- Volume 9, Issue 23:
Investing in Yourself-Certain Qualified Investments for Self-Directed RRSPs
- Volume 9, Issue 24:
Financial Transactions and Commodities Related to Carbon Credits
Investing In Yourself-Certain Qualified Investments For
By: Laura M. G. Snell
The current economic situation has had a substantial effect on the availability of bank loans to small and medium-sized businesses. Unfortunately, this has resulted in a crippling of certain businesses and a further hit on the economy. The decreased supply of capital from traditional sources has led businesses to look elsewhere for much-needed investment.
One alternative source of funding is investment by self-directed registered retirement savings plans ("RRSPs"). A self-directed RRSP is a retirement savings plan in which the person funding the plan (the "Beneficiary") directs the investment of the fund. The Income Tax Act (the "ITA") allows investment by these self-directed RRSPs in certain "Qualified Investments".
If a Beneficiary funding the RRSP owns less than 10% of an Eligible Corporation or Small Business Corporation (or his or her shares are valued at $25,000 or less of the company or a related company, which he or she doesn't control), the Beneficiary can give a cash injection to that company by directing the self-directed RRSP to purchase shares of the same.
RRSPs can invest in any Qualified Investment, as defined in the ITA. The following are some examples of Qualified Investments: 1
- Shares of a Small Business Corporation
- Shares of an Eligible Corporation
- Certain debt obligations (including a debt obligation secured by a mortgage on real property in Canada)
- Money or Deposits
- Shares, debt obligations or securities issued by a publicly traded corporation listed on a Canadian stock exchange or designated foreign stock exchanges
- Certain annuities
- A unit of a mutual fund or certain other trusts
- A bond, debenture or debt obligation of a public corporation
- Options, warrants or other similar rights to acquire a Qualified Investment or to receive a cash settlement.
As is shown by the list above, there are many types of Qualified Investments for RRSPs. This article will focus on investments in shares of Eligible Corporations and Small Business Corporations. First, these two types of corporations will be defined, then eligibility limitations for investment in these corporations by self-directed RRSPs will be outlined.
Eligible Corporations ("ECs") are Qualified Investments, that is, their shares can be purchased by an RRSP as an investment. An Eligible Corporation is defined in the ITA2 as:
1. a corporation whose assets are one or both of the following:
- used in a business carried on within Canada and which is not just the derivation of income from property,
- shares of a related Eligible Corporation;3
2. a Specified Holding Company, which is a taxable Canadian Corporation whose assets are used in a qualifying active business, are shares of one or more controlled or related Eligible Corporations, are debt obligations issued by controlled corporations or related Eligible Corporations, or are a combination of these three; or
3. a Venture Capital Corporation, which is a corporation incorporated pursuant to venture capital corporation legislation.
Small Business Corporations
A Small Business Corporation4 ("SBC") is a corporation which uses all or substantially all of its assets principally in an active business carried on primarily in Canada 5 (i.e. not a business whose principal purpose is to derive income from property). A SBC cannot be controlled, even indirectly by a non-resident of Canada. A corporation, of which all or substantially all its assets are shares in a Small Business Corporation, is also a Qualified Investment for a RRSP.
The definitions of EC and SBC are similar, EC being broader to encompass holding and venture capital companies, and having fewer restrictions on residency of the person controlling the company.
Shares of These Corporations Are Qualified Investments for RRSPs
Along with the rest of the list of Qualified Investments above, RRSPs can invest in shares of ECs and SBCs. Where a Beneficiary of a RRSP owns part of one of these corporations, he or she may want to consider directing the RRSP to invest in its shares. This gives a cash infusion to the corporation and allows the Beneficiary to put money from his or her RRSP into the corporation, instead of putting the money directly into the corporation.
There are limitations on a Beneficiary's ownership for these companies to have Qualified Investment status. If the Beneficiary's ownership is past the thresholds outlined below, the investment is not a Qualified Investment for the RRSP.
Disqualification for Connected Persons
A RRSP cannot invest in the shares of an Eligible Corporation or a Small Business Corporation of a "connected person". That is, if any Beneficiary or annuitant of the RRSP exceeds the allowable thresholds of ownership in the corporation or related corporations.
A Beneficiary of the self-directed RRSP cannot own more, or have the right to own more, than 10% of the total shares of the Corporation or any related corporation.6
Exception for Certain Connected Persons
If a Beneficiary owns or has the right to own more than 10% of the shares of the corporation or any related corporation, but the total value of the taxpayer's investment in the corporation and any related corporation is less than $25,000, and he or she does not control the corporation,7 the Beneficiary is not a connected person, and shares in the corporation can still be a Qualified Investment for his or her RRSP. 8
The following are two examples determining whether ownership thresholds have been exceeded:
Example 1. A Beneficiary of a RRSP owns 7% of an Eligible Corporation, but 15% of a related corporation. The 10% ownership limit is exceeded because the Beneficiary owns more than 10% of a related corporation. The status of Qualified Investment for that Corporation is lost unless the Beneficiary's total investment is less than $25,000, and he or she does not control any of the corporations.
Example 2. Where a Beneficiary owns 20% of an Eligible corporation, and the value of those shares is $24,000, the corporation is a Qualified Investment for the self-directed RRSP of the Beneficiary as long as the Beneficiary doesn't control the corporation or any related corporation. If the Beneficiary also owns shares of a related corporation valued at $1,000 or more, the ownership threshold is exceeded and the corporation is no longer a Qualified Investment.
