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Federal Finance Minister Jim Flaherty (CHRIS WATTIE/CHRIS WATTIE/REUTERS)
Federal Finance Minister Jim Flaherty (CHRIS WATTIE/CHRIS WATTIE/REUTERS)

Ottawa targets abusers of tax-free savings accounts Add to ...

Finance Minister Jim Flaherty is cracking down on abuse of Tax Free Savings Accounts, closing loopholes in the popular investment program that is one of his centrepieces.

Citing a need to "challenge aggressive tax planning," the Finance Department is moving to stop transactions involving TFSAs that violate the spirit of the program, which is intended to coax Canadians to build up their personal savings.

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The program, a key element of the government's 2008 budget, allows savers to invest a certain amount each year without paying taxes on the gains. The changes, which went into effect Monday, seek to stamp out schemes that saw investors make deliberate overcontributions or unapproved investments because the tax-free gains exceeded the penalties.

While the minister's move will affect only a small number of TFSA holders, it is aimed at curbing potential abuses in the accounts before they are more widely adopted and contain larger amounts.

Finance does not yet have a tally of how many tax-free accounts have been opened since the program came into being on Jan. 1, but a survey by HSBC Bank Canada earlier this year found that two-thirds of Canadians planned to open one.

One move Finance is seeking to end involved savers putting money into their tax-free accounts in excess of the annual $5,000 limit.

The previous penalty for going over the limit was 1 per cent a month.

Finance said that "some TFSA holders are attempting to generate a rate of return" by going over the limit for "a short period of time," in the belief they can earn more than enough to outweigh the cost of the penalty. To close the loophole, Finance instructed the Canada Revenue Agency to charge a levy of 100 per cent on overcontributions.

TFSAs, which Mr. Flaherty calls the most important innovation in Canadian tax policy since the introduction of Registered Retirement Savings Plans, have proved popular with both taxpayers and financial institutions.

In May, Peter Aceto, chief executive officer of ING Direct Canada, went to Ottawa to present Mr. Flaherty and National Revenue Minister Jean-Pierre Blackburn with a poster signed by more than 2,000 clients "thanking" the government for introducing the program.

Essentially, taxpayers who are 18 years and older may make contributions of $5,000 annually to a TFSA and may withdraw the money tax-free at any time, for any purpose. As with an RRSP, savers can make contributions above the limit when they have contributed less than $5,000 in previous years. Unlike RRSPs, they can replenish money they withdraw from their TFSA account.

David Barnabe, a spokesman for the Finance Department, said the government learned of the alleged abuse from concerned individuals, and that inappropriate transactions had occurred in a "very small minority" of accounts.

The government also discovered some investors were seeking to cash in on gains in the value of their investments by transferring money from their RRSPs and other registered savings plans, which discourage early withdrawals with heavy taxes, to their TFSAs. From now on, TFSA amounts that are "reasonably attributable" to these kinds of transfers, will face a tax of 100 per cent.

The third loophole Mr. Flaherty is closing relates to unqualified investments, such as property or companies in which the account holder has a significant stake. It appears some investors were making these investments despite the existing penalties because the gains remained in the accounts even after the offending purchase was removed.

Follow on Twitter: @CarmichaelKevin

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