Investment Restrictions on Registered Plans
The Income Tax Act (“ITA”) imposes certain investment restrictions on registered plans. Registered plans are only allowed to invest in property that is considered a “qualified investment.” These plans are also not allowed to invest in property considered a “prohibited investment.” In addition, they must avoid any investments or structured transactions that aim to artificially shift value into or out of the plans or which result in certain supplementary “advantages.”
Registered plans include:
– Registered Retirement Savings Plans (RRSPs)
– Registered Education Savings Plans (RESPs)
– Registered Retirement Income Funds (RRIFs)
– Registered Disability Savings Plans (RDSPs)
– Tax-Free Savings Accounts (TFSAs)
These investment limitations have been put in place to safeguard against abusive tax planning. These investment restrictions originally only applied to TFSAs. However, in 2011, the rules were extended to apply to RRIFs and RRSPs, and in 2017, they were extended to apply to RESPs and RDSPs.
Qualified Investments
Pursuant to subsection 207.04(1) of the ITA, registered plans are required to limit their investments to “qualified investments.”
The following types of assets are some of the common types of qualified investments:
– Money, GICs and other deposits
(Digital currencies like bitcoin are not considered to be qualified investments as they are not recognized as money that is issued by government)
(Foreign exchange contracts are also not recognized as money and therefore not considered a qualified investment)
– Securities listed on a designated stock exchange (with the exception of certain derivatives)
(This includes shares of corporations, warrants, put and call options, exchange-traded funds and real estate investment trusts)
– Mutual funds and segregated funds
– Canada savings bonds and provincial savings bonds
– Debt obligations of a corporation listed on a designated stock exchange
– Insured mortgages
– Gold and silver bullion coins, bars and certificates
(Futures contracts where the holder’s risk of loss can exceed the cost are not considered to be qualified investments)
Taxes on Non-Qualified Investments
If a registered plan acquires or holds an investment not considered a qualified investment, the “controlling individual” of the registered plan is subject to a 50% tax on the property’s fair market value. The “controlling individual” of a registered plan is defined under subsection 207.01(1) of the ITA as the annuitant of an RRSP or RRIF, the subscriber of an RESP or the holder of an RDSP or TFSA. In addition, any income earned on the non-qualified investments will also be taxed by the Canada Revenue Agency (“CRA”).
This 50% tax is refundable in certain circumstances if the investment is disposed of before the end of the calendar year following the year in which the tax arose. To be refundable, the controlling individual must not have known or ought to have known that the investment was or would become a non-qualified investment.
Prohibited Investments
A registered plan is not allowed to invest in property that is a “prohibited investment.” Under subsection 207.01(1) of the ITA, a “prohibited investment”is defined as any of the following:
– A debt of the controlling individual of the registered plan
– A share of the capital stock of, an interest in, or debt of
(i) a corporation, partnership or trust in which the controlling individual has a significant interest, or
(ii) a person or partnership that does not deal at arm’s length with the controlling individual;
– An interest (or, for civil law, a right) in, or a right to acquire, a share, interest or debt described in paragraph (a) or (b)
– Certain prescribed property
Taxes on Prohibited Investments
Under the ITA, two special taxes apply to the controlling individual of the registered plan when a registered plan acquires or holds a prohibited investment:
– A 50% tax on the fair market value of the investment (at the time it is acquired or becomes a prohibited investment)
– A 100% tax on any income or capital gain derived from the investment
Like with non-qualified investments, the 50% tax is refundable in certain circumstances if the investment is disposed of before the end of the calendar year following the year in which the tax arose. To be refundable, the controlling individual must not have known or ought to have known that the investment was or would become a prohibited investment.
If an investment is considered as both a non-qualified and a prohibited investment, subsection 207.04(3) of the ITA deems the investment to be only a prohibited investment.
“Advantages” in Relation to Registered Plans
An “advantage”in relation to a registered plan is defined in subsection 207.01(1) of the ITA as any of the following:
– Any benefit, loan or indebtedness that is conditional in any way on the existence of the registered plan, subject to specific listed exceptions
– A benefit that is an increase in the total fair market value of the property held in connection with the plan (if it is reasonable to consider that the increase was attributable, directly or indirectly, to certain transactions or amounts
– A benefit that is income or a capital gain (which can reasonably be attributable to certain property or transactions in respect of the plan)
– A “registered plan strip” in relation to the plan
A “registered plan strip” is defined in subsection 207.01(1) of the ITA as:
“the amount of a reduction in the fair market value of property held in connection with the registered plan, if the value is reduced as part of a transaction or event or a series of transactions or events one of the main purposes of which is to enable the controlling individual of the registered plan, or a person who does not deal at arm’s length with the controlling individual, to obtain a benefit in respect of property held in connection with the registered plan or to obtain a benefit as a result of the reduction….”
Taxes on Advantages
A tax is imposed under section 207.05 of the ITA if certain supplementary “advantages” are received (in relation to a registered plan) by the controlling individual of a registered plan.
The tax is equal to 100% of:
– In the case of a benefit, the FMV of the benefit
– In the case of a loan or other indebtedness, the amount of the debt
– In the case of a registered plan strip, the amount of the registered plan strip
Waiver of Taxes
Under subsection 207.06(2) of the ITA, the CRA has the discretion to cancel or waive all or part of the taxes applied on these investment restrictions in certain circumstances. In determining whether to exercise its discretion, the CRA will take into account various factors. These factors include reasonable error, the extent to which the particular transactions that gave rise to the tax also gave rise to another tax payable, and the extent to which the payments were made from the taxpayer’s registered plan.
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By Kaveh Rezaei – Attorney at KR Law Firm
**Disclaimer
This article contains information of a general nature only and does not constitute legal advice. All legal matters have their own specific and unique facts and will differ from each other. If you have a specific legal question, it may be appropriate to seek the services of a lawyer.
