The Department of Finance recently released a broad set of changes to the Income Tax Act (Canada)(the Tax Act). The proposed legislation will, upon passage, implement changes first announced on March 22, 2011 and subsequently updated in June of 2011.
One of the changes is in respect of registered retirement savings plans (RRSPs). Specifically, the penalties imposed upon those uses of RRSPs that are viewed as abusive have been expanded significantly.
Historically, RRSPs have been restricted in their investment activities by the “qualified investment” rules. Conversely, RRSPs will now be subject to the “qualified investment” rules and “advantage” and “prohibited investment” rules. Both of these new sets of rules previously applied in respect of TFSAs, though the amendments include expansions to the existing rules applicable to TFSAs.
An “advantage” is subject to a penalty tax of 100% of its fair market value. There is also uncertainty as to the intended scope of the definition of “advantage”: the language is exceedingly broad. The Department of Finance has, however, provided some indication of the types of transactions it intends to target as “advantages”. Specifically, two new definitions will be added to the Tax Act: “RRSP Strip” and “swap transaction”. Both provide expansive definitions, with the latter often being a type of the former, that have the economic result of allowing a taxpayer to ‘access’ RRSP funds without amounts being included in income.
A “prohibited investment” will be subject to a penalty tax of 50% of its fair market value. There is an ‘accidental acquisition’ clause that allows for a deduction equal to the penalty tax on the disposition of the prohibited investment if the investment is disposed on in the same year as it becomes a prohibited investment or in the immediately subsequent year and the annuitant of the RRSP did not know or should not have known that it was or would become a prohibited investment. Notably, a “prohibited investment” is, amongst other things, an investment in which the annuitant or a person not at arm’s length to the annuitant has a significant interest (e.g. 10% of the debt or equity). There may thus, be a very large number of RRSP annuitants that have historically held assets that would now become prohibited investment.
The taxation treatment of a “non-qualified investment” is also changing. The penalty tax imposed will now be equal to 50% of the fair market value of a non-qualified investment at the time it was acquired or at the time it became non-qualified. This tax should be refundable on subsequent disposition if it was not known or ought not to have been known by the Annuitant that the investment would be a “non-qualified investment”.