RRSP and TFSA Over-Contribution Tax
Each year individuals have a certain amount they can contribute to their Registered Retirement Savings Plan (“RRSP”) and Tax Free Savings Plans (“TFSA”) for the year known as “contribution room”. If an individual contributes an amount to his or her RRSP or TFSA which exceeds his or her available contribution room, the individual has “over-contributed”. An over-contribution tax is applied to the over-contributed amount equal to 1% of the over-contributed amount per month.
Over-contribution tax applies to any amount of over-contribution to a TFSA, but an individual who is over 18 must over-contribute more than $2,000 to his or her RRSP over their lifetime to be subject to the over-contribution tax. The $2,000 buffer on RRSP over-contributions is not tax deductible.
A taxpayer who has over-contributed to either a RRSP or TFSA has two options. The taxpayer can cease contributing until enough contribution room has accrued so that the contribution room has “caught up” to the over-contributed amount. Alternately, the taxpayer can remove the over-contributed amounts as soon as possible upon noticing the over-contribution. This latter method is usually preferable as over-contribution tax continues to accrue while the taxpayer waits for the contribution room to “catch up”.
The “catch up” method described above does not apply in most cases to non-residents of Canada for tax purposes who have over-contributed to their TFSAs because non-residents do not accrue TFSA contribution room while they are non-resident. This lack of accrual of contribution room can also make it easier for non-residents to inadvertently over-contribute to their TFSA. Non-residents can continue to contribute to their RRSPs so long as they have available contribution room, which is based on their Canadian source income.
Failing to pay the over-contribution tax will also result in interest accruing on the unpaid amounts.
TFSA Non-Resident Contribution Tax
An individual cannot contribute to their TFSA when they are a non-resident of Canada for tax purposes. If a non-resident of Canada does contribute to his or her TFSA, a tax of 1% per month is applied to the amount contributed.
There is no non-resident contribution tax for RRSPs.
Tax Returns on Over-Contributions and Non-Resident Contributions
A taxpayer who is subject to the RRSP over-contribution tax must file a T1-OVP 2020 Individual Tax Return. This return must be filed within 90 days of the end of the calendar year to which the return applies.
A taxpayer who over-contributes or contributes as a non-resident to a TFSA must file a Tax-Free Savings Account (TFSA) Return. This return must be filed by June 30th of the year following the end of the calendar year to which the return applies.
A failure to file either of the above returns when required will result in a failure to file penalty, as well as related interest.
A taxpayer who fails to file the above returns as required may be able to use the Voluntary Disclosure Program to file the returns. The Voluntary Disclosure Program allows a taxpayer’s Canadian tax lawyer to proactively correct erroneous or unfiled returns in exchange for relief from penalties and interest.
Over-Contribution and Non-Resident Contribution Tax Waivers
The Minister of National Revenue can, at her discretion, waive the over-contribution or non-resident contribution taxes discussed above. The Canada Revenue Agency (“CRA”) administers this relief on behalf of the Minister. The CRA will grant a waiver of the tax where the taxpayer meets the necessary conditions under sections 207 and 208 of the Income Tax Act.
The first condition for a waiver of the tax arising from either a RRSP or TFSA is that the contributions which led to the tax were made as a consequence of reasonable error. Whether a reasonable error occurred is highly dependent on the facts of the individual case.
Obtaining a waiver of the over-contribution tax arising from a RRSP requires the taxpayer to have taken reasonable steps to eliminate the excess. The Income Tax Act does not define what constitutes “reasonable steps”. The CRA takes the position that “reasonable steps” is removing the over-contributed amount as soon as the taxpayer is able. They may also consider whether the taxpayer filed any required over-contribution (OVP) returns. However, because this relief is discretionary, the CRA must give regard to each taxpayers’ individual circumstances when considering whether reasonable steps were taken.
Obtaining a waiver of the over-contribution or non-resident contribution tax arising from a TFSA specifically requires the taxpayer to have removed the incorrectly contributed amount as well as any income reasonably attributable to the incorrectly contributed amount.
If the two conditions enumerated above, the over-contribution and/or non-resident tax will be waived. As interest on the over-contribution and non-resident tax is calculated as a percentage of the underlying tax, a waiver of the tax will result in an accompanying decrease in the interest.
Pro Tax Tips: Applying for Taxpayer Relief Applications
A taxpayer who over-contributes or contributes as a non-resident, and/or fails to file the required returns can also consider applying for taxpayer relief. Taxpayer relief will result in the elimination of penalties and interest, though not a change or waiver of the underlying tax. Taxpayer relief will be granted where the taxpayer can demonstrate the penalties or interest arose due to circumstances involving:
- Medical/health problem or family member death
- Disaster (such as fire or an ice storm)
- Error on the part of the CRA
- Financial hardship, though the CRA is very reluctant to provide relief on these grounds
Unlike the waiver, there is no requirement the amount be removed for taxpayer relief to be granted. Contact our experienced Canadian tax lawyers for assistance in identifying the appropriate strategy for limiting taxes, penalties and interest arising from an over-contribution from an RRSP or TFSA or non-resident contribution to a TFSA, and applying for the appropriate relief.
Can Canadian non-residents for tax purposes contribute to their TFSAs?
Technically, yes, but practically no since the tax impact will make contributing as a non-resident for tax purposes inadvisable in most circumstances. Non-residents who contribute to their TFSAs will face a 1% a month non-resident contribution tax. Non-residents also do not accrue contribution room for their TFSAs, making it much easier to accidentally over-contribute and incur the 1% a month over-contribution tax.
What are the two criteria for a successful RRSP over-contribution waiver application?
The two criteria for a successful RRSP over-contribution waiver application are that the over-contribution was made due to reasonable error, and that the individual took reasonable steps to eliminate the over-contribution.
What are the two criteria for a successful TFSA over-contribution or TFSA non-resident contribution waiver application?
The two criteria for a successful TFSA over-contribution or TFSA non-resident contribution waiver application are that the contribution(s) at issue was made due to reasonable error, and that the individual removed the contribution(s) at issue and any income reasonably attributable to the contribution(s) at issue.