RRSPs are an extremely popular investment vehicle for Canadians. With the mild weather, it may be easy to forget it is February and the RRSP deadline is February 29th. (The deadline is usually March 1, but with 2012 being a leap year it will be the last day of February.) This RRSP season, taxpayers and their advisors should be aware of a change in the RRSP rules enacted as a result of the 2011 Federal Budget. These new "advantage rules" target tax avoidance schemes and other structures that most taxpayers would not be involved in, but these rules also set a trap for the unwary. If the advantage rules apply, the Canada Revenue Agency ("CRA") may impose a penalty tax of 100%. In general terms, this 100% tax is on the amount of the "advantage", which may be the entire value of the investment.
The advantage rules are complex and their intended policy may be subject to debate. But in very broad strokes, these rules target schemes including economic benefits resulting from trading RRSP room between taxpayers, transactions that artificially inflate RRSP room, conversion of taxable employment income or business income into tax-sheltered RRSP investments, and a variety of other tax-avoidance concoctions yet to be conceived that take advantage of the RRSP rules in an inappropriate manner.
As mentioned, the advantage rules are unlikely to effect the transactions or investments of most taxpayers. However, the pitfall lies in "swap transactions", which are probably completed by a number of taxpayers fairly regularly.
It is well known that a withdrawal from an RRSP is generally included in a taxpayer's income, subject to certain exceptions.1 In certain cases, a deduction is available where an amount is withdrawn from an RRSP, but these exceptions are narrow. These exceptions are where a taxpayer recontributes or transfers an amount to a pension plan,2 a retirement compensation plan,3 or a retiring allowance.4 There is also an exception involving the death of an RRSP annuitant.5 That said, many advisors had believed it to be permissible to "swap" investments to or from an RRSP. For example, before the enactment of the advantage rules, taxpayers might withdraw cash from their RRSP but contribute other investments to the RRSP, and provided that the investments contributed were of at least the same value as the amount withdrawn, it was believed that the withdrawal would not be a taxable amount. Prior to the advantage rules, we understand the CRA generally took no issue with this practice.
The advantage rules, however, impose the penalty tax on a "swap transaction", which is defined as follows:
"swap transaction", in respect of a registered plan, means a transfer of property between the registered plan and its controlling individual or a person with whom the controlling individual does not deal at arm's length, but does not include
- a payment out of or under the registered plan in satisfaction of all or part of the controlling individual's interest in the registered plan;
- a payment into the registered plan that is a contribution, a premium, or an amount transferred in accordance with paragraph 146.3(2)(f);
- a transfer of a prohibited investment or a non-qualified investment from the registered plan, in circumstances where the controlling individual is entitled to a refund under subsection 207.04(4) on the transfer; or
- a transfer of property from one registered plan of a controlling individual to another registered plan of the controlling individual if
- both registered plans are RRIFs or RRSPs, or
- both registered plans are TFSAs.
These broad provisions contemplate a variety of transfers in and out registered plans as well as transfers between "registered plans" (which is defined to include RRSPs, RRIFs, and TFSAs).6 Indeed, the seemingly innocuous practice of replacing cash inside an RRSP with other investments of the same value held outside an RRSP, or vice versa, seems to be caught.
The CRA has confirmed this is the case in a recent technical interpretation.7 The CRA noted that fair market value transactions are not excluded from the "swap transaction" definition. There are limited exceptions to the "swap transaction" definition set out in paragraphs (a) through (d) reproduced above. Otherwise, in the CRA's view, the advantage rules effectively create a wholesale prohibition on swap transactions.
As a result, taxpayers and investment advisors should avoid moving assets in and out of RRSPs unless they are prepared to suffer an income inclusion, as they would under most RRSP withdrawals – or, even more unfavourably, pay the 100% penalty tax.
1 An "excluded withdrawal", defined in subsection 146.01(1) of the Income Tax Act is not taxable. As well, there are very limited exceptions set out in the case law where RRSP withdrawals are not taxable.
2 Paragraph 60(j).
3 Paragraph 60(j.1).
4 Ibid. "Retirement compensation plan" and "retiring allowance" are defined in subsection 248(1).
5 Subsection 60(l).
6 It should be noted that the advantage rules apply to RRIFs and TFSAs as well as to RRSPs.
7 CRA document no. 2011-0429561M4.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.