Exploring Investment Opportunities within the Canadian Tax Environment
Several different investment vehicles and opportunities currently exist within the Canadian tax environment that offer a deferral on amounts earned within them. Please be aware that certain specificities exist within these two different vehicles which each taxpayer needs to be aware of.
Tax-Free Savings Account (TFSA)
A tax-free savings account (“TFSA”) is a registered investment account designed to help Canadians save using after-tax dollars which will grow on a tax-free basis. The main advantage of a TFSA account, as compared to a regular investment account, is that the income generated in the account will generally not be subject to tax.
Registered Retirement Saving Account (RRSP)
In comparison, a registered retirement saving account (“RRSP”) is a registered investment account designed to help Canadians save for retirement using pre-tax dollars. The main advantage of an RRSP account, as compared to a regular investment account, is the ability to defer tax on contributions and on earnings.
Contribution Limits and Conditions
One main consideration that most people are not aware of is that in both the TFSA account and the RRSP account, certain conditions exist when calculating the total contribution limit in each account. The annual contribution to a taxpayer’s TFSA is limited to the amount legislated by the Minister of Finance each year. The individual may only contribute up to that limit plus any prior uncontributed limits which were available. In addition, if there were any amounts withdrawn from their TFSA in a prior calendar year, that amount may also be contributed.
The annual contribution to a taxpayer’s RRSP is limited to a percentage of the “earned income” of the individual contributor subject to a maximum limit legislated by Canada Revenue Agency each year. The individual may only contribute up to that limit plus any prior uncontributed limits which were available. Unlike the TFSA, there is no ability to re-contribute any amounts withdrawn (except for the amounts withdrawn for the home buyers plan and the lifelong learning plan).
Overcontribution and Penalties
At any time in the year, if you contribute more than your available contribution room you will have to pay a tax equal to 1% of the highest excess TFSA amount in the month, for each month that the excess amount stays in your account. Whereas the 1% penalty on the RRSP overcontribution is calculated monthly on the remaining excess contributions that exceed your RRSP deduction limit by more than $2,000. Certain steps need to be undertaken in order to correct the overcontribution errors that may have been created in a timely manner. Please also be mindful in case of an overcontribution that the entire amount of the overcontribution needs to be withdrawn from the registered investment account.
In case of a decrease within the investment account, the federal tax authorities have certain views that state the entire overcontribution needs to be withdrawn if not penalties will continue to accrue (in case of a loss of capital).
Business Activities within Accounts
Additionally, within a TFSA a taxpayer must also not carry on a business. If a TFSA does carry on a business, its income from those investments or that business will be taxable. In a recent tax case involving an investment advisor, frequent transactions inside a TFSA where securities are owned for short periods may lead to the determination that the TFSA is carrying on a business, and as a result gains on the disposition of securities would become taxable. Whereas in the RRSP account the buying and selling of qualified investments does not cause the income from trading those investments to be taxable as income from carrying on business. This is caused by the types of funds used to fund the account (TFSA uses after-tax dollars whereas RRSP uses pretax dollars).
Concluding Remarks and Further Guidance
To gain deeper insights, we encourage you to reach out to your dedicated UpCounting Services advisor.