There seems to be no limit to the number of clever schemes that tax experts come up with to avoid paying taxes. The Canadian government is planning to make some changes to the rules governing Tax-Free Savings Accounts (TFSAs) to close some loopholes.
The most interesting tax avoidance scheme involves swaps between RRSPs and TFSAs. Before now I wasn’t aware that such swaps were permitted without any tax implications. The idea is that if you have $5000 in cash in one account and $5000 worth of stock in the other, you can swap the cash for the stock without it counting as a withdrawal or contribution.
This makes some sense. After all, the total value in each account doesn’t change. It’s like one account bought the stock from the other account at fair market value. However, this swapping idea led to an amusing scheme to shift assets from an RRSP to a TFSA. I’ll explain it with an example.
Suppose that Tammy the tax avoider is nearing retirement with $100,000 in an RRSP and $5000 in a TFSA. Tammy is facing the prospect of having to pay income taxes on the $100,000 as she withdraws it from her RRSP over time. She’d much rather have the money in a TFSA where it can be withdrawn tax-free.
Tammy begins by buying 500 shares of (hypothetical) ABC shares for $10 each:
TFSA: $0 plus 500 ABC shares
Suppose that ABC stock goes up to $12. Then Tammy swaps the TFSA shares for $6000 cash in the RRSP:
RRSP: $94,000 plus 500 ABC shares
Then the stock goes back down to $10, and Tammy swaps them back for $5000:
TFSA: $1000 plus 500 ABC shares
Since the stock went up then back down, Tammy hasn’t made any money, but notice that she has managed to shift $1000 from her RRSP to her TFSA. If ABC stock cooperates by continuing to bounce up and down, Tammy can keep shifting money from her RRSP to her TFSA.
The proposed new rules for TFSAs will apply a 100% tax (ouch!) to TFSA amounts that can be attributed to such a scheme. Tax avoidance is all fun and games until your money gets confiscated.
UPDATE: Some have suggested that when performing a swap, there is the opportunity to select any price in the day's trading range. This means that when stock moves out of the TFSA, a high price can be chosen, and when it moves back into the TFSA, a low price can be chosen. This makes this scheme much more effective.