RRSP Anti-Avoidance Rules: RRSP Advantage

RRSP Background – RRSP Anti-Avoidance Rules: RRSP Advantage

Registered retirement savings plans (RRSPs) are tax efficient method of investment for individuals created by the government to encourage Canadians to save for retirements.

The basic structure of an RRSP is that a financial institution (the issuer) holds investments in trust (the RRSP) for an individual with whom the issuer has a contract or arrangement that meets certain requirements. When the individual makes eligible contributions to the RRSP, then the individual receives an income tax deduction in the same amount as the contribution. The individual is called the “controlling individual” of the RRSP. The RRSP can then invest the contributions into various types of investments. RRSPs are not allowed to own certain “non-qualifying” or “prohibited” investments. The RRSP itself is exempt from income tax. When the individual eventually withdraws funds from the RRSP, the individual has an income inclusion for the amount of the funds withdrawn. This means that RRSPs functionally allow individuals to invest with “pre-tax income” and have their investments compound tax free until withdrawal.

RRSP contribution room is determined by an individual’s “earned income”, which among other things includes employment income or business income earned while a tax resident of Canada. Taxpayers can contribute to their RRSPs until December 31 of the year in which they turn 71 years old. Individuals are also required to collapse their RRSPs by December 31 of the year they turn 71. The main options are transferring your RRSP to a registered retirement income fund (RRIF) on a tax deferred basis, purchasing eligible annuities on a tax deferred basis, or withdrawing the funds and having an income inclusion. A RRIF operates in a similar manner to an RRSP, but it requires the beneficiary of the RRIF to withdraw a minimum amount every year.

To maintain the integrity of the RRSP system, the Canadian Income Tax Act contains numerous anti-avoidance rules which can result in severe problems for taxpayers. This article focuses on the anti-avoidance rules regarding RRSP advantage.

Definition of RRSP Advantage – RRSP Anti-Avoidance Rules: RRSP Advantage

RRSP advantage is a broad concept which in intended to capture a variety of different ways in which a taxpayers could obtain some kind of benefit from or using their RRSP in a manner considered abusive by parliament. Many of these benefits are achieved by finding a way to shift value either into an RRSP while avoiding the contribution limit or out of an RRSP while avoiding the income inclusion.

Benefits or Indebtedness Conditional on the RRSP

One form of RRSP advantage is any form of benefit, loan, or indebtedness conditional in any way on the existence of the RRSP. The CRA has given as an example of this kind of benefit a taxpayer who invests in a mutual fund that holds rental properties near a ski hill through an RRSP which offers a 25% discount to investors. In CRA’s view, the amount of the discount would be an advantage.

This category of RRSP advantages is subject to some explicit exceptions. These exceptions are mostly designed to exclude from the definition of an RRSP advantage types of benefits that would be available in normal transactions in the open market. These exceptions from this prong of the definition of advantage include:

• administrative or investment services provided in connection with the RRSP,
• a loan or other debt that reflects arm’s-length terms and conditions;
• a distribution from the RRSP in satisfaction of all or part of the taxpayer’s interest in the plan;
• a payment or allocation to the plan by the issuer, carrier, or promoter of the RRSP; and
• a promotional incentive under a program offered to a broad class of persons in a normal commercial or investment context and not established mainly for tax purposes.

A benefit that fits into one of these exceptions may nevertheless be an RRSP advantage if it fits into one of the other criteria for RRSP advantage discussed below.

Note that these exclusions mean that loans contingent on the existence of an RRSP do not necessarily count as an RRSP advantage. However, a significant degree of caution should be exercised when entering into such an agreement, particularly if the loan appears much more favourable than loans that do not involve an RRSP or if it is not being offered by a large financial institution which offers similar loans broadly to the public.  

Increasing the Value of Property held in Connection with the RRSP

Another form of RRSP advantage is a benefit that is an increase in the total fair market value of the property held in connection with an RRSP if it is reasonable to consider the increase to be attributable to an improper source of the type described below.

