Many consider the Tax-Free Savings Account (TFSA) to be the most versatile savings account available to Canadians. Not only does it provide tangible benefits such as tax-free income and withdrawals, but it is available to all adult Canadians regardless of age or income level. Unlike other tax-efficient plans that restrict contributions and/or withdrawals based on age or income earned, TFSAs are available to young adults, middle-aged Canadians and seniors alike. And, because earned income is not required to accumulate TFSA contribution room, Canadians of all income levels can participate.
Given the broad audience to which the TFSA is targeted, it is likely to become increasingly popular amongst Canadian households. In fact, the Department of Finance predicts that in 20 years, 90% of Canadians will have all their financial wealth in tax-efficient accounts, including TFSAs.
Thousands of Canadians become non-residents each year. Some leave Canada to accept jobs in other countries, while others explore new challenges or retire abroad. If the TFSA becomes as widely held as predicted, what consequences will result when a TFSA holder becomes a non-resident? Before addressing the impact of non-residency on TFSAs, it is important to determine when/how one becomes a non-resident.
Generally, for Canadian tax purposes, an individual is considered a resident of only one country at a time. If that country is Canada, the individual would have full access to a TFSA provided they are 18 or older, have a valid Social Insurance Number and file a Canadian tax return each year. If the individual is a non-resident of Canada, a TFSA would not normally be available. To determine if an individual is a resident of Canada, the Canada Revenue Agency (CRA) normally looks at the location of the individual’s most significant residential ties.
Primary residential ties include the locations of real estate, a spouse or common-law partner and dependants. Secondary ties include the location of personal property (such as furniture or automobiles), a driver’s license, or memberships in a union or professional organization. Where the above ties are not significant enough to classify an individual as a resident of Canada, he or she could still be deemed a resident for the year if they spend 183 days or more in Canada, is a government employee, or is a member of the Canadian Forces. The CRA might also look at additional factors which, in conjunction with ties to Canada, might cause the individual to be a resident of Canada.
These rules impact TFSAs as they define what an individual can and cannot do with a TFSA.
Let’s say your client, Meg, a long-time Canadian resident and new TFSA holder, decides to move to the United States. How would the move impact Meg’s TFSA if she becomes a non-resident of Canada?
Similar to RRSPs and RRIFs, for Canadian tax purposes, individuals are not deemed to dispose of TFSAs when leaving the country. Meg would maintain all rights and interests in the account and the account would maintain its tax-free status in Canada. Withdrawals would also be permitted at any time, tax-free.
There is a caveat, however. Do not assume that a tax-free status in Canada also means a tax-free status in your client’s new country of residence. Some countries (such as the United States) have provisions to allow for a domestic tax-deferral where income is earned in a Canadian tax-deferred plan such as the RRSP. But for many countries, including the United States, these provisions do not yet extend to TFSAs. Therefore, Meg would likely have to pay income tax in the United States on the income earned within her TFSA. For this reason, when dealing with clients who are becoming non-residents, you should advise them to check with an accountant in their country of residence to determine local tax implications for their Canadian TFSA.
Seeing that Meg now resides in the United States and is benefiting from Canadian tax-free growth in her TFSA, what about contributions? Does she earn TFSA contribution room as a non-resident? If she has unused contribution room from her time as a Canadian resident, can she contribute to her plan and make use of the room?
TFSA contribution room does not accrue for any year throughout which an individual is a non-resident of Canada, nor are contributions permitted. Where contributions are made, a 1% per month penalty tax applies. This penalty continues until the contribution is withdrawn (the withdrawal must be designated in connection with the contribution), or until the individual returns to Canada as a Canadian resident, whichever is earliest. A separate 1% per month penalty tax would also apply if the contribution exceeds the individual’s unused TFSA contribution room carried over from their period as a Canadian resident.
Revisiting Meg’s situation, Meg would not be permitted to contribute to her TFSA while residing in the United States, even if she has unused contribution room. Such a contribution would be subject to a penalty tax of 1% per month until the contribution is withdrawn, or until she returns to Canada as a resident. She would also be subject to an additional penalty tax of 1% per month for the portion of her contribution that exceeds her unused contribution room — room accrued while she resided in Canada.
Non-residents are permitted tax-free withdrawals from TFSAs at any time (again, non-residents should check with local accountants to determine tax implications in their country of residence), and amounts withdrawn will be added to the individual’s unused TFSA contribution room for a future year. The ability to make use of the extra room, however, would not be available until the individual returns to Canada.
As TFSAs grow in value and popularity, questions of non-residency are sure to come up. Keeping up to speed on the rules in this area can help reduce confusion when faced with complicated cross border matters.