2008 federal budget

Tax-free savings account and other highlights

Proposed changes

The Conservative government revealed its 2008 federal budget on Feb. 26, 2008. It contained a number of proposals that could affect businesses, financial security advisors and investors. This article doesn’t contain a complete list, but outlines proposals affecting those within the financial services industry, particularly the tax-free savings account.

Remember: The announced budget contains proposals that may undergo revisions before becoming law, especially since a minority government is in power. It's not clear at this point whether the provinces will implement changes to their tax legislation.

Tax-free savings account

Budget 2008 proposes to introduce a tax-free savings account (TFSA). The TFSA is described as a flexible, registered, general-purpose savings vehicle that will be available for taxation years starting in 2009.

Flexibility of the TFSA:

There is no age at which this plan must mature, unlike other registered plans such as registered retirement savings plans (RRSPs), registered pension plans (RPPs) or deferred profit sharing plans (DPSPs).

• There is no maximum contribution period, unlike registered education savings plans (RESPs).
• There are no restrictions on how the savings can be used.
• There is no limit to the number of TFSAs that individuals can open.

The budget proposal outlines the following features:

Eligibility:

• Canadian residents who are 18 years of age or older

Contribution limits:

• Beginning in 2009, eligible individuals can contribute up to $5,000 each year.
• Individuals will be able to contribute up to the amount of contribution room they have available in any taxation year.
• Unused contribution room can be carried forward to future years with no limits.
• Amounts withdrawn in a year will be added to the individual’s contribution room for the following year.
• Contributions that exceed the individual’s available contribution room will be taxed one per cent per month on the excess amount.
• The annual $5,000 limit will be indexed to the inflation rate and annual additions to contribution room will be rounded to the nearest $500.

Tax treatment of the TFSA:

• Contributions will not be deductible when calculating taxable income.
• Withdrawals, income earned and capital gains realized on assets held in the TFSA will not be taxed, nor will they be considered when determining eligibility for income-tested benefits or credits delivered through the income tax system, e.g., Canada Child Tax Benefit, GST credit, etc. In addition, these amounts will have no impact on the calculation of benefits subject to claw back at higher income levels, e.g., Old Age Security, Guaranteed Income Supplement and Employment Insurance benefits.

Qualified issuers:

• Financial institutions that are eligible to issue RRSPs will be permitted to issue TFSAs, including trust companies, life insurance companies, chartered banks and credit unions.

Qualified investments:

• Generally, a TFSA will be permitted to hold the same investments as an RRSP.
• A TFSA will not be permitted to hold investments in any entity with which the accountholder does not deal at arm’s length, including a corporation in which the accountholder is a specified shareholder, i.e., holds more than 10 per cent of any class of the corporation’s shares.

Attribution rules:

• Individuals may provide funds for use by their spouse or common-law partner to make a contribution to a TFSA without being subject to attribution rules on income earned.

Treatment on death:

• Generally, a TFSA will lose its tax-free status upon death of the accountholder. Investment income and gains that are accrued to the date of death will be tax-free. Income and gains that are accrued after the date of death will be taxable.
• The spouse or common-law partner of the deceased can be named as a successor accountholder without impacting the account’s tax-free status.
• TFSA assets of a deceased accountholder may be transferred to a TFSA of the surviving spouse or common-law partner. The transfer is not restricted by the contribution room available to the surviving spouse or common-law partner nor does the transfer reduce the existing contribution room of the surviving spouse or common-law partner.

Treatment on marital breakdown:

• Upon breakdown of a marriage or common-law partnership, an amount may be transferred directly from one person’s TFSA to the other’s.
• The transfer will not reinstate contribution room of the person who is transferring nor will it reduce the contribution room of the recipient.

Non-residents:

• Individuals who are no longer Canadian residents after opening a TFSA will be allowed to maintain their account. Income, gains and withdrawals will not be subject to tax.
• No contributions will be permitted while the accountholder is non-resident.
• No contribution room will accrue for any year in which the accountholder is non-resident throughout the year.

Treatment of interest deductibility and collateral:

• Interest on funds borrowed to contribute to a TFSA will not be deductible.
• TFSA assets may be used as collateral for a loan, unlike assets held in an RRSP.

Reporting requirements for issuers of TFSAs:

• Issuers will be required to file annual information returns with the Canada Revenue Agency (CRA).
• Required information is expected to include the fair market value of the account at the beginning and end of the reporting year, as well as the amount of contributions, withdrawals and transfers made in the year.

This is a federal initiative and each province will need to formally indicate whether it will adopt this proposal. If any province does not adopt the proposal, the tax benefits of this plan will not apply for the provincial taxes of residents in that province. As more details are known, we will provide more information about how this affects our business.

Longer timelines for registered education savings plans (RESPs)
The budget proposes to give beneficiaries of RESPs 10 years longer to contribute and an additional 10 years to make use of the assets:

• The maximum number of years to contribute increases to 31 years after the plan is opened, up from 21 years.
• The deadline by which plans must be terminated increases to the year of the plan’s 35th anniversary, not the 25th anniversary.
• The age by which contributions must be made for family plan members has been increased to a maximum age of 31 instead of 21.

In addition, the budget proposes to permit RESP beneficiaries to extend the time that plan benefits can be paid to help provide income after they are no longer enrolled in their education program.

Canada Education Savings Grants (CESGs) and the growth in the plan assets are paid out of an RESP using educational assistance payments (EAPs). Currently, beneficiaries have to be enrolled in a qualifying program in order to receive EAPs from the plan. The budget proposes to allow EAPs up to six months after beneficiaries cease to be enrolled in a program, provided they would have qualified for the EAPs immediately prior to their enrollment ceasing.

The proposed changes would take effect Jan. 1, 2008.

More flexibility for federally regulated life income funds (LIFs)
The budget proposes to introduce three new withdrawal choices for individuals who hold federally regulated LIFs to provide more options to access their funds. This is consistent with the direction some provinces have taken with their provincially regulated LIFs.

Proposed withdrawal options:

• Those who are 55 years of age or older with LIF holdings of less than $22,450 may wind up their LIF accounts with the option to convert to a tax-deferred savings vehicle such as an RRSP.
• Individuals who are facing financial hardship will also be entitled to unlock an amount up to $22,450.
• Those who are 55 or older will also be entitled to a one-time conversion of up to 50 per cent of their LIF holdings into a tax-deferred savings vehicle, such as a registered retirement income fund (RRIF), with no maximum withdrawal limits.

The $22,450 limits will be increased annually with the average industrial wage.

No effective date was mentioned in the federal budget.

Decrease in eligible dividend tax credit
The 2008 budget proposes to decrease the dividend gross up and dividend tax credit on eligible dividends that Canadian residents receive. These decreases reflect the reduction in the corporate tax rates announced in the October 2007 Economic Statement. The government’s objective is to better integrate federal taxes paid on income earned indirectly through a corporation with income earned directly by an individual.

These proposed changes will not affect rates for 2008 or 2009. By 2012, it’s proposed that the gross-up will reduce to 38 per cent from the current 45 per cent and the dividend tax credit will reduce to 15 per cent from the current 19 per cent.

These proposed changes will increase the maximum effective federal tax rate on eligible dividends to 19.29 per cent in 2012 from 14.55 per cent in 2008.

Eligible Dividends

	2008	2009	2010	2011	2012
Dividend gross up	45%	45%	44%	41%	38%
Dividend tax credit on grossed-up income	19%	19%	18%	16.5%	15%
Top federal rate	14.55%	14.55%	15.88%	17.72%	19.29%

No changes were announced for non-eligible dividends paid from income that was subject to the small business tax rate.