Non-Commercial Transactions or Events Intended to Benefit from the RRSP Exemption

One type of improper source is any transaction or event (or series of events or transactions) that:

• would not have occurred in a normal arm’s length commercial context involving knowledgeable, and prudent parties; and
• where one of the main purposes is to enable a person or partnership to benefit from the RRSP’s exemption from income tax.

Determining whether a transaction or event fits with this definition requires a thorough evaluation of all the relevant facts by an expert Canadian tax lawyer. Some signs warning signs of a not commercially reasonable transactions are:

• property was purchased not at fair market value or in circumstances where it its value is difficult to determine,
• the transaction involves an investment the terms of which provide the parties a mechanism to stream disproportionate returns into the RRSP, or
• the transactions involve a much higher return on investment than would be expected given the risks involved.

Substituted Payments

Another type of improper source of increasing the value of the RRSP property is a payment received as, on account or in leu of, or in satisfaction of, a payment:

• for services provided by the controlling individual of the RRSP or someone not at arm’s length with the controlling individual, or
• of interest, dividend, rent, royalty, proceeds of disposition, or other return on investment in respect of property (other than property held with respect to the RRSP) held by the controlling individual or someone not at arm’s length with from the controlling individual.

The idea behind this source is to prevent the use of arrangements that shift otherwise taxable amounts into an RRSP.

Swap Transactions

Another category of improper source of increase in the value of RRSP property is increasing the value of RRSP through a swap transaction. A swap transaction is a transfer of property between the RRSP and its controlling individual or a person with whom the controlling individual is not dealing at arm’s length. CRA’s view is that a swap transaction that takes place at fair market value does not prevent subsequent increases in value of the RRSP attributable to the swap transaction giving rise to advantage.

There are a number of explicit exceptions from the definition of swap transaction which include:

• an RRSP withdrawal (i.e. a payment out of the RRSP in part or whole satisfaction of the controlling individual’s interest in the RRSP),
• an RRSP contribution,
• a transfers of property between the RRSP and another RRSP or RRIF of the same individual, and
• the sale of non-qualified or prohibited investment by the RRSP to the plan’s controlling individual.

Specified Non-Qualified Investment Income

Another improper source of the increase in the value of RRSP property relates to specified non-qualified investment income. Specified non-qualified investment income is income or a capital gain that is reasonably attributable, directly or indirectly, to an amount in respect of which regular income tax was payable by the RRSP or another registered plan belonging to the same individual. This normally results from an RRSP generating taxable income (e.g. by the RRSP carrying on a business or holding a non-qualified investment), and then investing that income.

The Canada Revenue Agency can issue a notice to the controlling individual of an RRSP to cause the RRSP to pay out its specified non-qualified investment income. If the controlling individual does not accomplish this within ninety days of receiving the notice, then the specified non-qualified investment income remaining in the plan will be advantage.

Investment Income or Gains from Improper Sources

Another type of RRSP advantage is income or capital gains that is reasonably attributable, directly or indirectly, to:

• a prohibited investment held in the RRSP or another registered plan held by the same individual,
• a deliberate overcontribution to the RRSP, or
• an amount received by the controlling individual of the RRSP (or a person not at arm’s length from that individual) if it is reasonable to consider that the amount was paid in relation to, or would not have been paid but for, property held in connection with the RRSP, and the amount was paid as, on account or in lieu of, or in satisfaction of, a payment
  • for services provided by a person who is, or who does not deal at arm’s length with the controlling individual of the RRSP, or
  • of interest, of a dividend, of rent, of a royalty, of proceeds of disposition or of any of there return on investment.

Note that the first two types above target taxpayers seeking to benefit from the RRSP exemption from income tax in ways that the government did not intend. The primary target of the third type is shifting income out of an RRSP to take advantage of favorable tax treatment outside of the plan (e.g. capital gains treatment).

