November 14, 2011 No. 2011-33
	New RRSP Anti-Avoidance Rules May Create Surprise Tax Liability If you have private company shares in your RRSP, you may be caught by new rules that have suddenly changed the landscape on allowing these shares in RRSPs. Because some private company RRSP investments have been swept into these strict new rules, you could face costly tax consequences if you have shares in your RRSP that have become prohibited investments. The new rules provide some transitional relief for investments that are now prohibited — you have until the end of 2021 to remove these investments from your RRSP but you may wish to do so sooner to avoid potentially harsh tax consequences. Background The government introduced new anti-avoidance rules for RRSPs in the 2011 federal budget. These rules are intended to prevent individuals from holding certain types of investments in their RRSPs and from using these accounts in tax planning arrangements that the government considers unacceptable. These new rules take effect as of March 22, 2011, when the federal budget was announced, with some transitional relief for RRSP investments that became prohibited under the new rules. The RRSP anti-avoidance rules also apply to Registered Retirement Income Funds (RRIF). Prohibited investments Before the 2011 federal budget, private company shares could be qualified investments for your RRSP if, at the time your RRSP acquired the shares, you (and others related to you) held less than 10% of the company’s shares. Even if you held more than 10% of the company’s shares, the shares could still be considered a qualified RRSP investment, provided you and related parties did not control the company and the original cost of the shares was less than $25,000. The new rules do not include the exception for shares with an original cost under $25,000. In addition, under the new rules, you are prohibited from holding in your RRSP: · Investments in entities in which you or a non-arm’s length person has a significant interest (generally 10% or more) · Investments in entities with which you (or any entity in which you have a significant interest) do not deal at arm’s length · Your own debt obligations. Example of a prohibited investment For example, in 1994, Mr. X used his RRSP to help finance the start-up of a business with four unrelated partners. At that time, his RRSP acquired 20% of the company’s shares for $20,000. On March 23, 2011, these shares became a prohibited investment because they represent more than 10% of the company’s outstanding shares.  Even if private company shares in your RRSP are not prohibited investments under the new rules, you will need to continually monitor the company shareholdings to ensure you don’t fall afoul of the strict new requirements. Prohibited investment penalty tax A special tax of 50% of the fair market value of the prohibited investment applies to you as the RRSP holder when your RRSP acquires a prohibited investment or at the time an investment already acquired becomes prohibited. The 50% prohibited investment tax may be refunded if your RRSP disposes of the prohibited investment by the end of the year following the year in which the tax applied, unless you knew or ought to have known that the investment was prohibited when your RRSP acquired it. Example of prohibited investment tax refund For example, in April 2011, Ms. S purchased a 5% interest in the shares of a publicly traded company (Pubco) within her RRSP. She did not know at the time that her brother, Mr. S, owned shares of Pubco that represented a 6% interest. Though her investing activities are independent from her brother’s, Ms. S’s Pubco shares would be a prohibited investment for her because together she and a non-arm’s length person (i.e., her brother) own more than a 10% interest in Pubco. As a result, Ms. S will be assessed the 50% prohibited investment tax in 2011. In this situation, it seems likely that the CRA could consider it reasonable to conclude that Ms. S was not aware at the time of her investment in Pubco that she was purchasing a prohibited investment in her RRSP. As such, provided that Ms. S removes the prohibited investment from her RRSP in 2012, she should be eligible for a refund of the 50% prohibited investment tax assessed in 2011. Prohibited investment tax transitional relief The new prohibited investment rules apply not only for investments acquired on or after March 22, 2011, but also for investments already held before that date. As such, you may have investments in your RRSP that have suddenly become prohibited. However, a qualified investment acquired before March 22, 2011 that became a prohibited investment under the new rules, either immediately on March 23, 2011 or before October 4, 2011, will not be subject to the 50% prohibited investment tax. Although the 50% prohibited investment tax may not apply to prohibited investments that were qualified investments held in your RRSP before March 22, 2011, any income