Principal Issues: Whether a mutual fund trust is considered a prohibited investment pursuant to subsection 207.01(1), if the holder of the Tax Free Savings Account (TFSA), either alone or with other non-arm's length parties, has a 10% or more fair market value interest in the trust.
Position: Yes, the investment would be considered a prohibited investment pursuant to subsection 207.01(1).
Reasons: Mutual fund trusts are generally qualified investments for TFSAs, but they are considered to be prohibited investments if the holder of the TFSA, either alone or with other non-arm's length parties, have a 10% or more fair market value interest in the trust.
XXXXXXXXXX 2008-030405 Peky Tsang (613) 957-2115 February 18, 2009
Dear XXXXXXXXXX :
Re: TFSA Prohibited Investments-Mutual Fund Trusts
This is in response to your e-mail of December 16, 2008, wherein you requested our comments on whether a public mutual fund trust is a prohibited investment for a Tax Free Savings Account ("TFSA"), where the individual holder of the TFSA along with other non-arm's length parties have 10% or more of all the interests in the mutual fund.
Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request. For more information concerning advance tax rulings, please refer to Information Circular 70-6R5 dated May 17, 2002. Where the particular transactions are completed, the enquiry should be addressed to the relevant tax services office. The following comments are, therefore of a general nature only and are not binding on the Canada Revenue Agency ("CRA"). All publications referred to herein can be accessed on the CRA website at the following address: http://www.ccra-adrc.gc.ca/formspubs/menu-e.html.
A mutual fund trust is defined under subsection 132(6) of the Income Tax Act (the "Act") and is considered a qualified investment for a TFSA under paragraph 4900(1)(d) of the Income Tax Regulations (the "Regulations"). However, pursuant to subsection 207.01(1) of the Act if the holder of the TFSA has a significant interest in the mutual fund trust then the investment in the mutual fund trust will be considered a prohibited investment for the TFSA.
Significant interest for a TFSA is defined in subsection 207.01(4) of the Act. Pursuant to paragraph 207.01(4)(c) of the Act, an individual has a significant interest in a trust if the individual alone or together with other non-arm's length persons holds interests as beneficiary under the trust having a fair market value equal to 10% or more of the fair market value of all the interests of all beneficiaries under the trust.
In the situation described in your letter, where the holder along with other non-arm's length persons hold 10% or more of all the interests in the mutual fund, the holder would be considered to have a significant interest in the trust. Consequently, the mutual fund investment would be considered a prohibited investment.
The holder of a TFSA trust which holds a prohibited investment during the calendar year is liable to pay tax. There are two amounts of tax payable pursuant to subsections 207.04(2) and 207.04(7) of the Act respectively. Subsection 207.04(2) of the Act imposes a tax amount equal to 50% of the fair market value of the prohibited investment. However, this tax is refundable if the prohibited investment is disposed of before the end of the calendar year following the calendar year in which the tax arose. However, no refund of this tax is available if it is reasonable to expect that the holder knew or ought to have known at the time the property was acquired by the TFSA trust that the property was, or would become, a non-qualified investment or a prohibited investment.
Pursuant to subsection 207.04(7) of the Act an additional tax is payable by the holder of the TFSA. The tax is equal to the tax payable under Part I of the Act by the TFSA trust for the taxation year that ends in the calendar year, if the trust had no income or losses other than from the prohibited investments that it held in the year and no capital gains or capital losses other than from the disposition of its prohibited investments.
We trust the above comments will be of assistance.
Yours truly,
Mary Pat Baldwin, CA
for Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch