TFSAs and Change in Residence Status

An individual can contribute to a tax-free savings account (TFSA) only while he or she is a resident of Canada; any contributions made while he or she is a non-resident are subject to a penalty tax of 1 percent per month. Thus, individuals who are about to emigrate from Canada may wish to consider making a TFSA contribution before they become non-resident, particularly if they expect to return to Canada eventually.

The penalty tax imposed on TFSA contributions made by non-residents is in addition to the tax on contributions in excess of the cumulative contribution limit. CRA publication RC4466 (Tax-Free Savings Account (TFSA), Guide for Individuals) provides examples illustrating the interaction of the two taxes.

A contribution that is subject to the non-resident penalty is tricky to reverse. A partial withdrawal of contributions does not reduce the 1 percent tax--only a full withdrawal counts.

Fortunately, some TFSA transactions by non-residents are not considered contributions for this purpose, and thus are not subject to the tax. Such transactions include a qualifying (that is, direct) transfer, which can occur on marital breakdown or on the transfer of funds between accounts at different financial institutions.

In some respects, a TFSA is true to its name and is tax-free in Canada for a non-resident, just as it is for a resident. For example, there is no tax upon emigration or immigration; the non-resident is not subject to tax on the earnings of the TFSA; and withdrawals do not attract a taxable income inclusion or the imposition of non-resident withholding tax.

Withdrawals made while the individual is a non-resident increase contribution room in the normal way, on the next January 1. Because of the tax on contributions by non-residents, the increase in contribution room will not be available for use until residence is re-established.

A TFSA owned by a non-resident may, however, be subject to foreign taxation. In particular, a US citizen or green-card holder must report the income earned through a TFSA on his or her personal US tax return, thus diminishing the primary benefit of the TFSA. A Roth IRA, which is a US vehicle that provides a mechanism for tax-free savings similar to the Canadian TFSA, may be a better option.

One rule favourable to taxpayers is that the $5,000 annual increase in TFSA contribution room is not prorated in the year of emigration or immigration. For example, an individual who immigrated to Canada in 2009 and emigrated from Canada in 2012 is still entitled to the same $20,000 cumulative contribution room as a person who was resident in Canada for that whole period.

A potential problem arises when assets are given to a spouse to make a contribution to his or her TFSA: in that case, the usual exemption from the attribution rules provided for TFSAs by paragraph 74.5(12)(c) may not apply if the spouse is a non-resident at any time in the year of the contribution. This counterintuitive result is the product of confusing wording in the definition of "excess TFSA amount" for the purposes of subsection 207.01(1). It is to be hoped that a future CRA technical interpretation will rule out this possibility.

Jason Uppal
Ernst & Young LLP, Edmonton

Canadian Tax Focus
Volume 2, Number 2, May 2012
©2012, Canadian Tax Foundation