ELI5 summary
What is allowed
The Income Tax Act lists “qualified investments” for registered plans, and the list is broadly the same for TFSAs, RRSPs, RRIFs, RESPs and FHSAs. It includes:
- cash and savings deposits;
- guaranteed investment certificates (GICs);
- government and corporate bonds;
- mutual funds and exchange-traded funds (ETFs);
- shares, units and warrants listed on a designated stock exchange, in Canada or abroad;
- certain shares of small business corporations, under conditions.
Direct holdings of cryptocurrency are not qualified investments. Exchange-listed ETFs that hold cryptocurrency generally are, because it is the ETF unit that the account holds.
Non-qualified and prohibited investments
Two kinds of holding cause trouble.
- Non-qualified investments are things that are not on the list at all, such as shares of most private companies, land, or a direct cryptocurrency holding.
- Prohibited investments are qualified in general but not for you, typically shares or debt of a company in which you and people you do not deal at arm’s length own 10% or more.
Either one triggers a tax equal to 50% of the investment’s fair market value when it is acquired or becomes non-qualified. The tax is generally refunded if the investment is disposed of by the end of the following year, unless you knew or should have known it was non-qualified or prohibited. Income from these holdings is also taxed: for prohibited investments, and some other “advantages”, the tax can be 100% of the income.
Foreign withholding tax: the U.S. dividend problem
When a U.S. company pays a dividend to a Canadian investor, the U.S. withholds tax at source, normally 15% under the Canada–United States tax treaty. What happens next depends on the account.
- Non-registered account: the 15% withheld can usually be claimed as a foreign tax credit on your Canadian return, so it is not lost.
- RRSP or RRIF: the treaty recognizes these as retirement plans, so dividends from U.S.-listed shares and ETFs held directly in the account are generally exempt from U.S. withholding.
- TFSA, FHSA and RESP: these are not treated as retirement plans under the treaty, so the 15% is withheld, and because the income is not taxed in Canada there is nothing to claim a credit against. The 15% is simply lost.
A second layer applies to funds. A Canadian-listed ETF that holds U.S. shares suffers the 15% U.S. withholding inside the fund, before anything reaches you, and that is not recoverable in any account type, including an RRSP.
Worked example
Leila holds $40,000 of U.S. dividend stocks with a 2% yield, so they pay $800 a year in dividends. In her TFSA, $120 a year (15%) is withheld and lost. If she held the same U.S.-listed shares directly in her RRSP, nothing would normally be withheld. The gap is about 0.3% of the holding each year. It matters over decades, but it is small compared with a difference in fees or asset mix, and it is zero for investments that pay little or no dividend.
Interest and capital gains are treated differently: U.S. capital gains are generally not subject to U.S. withholding for Canadian residents, and Canadian dividends and interest have no foreign withholding at all.
Frequent trading inside a TFSA
Gains in a TFSA are tax-free because they are investment income. If the CRA concludes that the account holder is carrying on a business of trading securities inside the TFSA, the profits become business income and are taxable. The CRA has reassessed TFSA holders on this basis, and the holder can be liable for the tax together with the account trustee.
There is no bright-line test. Factors the courts and the CRA consider include how often you trade, how long you hold positions, whether you use margin or options strategies, how much time you spend, and whether your trading knowledge comes from your job. Buying and holding diversified funds, even in large amounts, is nowhere near that line. Daily or weekly trading of individual stocks can be.
Losses and borrowing
- Losses inside a registered account cannot be claimed against other income. A stock that falls 50% in your TFSA simply reduces your balance; it does not give room back.
- Interest on money borrowed to contribute to a TFSA, RRSP or FHSA is not deductible.
Show the math
Qualified investments are defined in section 204 of the Income Tax Act and Regulation 4900, and apply to TFSAs, RRSPs, RRIFs, RESPs, RDSPs and FHSAs. Tax on non-qualified or prohibited investments: 50% of fair market value at acquisition (or when the property becomes non-qualified or prohibited), refundable on disposition by the end of the following calendar year unless the holder knew or ought to have known. Prohibited investment: debt or shares of an entity in which the holder has a significant interest (generally 10% or more, including non-arm’s-length holdings). Income from prohibited investments and other advantages: 100% advantage tax. Canada–U.S. treaty Article XXI exempts qualifying retirement trusts (RRSPs, RRIFs) from U.S. withholding on U.S.-source dividends; TFSAs, FHSAs and RESPs are not covered.
A practical checklist
- Before buying something unusual in a registered account, ask the institution to confirm it is a qualified investment for that account type.
- Do not hold shares of a company you, or your family together, own 10% or more of.
- If U.S. dividends are a large part of your plan, consider which account holds them, but do not let a 15% tax on the dividend alone drive the whole allocation.
- Keep a TFSA for investing, not for frequent trading.
Key takeaways
- Almost any ordinary investment is allowed in a TFSA, RRSP or FHSA; direct crypto and private company shares are not.
- Non-qualified and prohibited investments trigger a 50% tax on their value.
- U.S. dividends lose 15% in a TFSA or FHSA; U.S.-listed holdings in an RRSP are generally exempt.
- Frequent trading can turn tax-free TFSA gains into taxable business income.