Timing of Qualification
The ownership conditions for an Eligible Corporation must be satisfied at the time of the acquisition of shares by the RRSP and throughout the entire period that the shares are held by the RRSP. If the shareholder later exceeds the ownership threshold, or if the corporation ceases to meet the definition of Eligible Corporation, the shares immediately cease to be a Qualified Investment and the RRSP is no longer eligible to hold them as an investment.
The ownership conditions for a Small Business Corporation must be satisfied at the time the shares are purchased by the RRSP. 9However, should these conditions cease to exist during the time the RRSP holds the shares, the shares maintain their status of Qualified Investment.
If a person with a self-directed RRSP owns part of an EC or SBC and does not exceed the ownership limitations, it is possible for his or her self-directed RRSP to invest in shares of that company. It should first be determined whether the shares fit into the Qualified Investment category of Eligible Corporation or Small Business Corporation. This will determine whether the ownership thresholds must be adhered to for the entire duration of the RRSP's investment in such shares, or simply at the time of purchase.
There are several benefits for minority owners of Eligible Corporations or Small Business Corporations in having self-directed RRSPs invest in shares of their companies. Not only is the taxpayer investing in his or her future by funding the RRSP, but he or she is also investing in the company's present. This may be one way to alleviate some of the pressure created by the current credit crunch for small and medium sized businesses in Canada.
Financial Transactions And Commodities Related To Carbon
By: Simon Labrecque
In this last article of a series of three, we will address the taxation of financial transactions involving Carbon Credits and related commodities.
If a market participant is engaged in a trading business, the analysis of the tax consequences of the purchase and sale by it of Carbon Credit instruments would most likely be similar to the analysis of the tax consequences of any other commodity trading activity. The expenditures made to acquire emissions instruments would be treated as cost of goods sold and inventoried accordingly.
The distinction between a company that is a trader and dealer of emission-allowance and emission-reduction commodities and a company that is investing in these instruments for the purposes of complying with environmental regulations may be difficult to make and will depend as always on all of the relevant facts of each case.
A useful hedging instrument for companies requiring Carbon Credits is assimilated to a future commodity. Typically, these will involve a financial institution agreeing notionally to supply a given quantity of Carbon Credits at a future date and at a fixed price in return for the agreement of a Canadian GHG-emitter to notionally supply the same quantity at the same future date, but at the then market price. On settlement, the difference between the two prices is paid by one party to the other. In the above-mentioned hedge, there is no physical delivery but merely a payout based on the value difference of the notional holdings of both parties.
For income tax purposes, the Canadian emitter may be taxed as earning business income, just as is the case with most derivative products. The complex income tax considerations of commodity futures will be treated in a subsequent article.
Recent interest in Carbon Credits as an investment or as a speculative instrument from which profits can be derived has sparked the interest of financial institutions and hedge funds in the carbon market.
Sales tax on Carbon Credits Commodities
In our view, CRA's administrative policies related to commodities should apply for Carbon Credits Commodities. In summary, no sales tax should apply if the transaction is cash settled on a recognized commodity exchange. However, the sales tax would apply if the underlying commodities, the Carbon Credits, are in fact delivered.
An "option for the future supply of a commodity" includes a right, but not an obligation, to buy or sell a commodity at a specified price within a stipulated future time period. The option buyer pays a premium to the dealer for this right, in addition to the usual commission. The supply of a commodity option where sold on a recognized commodity exchange should be an exempt financial service, thus not subject to sales tax. However, if the option is exercised, because of the taxable status of the Carbon Credits, sales tax should be applicable.
A "futures contract" is an agreement to buy or sell a specific amount of a commodity at a particular price on a stipulated future date. Contrary to a commodity option, a futures contract obligates the buyer to purchase the underlying commodity and the seller to sell it, unless the contract is sold to another before the exercise date. The supply of a futures contract where sold on a recognized commodity exchange is also an exempted financial service not subject to sales tax. However, when the exercise date becomes due, sales tax should be applicable on the taxable supply of the Carbon Credits.
Admittedly there is still a great deal of uncertainty with regard to the tax treatment of the purchase and sale of emission allowances and Carbon Credits although some tendencies seem to be emerging. To date, it seems that current tax principles are being canvassed and compared against specific fact situations in order to derive a logical tax characterization for each transaction and from there to determine the applicable tax consequences.
It is therefore imperative for companies looking to engage in this market to carefully consider the possible tax planning opportunities and risks created by these uncertainties and to monitor the tax developments in this field with the help of a tax professional.
1. S.146, s.204 and s.4900 of the Regulations to the ITA
2. At Regulation 5100.
3. A related corporation is a corporation controlled by the same Epson or group of people, Section251(2)(c).
4. At Regulation 4900(12).
5. At least 90% of the business is carried on in Canada.
6. A related corporation is a corporation controlled by the same person or group of people, Section 251(2)(c).
7. Or is not a part of a group of related persons who control the corporation.
8. All the investments in the corporation or related corporations must be taken into account when determining the 10% and the $25,000 thresholds.
9. The business must meet the criteria for Small Business Corporation status at the end of the tax year before the RRSP invests in its shares
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.