Note that while these proposals to the anti-avoidance rules may apply to RRSPs, registered retirement income funds (RRIF) and tax-free savings accounts (TFSA) due to the similarity of the rules, this article will refer solely to the effect on RRSPs.
Although this relief is welcome, there is still ambiguity about how the relief may apply in certain situations.
The Joint Committee made a submission on October 28, 2011 to Finance on the RRSP and RRIF anti-avoidance rules announced in the 2011 budget and implemented via Bill C-13. The Committee's 14-page submission addressed 15 topics, including recommendations to fine-tune the rules to more appropriately target perceived abuses, clarify timing and definitions, and address some specific concerns regarding swap transactions and RRSP strips.
Finance cites CRA's administrative relief
In its comfort letter response, Finance notes that the CRA has already provided important administrative guidance to taxpayers regarding the new RRSP anti-avoidance rules. In particular, Finance refers to the CRA's online Q&A and to CRA Rulings' positions in technical interpretation 2011-0418161E5, dealing with the tax treatment of prohibited investments acquired before March 23, 2011, and 2011-0430141E5, dealing with a waiver of the advantage and prohibited investment tax.
Advantage and advantage tax - Waiver of tax mechanism
Finance notes that it has been advised by the CRA that the restriction in subsection 207.06(3), which requires an amount equal to the "advantage" to be distributed from the RRSP before the advantage tax is waived, can restrict the CRA's scope for exercising its waiver powers in Part XI.01. As a result, Finance will recommend that subsection 207.06(3) be repealed and replaced by an additional paragraph in subsection 207.06(2) that allows the full or partial removal of an advantage amount from an RRSP to be considered in determining whether some or all of the tax should be waived.
Advantage and advantage tax - "Open market" clarified
Finance recognizes that the phrase, "would not have occurred in an open market", in paragraph (b) of the definition of "advantage" in subsection 207.01(1), is broad and has created uncertainty. For example, this definition could be interpreted as only excluding transactions on stock exchanges.
Finance states that the term is intended to describe a transaction that does not occur on a commercially reasonable basis, such as where parties act in concert to achieve a tax benefit. Thus, Finance will recommend amending clause (b)(i)(A) of the definition to refer to a transaction or event (or a series of transactions or events) which would not have occurred in a "normal commercial or investment context" where parties deal at arm's length and act prudently, knowledgeably and willingly. Finance also clarified that estate freezes that result in an RRSP owning share of the freeze corporation will result in a prohibited investment..
Prohibited investments - Grandfathering
The Joint Committee had asked Finance to grandfather pre-March 23, 2011 investments completely. Finance says that, due to fairness concerns, it does not agree with providing complete grandfathering. However, because the transitional rules require Part I tax recognition of income and gains on prohibited investments, Finance agrees to make the current 10-year transitional period indefinite, and thus it will recommend removing the termination date for transitional prohibited investment benefits.
Prohibited investments - Portfolio investments
Finance agrees that the prohibited investment definition is so broad that it is possible to hold a portfolio position that, unknown to the taxpayer, is a prohibited investment because of a combination of family holdings or non-arm's length relationships. Thus, Finance will recommend eliminating the words "or with a person or partnership described in subparagraph (i)" in subparagraph (b)(ii) of the definition of "prohibited investment" in section 207.01 so that an investment will not be considered to be a prohibited investment where the RRSP annuitant does not have a "significant interest" (i.e., 10%) in the corporation, partnership or trust and he or she deals at arm's length with the corporation, partnership or trust.
Prohibited investments - Four-part test for "Prohibited investment"
A new four-part test will allow registered plan investors to demonstrate that an otherwise prohibited investment represents a portfolio-style interest in a qualified investment for which the investor cannot manipulate the valuation or income distribution. Finance notes that the four-part test may be difficult to apply.
KPMG observation - The four tests require arm's-length persons, among other things, to own 90% or more of the "equity value" of the investment (generally defined as shares, partnership interests or capital interests in a trust under subsection 122.1(1)). It will be interesting to see if this test will provide relief to investors who hold "portfolio style" shares of mortgage investment corporations (MIC) shares within an RRSP.
Prohibited investments - Investment funds start-up and wind-up
Finance recognizes that it is difficult for the first few or last few investors in an investment fund to avoid the prohibited investment rule for a fund that is intended to be (or was) widely held. An existing rule in paragraph 5000(b) of the Income Tax Regulations generally provides a time-limited exclusion from the prohibited investment rules for mutual funds in their start-up phase that comply with National Instrument 81-102 of the Canadian Securities Administrators. Finance will recommend expanding this rule to apply to registered investments that meet a "basic diversification test" and are not established with a tax avoidance objective and to a reasonable winding-up period for funds that qualify for the start-up period exclusion.
Prohibited investments - Deemed disposition rule
Finance agrees that a deemed disposition and reacquisition of a property at the time immediately before it becomes a prohibited investment would provide clearer results that would be consistent with the policy intent of the rules.
Finance will recommend amending paragraph (c) of the definition of "swap transaction" to clarify that transferring in cash to remove a prohibited investment is excluded from the definition of "swap transaction".
Finance will recommend that these proposed amendments coincide with the effective dates for the current RRSP anti-avoidance rules (i.e., generally be effective on March 23, 2011).
For more information, contact your KPMG adviser.