RRSP Strip

Another form of RRSP advantage is an RRSP strip. This form of advantage is meant to target taxpayers finding ways to in effect withdraw from their RRSPs without a corresponding income inclusion. More precisely, an RRSP strip is the amount of a reduction in the fair market value of property held by an RRSP if the value is reduced as a part of a transaction one of the main purposes of which is to enable the controlling individual of the RRSP (or a person not at arm’s length from that individual) to obtain a benefit as result of that reduction.

There are several types of amounts that might otherwise meet the definition above that are excluded from being RRSP strips by the Income Tax Act including the following:

• an amount that is included in the income of the controlling individual of the RRSP or his or her spouse or common law partner as a result of an RRSP withdrawal,
• an amount that is transferred into another RRSP or other registered plan on a tax deferred basis,
• amounts withdrawn under the Home Buyer’s Plan[IT1] .

Tax on RRSP Advantage – RRSP Anti-Avoidance Rules: RRSP Advantage

If during the course of a calendar year, an advantage with respect to an RRSP is received or receivable by the controlling individual of the RRSP, a trust governed by the RRSP, or a person not at arm’s length from the controlling individual, then a tax is payable for that year.

By default, liability for the tax falls on the controlling individual of the RRSP. However, in the event that an RRSP advantage is extended by the issuer or carrier of the RRSP, or a person with whom the issuer or carrier is not at arm’s length, then liability for the tax falls on the issuer or carrier of the RRSP and not the controlling individual of the RRSP.

Amount of the Tax

The amount of the tax on RRSP advantage is determined as follows:

• in the case that the advantage is a benefit, the tax is the fair market value of the benefit,
• in the case that the advantage is a loan, the tax is the full amount of the loan, and
• in the case of an RRSP strip, the amount of the RRSP strip.

In other words, the tax is equal to 100% of any RRSP advantage received or receivable.

Return and Payment of the Tax

The person liable to pay the tax on RRSP advantage in a calendar year is required to file a corresponding form RC339 tax return and pay the tax before July of the following calendar year. As with regular income tax, interest will accrue on a late payment and penalties may apply if a return is filed late or not filed at all.

Discretionary Relief from RRSP auditAdvantage Tax – RRSP Anti-Avoidance Rules: RRSP Advantage

CRA has the discretion to waive or cancel part or all of a taxpayer’s RRSP tax owing in circumstances where the Canada Revenue Agency determines that it would be just and equitable to do so. Some of the circumstances in which CRA may exercise its discretion are:

• when the tax arose as a consequence of a reasonable error,
• when the transactions that gave rise to the RRSP advantage tax also gave rise to another tax under the Income Tax Act,
• when payments have already been made from the RRSP.

To request that RRSP advantage tax be waived or cancelled, the taxpayer’s experienced Canadian tax lawyer must submit a written application to the CRA’s Pension Workflow Team located at either the Sudbury Tax Centre or the Winnipeg Tax Centre depending on the location of the taxpayer’s residential address. The application should describe in detail the circumstances giving rise to the advantage tax and why it would be just and equitable for the advantage tax to be waived or cancelled.

Note that the CRA’s taxpayer relief and voluntary disclosures programs which offer penalty and interest relief in some circumstances cannot be appealed to in order for the RRSP advantage tax itself to be waived or cancelled because it is a tax and not a penalty. It is possible however to get relief under those programs from penalties or interest associated with the RRSP advantage tax.

Pro Tax Tips – RRSP Anti-Avoidance Rules: RRSP Advantage

The definition of RRSP advantage is quite comprehensive and the consequences of an advantage existing are severe. Taxpayers should be extremely weary of any plans proposed to them that allow them to get an unusual tax benefit from an RRSP and consult with an experienced Toronto tax lawyer prior to proceeding with the plan.

In the event that you think you may have received an RRSP advantage or if CRA has assessed you as such in an audit, it is highly recommended that you speak with an expert Canadian tax lawyer regarding whether any steps can be taken dispute whether there was an RRSP advantage or apply for discretionary relief.