to the provincial part of the HST on designated items.

As of July 1, 2010, Ontario harmonized its retail sales tax with the GST to implement the HST at the rate of 13% and British Columbia harmonized its provincial sales tax with the GST to implement the HST at the rate of 12% although, the HST in BC has now been repealed. Also, as of July 1, 2010, Nova Scotia increased its HST rate from 13% to 15%.

Almost everyone has to pay the GST/HST on purchases of taxable supplies of property and services (other than zero-rated supplies). A limited number of sales or supplies are exempt from GST/HST.

Although the consumer pays the tax, businesses are generally responsible for collecting and remitting it to the government. Businesses that are required to have a GST/HST registration number are called registrants.

Registrants collect the GST/HST on most of their sales and pay the GST/HST on most purchases they make to operate their business. They can claim an input tax credit, to recover the GST/HST paid or payable on the purchases they use in their commercial activities.

GST/HST registrants must meet certain responsibilities. Generally, they must file returns on a regular basis, collect the tax on taxable supplies they make in Canada, and remit any resulting net tax owing.

Taxable, zero-rated, and exempt supplies?

It is important to know which property and services are taxable and at what rate. You also need to know which property and services are exempt from the GST/HST.

Taxable supplies

Most supplies of property and services supplied in or imported into Canada are subject to the GST/HST.

The GST is a tax that applies to the supply of most property and services in Alberta, Manitoba, North West Territories, Nunavut, Prince Edward Island, Quebec, Saskatchewan and the Yukon. The GST rate for these provinces and territories is 5%.

The HST is a tax that applies to the supply of most property and services in participating provinces of Nova Scotia, New Brunswick, Newfoundland and Labrador and Ontario. The HST is composed of the GST and their respective provincial tax. Generally, the HST applies to the same base of property and services as the GST. In some participating provinces, there are point-of-sale rebates equivalent to the provincial part of the HST on designated items.

Zero-rated supplies

Some supplies of property and services are taxable at the rate of 0% (zero-rated). This means that you do not charge GST/HST on these supplies. Some common examples of zero-rated supplies of property and services are:

•basic groceries such as milk, bread, and vegetables;

•agricultural products such as grain, raw wool;

•prescription drugs and drug-dispensing fees; and

•medical devices such as hearing aids and artificial teeth.

Exempt supplies

A small number of supplies of property and services are exempt from the GST/HST. This means the GST/HST is not charged. Some common examples of exempt supplies of property and services are:

•used residential housing;

•most health care and dental services;

•certain childcare services; and

•many educational services.

 

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Canada supports innovation and entrepreneurship through one of the most favourable and efficient tax treatments for scientific research and experimental development (SR&ED) expenditures in the world. This is especially true when combined with the provincial SR&ED tax incentives. An average benefit rate on research and development (R&D) investment is 30 per cent for the corporation. Reducing R&D costs Canada’s SR&ED tax incentive program is the largest R&D support program aimed at the private sector. All companies based in Canada that invest in R&D can qualify, irrespective of their size, industry sector or technology area they represent – as long as they perform qualified R&D. Based on the 2009 data, the total value of federal SR&ED tax credit expenditure is approximately $ 3.5 billion.

Generally, in addition to full tax deduction of current SR&ED expenditures, a tax credit is also available based on qualifying SR&ED expenditures carried out in Canada. Other distinct advantages of the SR&ED program include eligibility of deducting the full cost of R&D machinery and equipment, no limits on subcontracting, and ability to defray part of the R&D expenses incurred abroad on Canadian R&D projects.

For large Canadian corporations and foreign controlled corporations, regardless of size or whether they are public or private, the rate of the tax credit is 20% and is non-refundable. A non-refundable tax credit can be used to offset Canadian federal taxes payable in the current year, in the previous three years, and/or in the next 20 years. There are no ceilings on R&D expenditures, taxable income or taxable capital for companies claiming the 20% tax credit rate.

On the other hand, small Canadian-controlled private corporations (CCPCs), with taxable income of up to $500,000 and taxable capital of up to a specified level, can receive a refundable tax credit of 35% of qualifying current and capital SR&ED expenditures, to a maximum of $3 million of expenditures per year. Over the $3 million SR&ED expenditure threshold, the credit rate is reduced to 20%, of which 40% may be refundable.

To top all of this off, various provinces have their own additional tax incentive programs for SR&ED activities carried out in their respective provinces. Although the provincial R&D tax credits must be deducted from a base for federal SR&ED tax credit, the net benefit is essentially one and a half times higher than the benefit of federal SR&ED tax credit alone. In addition, many provinces make the refund of their R&D tax credit available for foreign-owned corporations.

How can foreign companies qualify for the Canadian SR&ED tax benefits?

(a) Through a Canadian subsidiary of a foreign parent
The Canadian subsidiary can carry out qualifying SR&ED activities in Canada and, through deducting the expenditures and claiming the 20% tax credit, the subsidiary can significantly reduce or even eliminate Canadian taxes payable. The foreign parent can contract the Canadian subsidiary to carry out the SR&ED activities on their behalf, in which case the foreign parent will own the rights to the SR&ED, and the Canadian subsidiary can still make use of the SR&ED tax incentive program.

(b) Through a Canadian-controlled private corporation
A foreign corporation can set up a CCPC in Canada as long as it owns 50% or less of the company’s shares and the shares do not have any special rights attached to them. Traditionally, non-residents set up CCPCs in Canada by having a Canadian investor such as a venture-capital firm or research institution hold the remaining shares.

Eligibility

Eligible activities include experimental development, applied research, basic research, and support work. Up to 10% of R&D wages and salaries of Canadian resident employees incurred abroad by a Canadian-based company are also eligible. The activities outside Canada must be in support of SR&ED carried on in Canada directly by the company. In general, activities not eligible for benefits under the SR&ED program include research in the social sciences or humanities; commercial production of a new or improved product; routine data collection; and prospecting for or producing minerals, petroleum or natural gas.

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