As part of the Government's attempt to fulfill its election promise to provide tax relief in respect of capital gains that are reinvested, the budget included a new proposed Tax-Free Savings Account ("TFSA").

Starting in 2009, individuals (other than trusts) resident in Canada who are 18 and older will be permitted to contribute up to $5,000 per year (indexed annually) to a TFSA. Contributions will not be deductible in computing taxable income. Nevertheless, income earned in a TFSA will not be taxable and can be withdrawn free of tax. Eligible investments will, in general terms, include investments that are qualified for a registered retirement savings plan ("RRSP"), but investments in any entity not dealing at arm's length with the account holder will not be permitted.

Other aspects of the proposed TFSA are as follows:

  • Unused contribution room can be carried forward indefinitely
  • Any amounts withdrawn from a TFSA in year will be added to the individual's contribution room.
  • Excess contributions will be subject to a penalty tax.
  • Interest on funds borrowed to contribute to a TFSA will not be tax deductible.
  • Assets within a TFSA will be able to be used as security.
  • Assets within a TFSA may be transferred on a tax-free basis to a spouse or common law partner upon death or breakdown of marriage.

Initial reactions are that the TFSA proposal will benefit a number of financial institutions permitted to establish RRSP accounts as well as individuals who will have an ability to select assets that will generate significant returns. Time will only tell how the TFSA will form part of the investment strategies of Canadians that will now be able to include the TFSA, RRSPs and registered education savings plans as part of their tax free savings tools.