A trust lost its status as a tax-free savings account (“TFSA”) because it contravened the registration restriction on borrowing money. It 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. What was its treatment during that period?
After noting that when the arrangement ceased to be a TFSA pursuant to s. 146.2(5)(c), it had a deemed disposition of its property under s. 146.2(8), and that the trust ceased to be exempt pursuant to s. 149(1)(u.2) and ceased to be excluded from the application of s. 75(2) by s. 75(3)(a), CRA stated:
[T]he terms of a TFSA trust would provide that the holder of the TFSA is the only person permitted to make contributions to the trust, and that those contributions can revert back to the holder as the beneficiary of the trust. Consequently, subsection 75(2) may apply to attribute any income, losses, taxable capital gains or allowable capital losses of a trust that has lost its status as a TFSA to the individual who was formerly the holder of the arrangement.
Subsection 75(2) does not apply to income earned by a trust from the re-investment of income that was previously subject to attribution (i.e., second generation income), as this income is not earned on property contributed to the trust by a person (or substituted property). Thus, any second generation income earned by the former TFSA trust after deregistration will generally be taxable to the trust to the extent that it is not paid or payable to the beneficiary of the trust.