We are still in the early days of TFSAs and all sorts of confusion about the rules that apply to TFSAs seem to abound not only among tax payers but also among financial advisors.
Recently, 70,000 out of the 4.7 million Canadians who have set up TFSA accounts since the beginning of 2009, received letters from CRA saying that they have made excess contributions to their TFSA accounts and therefore have to pay penalties on the excess contributions that in some cases amounted to hundreds of dollars (Source: “Ottawa acts on TFSA confusion”, Globe and Mail, June 25th, 2010).
Fortunately the government soon realized that most of the tax payers who were being penalized had made innocent mistakes in their interpretation of the TFSA withdrawal rules and therefore decided to show leniency and maximum flexibility in dealing with the offenders.
Another area of confusion among investors and financial advisors (including myself) has been the treatment of dividends paid by U.S. stocks in TFSA accounts. My colleague Jamie Golombek, who is a very knowledgeable CFP Professional and CA as well as a U.S. CPA and tax expert recently pointed this out to me and I am very thankful to him for that. As a matter of fact Jamie has written an excellent article on this subject that you can read for more detail on the subject. The following excerpt from that article talks about the tax treatment of foreign dividends in TFSAs and is a good caveat for investors to try not to hold dividend paying U.S. stocks in their TFSA accounts:
“Foreign dividends are not eligible for the dividend tax credit and are taxed at your full marginal tax rate when earned outside of an RRSP or TFSA, seemingly making them ideal for your RRSP or TFSA. But the problem with foreign dividends is that in most cases, a foreign non-resident withholding tax is applied by the foreign jurisdiction before the dividend is received in Canada.
If you hold the foreign stock in a non-registered account, you can claim a foreign tax credit against your Canadian tax payable for the amount of tax withheld. But if the foreign dividend is paid into an RRSP or TFSA, the foreign tax withheld is non-recoverable and no credit is available.
The Canada-United States tax treaty exempts U.S. dividends from withholding tax when paid to an RRSP or RRIF. But that same break does not apply to a TFSA, making U.S. dividend-paying stocks better off in RRSPs.”
