The income tax treatment of a trust and its beneficiary where the trust lost its status as a tax-free savings account (TFSA) because it contravened the registration restriction on borrowing money was the subject of a recent Canada Revenue Agency(CRA) technical interpretation. The trust continued to exist for several years after the borrowing occurred and was administered during that time by the TFSA issuer as though it were a TFSA.
To qualify as a TFSA, the terms of a TFSA trust prohibit the trust from borrowing money or other property. If not administered this way the arrangement automatically ceases to be a TFSA, and loses its tax-exempt status at the time the borrowing occurs. The tax year of the TFSA is deemed to have immediately ended and a new year to have begun. As well, the TFSA is deemed:
- to have disposed of, immediately before the time, each property held by the trust for proceeds equal to the property’s fair market value immediately before the time; and
- to have acquired, at the particular time, each such property at a cost equal to that fair market value.
As a result of ceasing to be a TFSA, the trust will no longer be exempt from tax and the general rules concerning the taxation of trusts and beneficiaries will apply. Further, the trust’s income or loss, or taxable capital gain or allowable capital loss, derived from the property (or substituted property) is attributed to the TFAS holder provided the person is alive and resident in Canada.
If any contributions, distributions or transfers had been made to or from the trust after the date it ceased to be a TFSA, those amounts should not be treated as having been made to or from a TFSA of the individual. The CRA should make corresponding adjustments to the individual’s TFSA contribution room to undo any incorrect reporting of amounts in the past. The loss of TFSA status and resulting deemed disposition and re-acquisition of property is not considered to be a distribution from the TFSA and no amount would be added back to the individual’s TFSA contribution room for the following year.
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