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TFSA – To Swap or Not to Swap

Should Swaps be banned completely?

This is one of the hot topics of discussion as regards TFSA contributions.   As soon as some innovation is introduced, there are those who don’t know much about it, those who educate themselves thoroughly to try and optimize the situation, and then, there are those who try to take advantage of a good thing.   It is this last group that the Government wishes to keep in check and thus implements new rules to ensure that no-one benefits to an unfair extent over others just by manipulating “loopholes” in the system.

One such area is that of swaps.   In-kind contributions are allowed into a TFSA.  Non-registered investments like stocks can be put in and if they appreciate in value and are withdrawn, then that creates extra contribution room to the tune of the value upon withdrawal.  A swap is slightly different.  It involves the exchange of equity or cash and equity of equal value.  For instance, if one had $4,000 in the TFSA and needed the money, one could put $4,000 of stocks into the account and free up $4,000 in cash to spend.  This makes swaps a useful planning strategy as they enable an investor to increase contribution room under the right circumstances.

A TFSA swap does not involve withdrawal and contribution, only acquisition and disposition of property at fair market value.

So why ban swaps?

What the Department of Finance is trying to crack down on is what they term as “the use of inappropriate transactions to draw excessive benefits” from the TFSA.   This amendment covers:

a) Purposeful excessive contributions to TFSAs

b) Holding non-qualified investments in TFSAs, and,

c) Swap transactions.

This is how the Department of Finance explains its stand: they say that swap transactions, which are not treated as withdrawal and re-contribution, are treated instead, as straightforward purchase and sale.  They are also called asset transfer transactions.   Subject to the application of prevalent anti-avoidance rules in the Income Tax Act, if these transfers are effected frequently with the objective of exploiting small changes in asset value, this is just a shift in value from one account to another with no real intention of disposing of the asset.

It has been studied how frequent swaps between an RRSP and a TFSA can slowly but surely transfer funds from the former to the latter and then be withdrawn tax-free.  But is a complete ban on swaps the solution to this problem?  The jury is surely divided!

The fact is, even in the absence of swaps, investors who wish to be crafty still have another option open to them.   They can sell an asset in one account and buy it in another.   Though this is a more expensive route, it is still available for those who wish to shift value into a TFSA from another account.

Maybe the Department of Finance does not wish to provide additional measures to investors to overuse the system.   That would be like encouraging dishonesty.   People are divided in their views on this topic of debate.  Maybe more stringent rules could have been laid down as regards swaps rather than banning the whole concept.   If used in moderation, it adds flexibility to the whole idea of TFSAs, and encourages savings further, in a sense.  It also helps deal with people’s negative view of the $5,000 ceiling for annual contributions.   A closer monitoring of these transactions in addition to more stringent rules could certainly have done the trick to clamp down on misuse of the system.

If you want to tell us what you think or register an opinion, send your comments below.

This entry was posted on Friday, September 3rd, 2010 at 4:44 pm and is filed under News, Opinion, Resources. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

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