If there is a way to scam the system, someone out there will find it.  I am just amazed at how fast and ingenious some people can be.  Unfortunately, taking advantage of the system usually ends up spoilling it for most of us honest people out there.

This time the “scam” is about taking advantage of Tax-Free Savings Accounts (TFSA).  The strategies in questions make deliberate use of the over-contribution and asset transfer transactions between TFSA’s and other accounts.

Canada’s Minister of Finance, Jim Flaherty, proposed amendments to the Income Tax Act to put an end to these practices.  Here is how it will now work:

Deliberate over-contributions

Contributions in excess of the annual $5000 contribution limit are subject to a tax of 1% per month on the highest amount of excess contributions for the month. The government says it has become aware that in certain situations that some TFSA holders are attempting to generate a rate of return on deliberate over-contributions over a short period of time sufficient to outweigh the cost of the 1% tax.

Under the proposed amendments, any income “reasonably attributable” to deliberate over-contributions will be made subject to a tax penalty on the income of 100%.

This means that if you earned, for example, $1,200 income or gain on an overcontribution then the tax penalty will be $1,200.  In other words, the government will tax back the entire profit that you made on an overcontribution.  Hikes!!  That is a hefty penalty ! It removes any incentive for “playing games” with the overcontribution limit !!

Asset transfer transactions

The government wants more scrutiny on asset transfer transactions – sometimes known as “swap transactions”. Asset transfer transaction usually are transfers of property (other than cash) for cash or other property between accounts for example, a RRSP and another registered account. When performed on a frequent basis with a view to exploiting small changes in asset value, the government says these transfers could potentially be used to shift value from, for example, an RRSP to a TFSA without paying tax, in the absence of any real intention to dispose of the asset.

The government’s proposed amendments would effectively prohibit asset transfer transactions between registered or non-registered accounts and TFSAs.  TFSA income amounts reasonably attributable to asset transfer transactions will also be taxable at 100%.

For full information on the government’s proposed changes can be read by clicking here