attributable to a prohibited investment may be subject to a new advantage tax (though at a reduced rate until 2022, see below). As such, it’s likely that you will still want to consider removing any prohibited investments from your RRSP as soon as possible. RRSP advantage tax The new RRSP anti-avoidance rules are designed to disallow certain “advantages”, which the government says are generally benefits obtained from transactions that are intended to inappropriately exploit the tax attributes of an RRSP. Among other items, the advantage tax will generally apply to: · Income attributable to prohibited investments · Increases in the fair market value of the RRSP's assets derived from transactions that would "not have occurred in an open market" (e.g., non-arm's-length transactions) and that were primarily undertaken to benefit from the RRSP's income tax exemption · Payments for services from the RRSP holder or a non-arm’s length person or returns on investments from property owned by the RRSP holder · Increases or decreases in the RRSP’s value due to “swap” or “strip” transactions (see below). These advantages are generally subject to a tax equal to their full fair market value, i.e., 100% of the advantage amount. As the RRSP holder, you are the one who must pay the tax (rather than your RRSP). This RRSP advantage income is generally not subject to further tax when you withdraw it from your RRSP. Although the rules don’t require you to withdraw the advantage amount, you will likely want to do so because any income the RRSP earns on the advantage amount could trigger a further advantage tax liability in the future. The advantage tax applies as of March 23, 2011, except for income earned and capital gains accrued before March 23, 2011 and transactions undertaken before 2022 to remove from the RRSP an investment that would be subject to the advantage tax or the 50% prohibited investment tax. CRA can waive advantage tax liability The CRA has the ability to waive an advantage tax liability if the amount that triggered the tax is paid from the RRSP “without delay”. It is not yet known under what circumstances the CRA will exercise this discretion. The CRA may also waive or cancel all or part of an advantage tax or prohibited investment tax liability if it is “just and equitable to do so”, including in situations where the tax arose as a result of a reasonable error or the transaction that caused the penalty tax gave rise to another tax under the new anti-avoidance rules. If the advantage tax is waived or cancelled, the income becomes subject to regular income tax when you withdraw it from your RRSP. Example of waived advantage tax For example, in September 2011, Ms. Y purchases public company (Pubco) shares in her RRSP that represent 9% of Pubco’s outstanding shares. In 2012, Pubco undergoes a share restructuring so that enough shares are redeemed from the company to cause Ms. Y’s Pubco share investment to increase to 10%. As a result, Ms. Y’s interest in Pubco’s shares is now a prohibited RRSP investment because she owns 10% of the company’s outstanding shares. As a minority shareholder, Ms. Y is not able to influence Pubco’s 2012 share restructuring so she should not be penalized for holding 10% of the company’s shares in her RRSP. In this situation, it seems likely that the CRA would waive the 50% prohibited investment tax and also the 100% advantage tax liability otherwise payable on any increase in value Ms. Y realizes when she removes her Pubco shares from her RRSP, provided that she does so “without delay”. Advantage tax transitional relief Transitional relief is available from the full advantage tax on income and capital gains arising from previously qualified RRSP investments that became prohibited investments under the new rules. This relief is available until December 31, 2021. Under the transitional rules, the advantage tax will apply at your marginal income tax rate (rather than 100%) to advantage amounts that qualify for this relief. Effectively, this rule provides the same tax result as a normal RRSP withdrawal. Income earned or capital gains realized by an RRSP can qualify for this lower tax rate if all the following conditions apply: · The income or capital gain was attributable to a prohibited investment owned by the RRSP on March 23, 2011 · Income was earned, or a capital gain was accrued and realized, between March 23, 2011 and December 31, 2021 · The income or gain is withdrawn and paid to the RRSP holder (not to another RRSP or RRIF) within 90 days after the end of the year. You must file an election before July 2012 to have this transitional rate apply to your qualifying RRSP advantage amounts. KPMG observation If you have prohibited investments in your RRSP, you should elect before July 2012 to have the transitional relief apply to any qualifying advantages that your RRSP has currently obtained or may obtain by December 31, 2021. Removing prohibited investments from your RRSP Normally, if you withdraw