Judge says blame bank, not CRA, in latest TFSA overcontribution case

In just a few weeks, 2021 will begin, presenting a new opportunity for Canadians to sock away an additional $6,000 into their TFSAS. And, yes, you read that correctly: The TFSA dollar limit will remain at $6,000 for the third year in a row, since the inflation indexing factor for 2021 was a mere one per cent — not enough to push the dollar limit to the next $500 threshold.

One of the benefits of a TFSA is that you can withdraw funds, at any time, for any reason, and recontribute the funds back to your TFSA, beginning the following calendar year. You can recontribute the entire amount withdrawn, including any income or gains on your original contributions. The same, however, cannot be said of losses in a TFSA. In other words, if you contributed $6,000 to your TFSA, invested in some energy stocks whose value has recently dropped to $4,500, you can’t make up the $1,500 loss with an additional contribution. Failure to understand this rule can lead to an overcontribution penalty tax, which is what happened in a recent case.

Overcontribution tax

Before going through the details of the case, let’s review the consequences of a TFSA overcontribution. Under the Income Tax Act, if you overcontribute to your TFSA, there’s a penalty tax of one per cent per month, multiplied by the overcontribution amount, for each month you’re over the limit.

Fortunately, the Canada Revenue Agency has the power to waive or cancel the overcontribution tax if it can be established that the tax arose “as a consequence of a reasonable error” and the overcontribution is withdrawn from the TFSA “without delay.” To request a waiver of the penalty tax, an affected taxpayer needs to forward a detailed written request to the TFSA Processing Unit 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 will grant it.

If the CRA refuses your request for relief, you can take your case to Federal Court, asking a judge to review whether the CRA’S decision to deny relief was reasonable.

The case

The case was heard last month, via teleconference, by a Federal Court judge sitting in Ottawa, and the taxpayer, in Toronto. The taxpayer’s TFSA was managed by a bank’s financial adviser. The taxpayer testified that, in 2016, he lost $19,225 from his TFSA portfolio after a cease trade order was placed on a company whose shares he held in his TFSA. The loss represented the reduction in the value of the shares. Apparently, the company had gone bankrupt and was delisted from the relevant stock exchange. The taxpayer claimed that at the end of 2016, the bank advised him that he could “replace” or “reimburse” the funds lost, by depositing $20,000 into his TFSA without paying tax.

For the 2016 taxation year, the taxpayer’s TFSA contribution limit was only $11,500. On Aug. 12, 2016, he contributed $12,000 to his TFSA, and he made an additional $25,000 contribution to his TFSA on Nov. 10, 2016 to make up for the loss, for a total overcontribution of $25,500.

In June 2017, the CRA sent the taxpayer “an educational letter,” advising him that he had made excess contributions of $25,500 to his TFSA. The letter told him about the excess contribution tax and the steps available to correct his situation, which included withdrawing the excess amounts “right away”, i.e. “immediately.” The taxpayer didn’t withdraw the $25,500 excess contributions at that time. Eventually, however, the excess contributions were reduced by the annual increase in the contribution limits allowed in 2018, and smaller withdrawals made by the taxpayer in 2018.

The taxpayer claimed he didn’t receive the educational letter, despite evidence that it was sent to the correct address. In July 2018, the CRA issued a Notice of Assessment (which, incidentally, was sent to the same address as the non-received educational letter) regarding excess contributions for the 2017 tax year. The CRA sent the Notice because the taxpayer failed to reduce the excess amount in his TFSA, as specified in the June 2017 educational letter. Shortly after receiving the Notice, however, the taxpayer withdrew excess amounts from his TFSA.

The taxpayer then wrote to the CRA to request a waiver of the tax imposed “because the excess contributions were made in error … because of the Bank’s advice that he was allowed ‘to replace (deposit) 20,000.00 (sic) that (he) lost earlier from (his) account without tax.’”

In February 2019, the CRA’S TFSA Processing Unit denied the taxpayer’s request for relief. In March 2019, the taxpayer requested a second-level review. The CRA officer who conducted the second-level review concluded the taxpayer had made excess contributions to his TFSA even after knowing he should not, and therefore refused to cancel the penalty tax. The taxpayer then applied to the Federal Court to review the decision.

In court, the taxpayer maintained that it was “unreasonable for the CRA not to advise him whether the Bank’s advice regarding topping up to cover reduction in share value was correct or incorrect.” The judge disagreed, writing: “(The taxpayer) must obtain his own tax advice. CRA is under no duty to provide legal or financial advice to the taxpayer in a case like this.” The judge cited a prior case in which the judge stated, “as a self-reporting system, the onus was on (the taxpayer) to understand the law … ignorance of the rules, particularly in a system which relies on the taxpayer, is not an excuse.” The court agreed with the CRA that even if the taxpayer hadn’t received the letter, it was still his responsibility to remove any excess contributions “without delay,” as required under the Tax Act.

The court found that the taxpayer “has not established the excess contributions arose as a consequence of reasonable error. Rather it was a consequence of several factors: not knowing the law as to when contributions were allowed, not seeking professional advice, relying on bad advice, and not eliminating the excess contributions without delay once informed of them. Reasonable error and removal of the excess contributions without delay are the two preconditions for relief.”

While the judge was sympathetic to the taxpayer’s situation, he nevertheless felt that the CRA’S decision to deny relief was reasonable. As the judge concluded, “To the extent (the taxpayer) relied on unsound advice from the Bank … his remedy may lie against the Bank, not the (CRA).”