funds or assets from your RRSP, the value of the withdrawal is taxed as regular income. At a top marginal tax rate, say of 45%, depending on your province, this can be a costly option for getting newly prohibited investments out of your RRSP. To recognize this situation, the new rules allow you to remove the shares from your RRSP by “swapping” them for cash or other property with the same value, but only until the end of 2021. The value of any private company shares you want to swap out of your RRSP will have to be supported by an appropriate valuation. Example of removing a prohibited investment Mr. X in our first example has private company shares in his RRSP that became a prohibited investment on March 23, 2011 because they represent more than 10% of the company’s outstanding shares. He paid $20,000 to acquire the shares in 1994 and they now have a value of $200,000. The 50% prohibited investment tax does not apply because the RRSP owned the prohibited investment before March 23, 2011. Mr. X elects before July 2012 to have transitional relief apply to any qualifying advantages that his RRSP may obtain by December 31, 2021. On December 31, 2012, when the shares have a fair market value of $250,000, Mr. X is able to obtain enough financing to purchase the shares from his RRSP for $250,000. Although the prohibited investment tax does not apply, Mr. X realizes an advantage of $50,000 (the difference between the December 31, 2012 value of $250,000 and the March 23, 2011 value of $200,000) as a capital gain the RRSP realized from a prohibited investment. As long as this $50,000 advantage amount is withdrawn from the RRSP and paid to Mr. X within 90 days after the end of 2012, he will be able to elect to have the advantage tax applied at his marginal tax rate of 45%, rather than the regular advantage tax rate of 100% that would otherwise apply. RRSP swap anti-avoidance rules The new RRSP anti-avoidance rules also include provisions intended to prevent aggressive types of transactions that taxpayers could use to inappropriately transfer value into or out of an RRSP by exploiting the volatility in the pricing of securities. For example, an asset held in an RRSP that is potentially worth more or less than its sometimes momentary trading price could be purchased from the RRSP at that price, creating a shift in value of the difference between the purchase price and the actual value. These “swap” transfers could allow a taxpayer to increase an RRSP's balance to shelter more investment income from tax, or reduce the balance of an RRSP to avoid personal tax on withdrawal (a “strip” transaction). To prevent taxpayers from using their RRSPs in swap transactions, an RRSP advantage now includes an increase in the fair market value of an RRSP that is in any way attributable to a swap transaction. Similarly, amounts extracted from an RRSP without being included in taxable income will be considered advantages. As such, these amounts will be subject to the 100% RRSP advantage tax. KPMG observation Although a swap transaction should not create an immediate advantage within an RRSP when the fair market value of the property taken out of the RRSP equals the fair market value of the property put into the RRSP, the CRA’s view is that any increase in the fair market value of the RRSP in the future from the swapped property, including dividends, interest and other amounts paid, would generally be subject to the advantage tax if the transitional rules do not apply. Transitional rules These new rules are considered to have come into force on March 23, 2011 but they will not apply swap transactions undertaken before July 2011 or transactions undertaken before 2022 to remove investments from an RRSP that would be subject to the advantage tax or the 50% prohibited investment tax. We can help Your KPMG adviser can help you review your RRSP investments to assess the potential impact of the new RRSP anti-avoidance rules. If your investments are affected, we can help you determine what steps you need to take to minimize the new rules’ cost for you and your RRSP. For details, please contact your KPMG adviser.
	Information is current to November 11, 2011. The information contained in this TaxNewsFlash-Canada is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG’s National Tax Centre at 416.777.8500. KPMG LLP, the audit, tax and advisory firm (kpmg.ca), a Canadian limited liability partnership established under the laws of Ontario, is the Canadian member firm of KPMG International Cooperative (“KPMG International”). KPMG International’s member firms have 140,000 professionals, including more than 7,900 partners, in 146 countries. The independent member firms of the KPMG network are affiliated with KPMG International, a Swiss entity. Each KPMG firm is a legally distinct and separate entity, and describes itself as such. KPMG's Canadian Web site is located at http://www.kpmg.ca/ © 2011 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International.