Compliance Bulletin No. 3
February 3, 2006
For the past three years, the Registered Plans Directorate (RPD) has published an annual Compliance Bulletin that focuses on areas of non-compliance relating to registered plans, and on the tax implications for members and employers. This third annual bulletin contains information on past service pension adjustments, fraudulent registered retirement savings plan (RRSP) arrangements, employer over-contributions, and purchase of annuity requirements.
As announced to industry professionals and pension plan administrators in November 2005, the RPD will be expanding its audit activities to ensure that deferred income plans are operated in accordance with their terms and the Income Tax Act and Regulations.
We will continue to encourage self-compliance, and we recommend this publication and other available on-line information as valuable tools to help prevent and correct non-compliance.
Calculation of past service pension adjustment
In our review of 2004 and 2005 actuarial valuation reports for individual pension plans, we noted that the past service pension adjustment (PSPA) is often incorrectly calculated. Many high-income earners are still using the previous maximum of $1,722.22. If a plan provides for the purchase of post-1989 past service, the PSPA must be calculated using whichever is less:
- the defined benefit limit for the year of calculation as defined in subsection 8500(1) of the Income Tax Regulations; or
- the plan limit.
We have also found cases where Form T1004, Applying for the Certification of a Provisional PSPA, is not being submitted to the Canada Revenue Agency, which means that the member's unused RRSP deduction room is not being appropriately reduced. Certification for a PSPA must be obtained when the conditions for exemption from the normal PSPA rules outlined in subsection 8306 (1) of the Income Tax Regulations are not met. While funding for the additional benefits may begin as soon as certification is requested, the contributions must cease if the certification is denied. Please note that we must certify the PSPA before benefits relating to the past service event can be paid to the member.
An incorrect calculation of the PSPA or failure to file Form T1004 could result in denial of service. See the PSPA section of our Web site for information on properly calculating and reporting a PSPA.
Fraudulent RRSP arrangements
We would like to warn taxpayers as well as industry professionals about a type of registered retirement savings plan (RRSP) arrangement that continues to be a compliance concern. These arrangements promise a tax-free withdrawal of RRSP funds.
The promoter, who claims to have discovered a loophole in the tax rules, entices taxpayers to convert their RRSP savings into a self-directed RRSP. The promoter then directs taxpayers to use the funds in their self-directed RRSP to purchase investments that are non-qualified, worthless, or non-existent. The funds may not be recoverable, and the taxpayers could also end up having to include an amount equal to the purchase price of the investment in their income.
For an RRSP trust that holds non-qualified investments, the annuitant is required to include the fair market value of the investment in income for the year of acquisition, according to subsection 146(10) of the Income Tax Act. In cases where the annuitant has not been assessed under subsection 146(10), the trust is required to pay a 1% tax per month on the fair market value of the investment, as outlined in subsection 207.1(1). In cases where the trust does not have marketable assets to pay this tax, the trustee can be held personally liable for the tax, as indicated in subsection 207.2(2).
Taxpayers should consult a knowledgeable tax advisor before they consider such an arrangement.
If you have questions or information on this type of arrangement, please call our telephone enquiries service (see "How to contact us" at the end of this bulletin).
Employer over-contributions to a registered pension plan
In cases where it is determined that an employer has contributed more than the amount deductible under subsection 147.2(1) and paragraph 20(1)(q) of the Income Tax Act, the amount of over-contribution must be returned to the employer and considered as income in the year received, and a deduction will not be allowed for the over-contribution.
Disallowing a deduction for the over-contribution and returning the amount from the plan to income may seem like double taxation, but it is not. While subsection 248(28) of the Income Tax Act controls double taxation, it does not prevent this tax treatment of an undeductible contribution. The deduction amount disallowed is a contribution to the plan, while the amount taxed coming out of the plan is a distribution (they are considered different amounts). For more information on this position, see Income Tax Rulings document 9605827.
We have commenced a dialogue with the Department of Finance to determine if there is a better way to deal with situations where legitimate errors have been made and are simply being corrected.
Purchase of annuity under subsection 147.4(1) of the Income Tax Act
We would like to remind industry professionals of the requirements of subsection 147.4(1) of the Income Tax Act, which apply when a member elects to purchase an annuity in satisfaction of benefits under a registered pension plan (RPP). We are aware that, in some cases, members are provided with a lump-sum payment from the plan and are then permitted to purchase an annuity with that lump sum. This practice may contravene paragraph 147.4(1)(a), which states that when a member elects to purchase an annuity, the annuity purchased must not be materially different than the benefits that would have been provided to the individual under the RPP. In other words, the annuity should provide the individual the same annual amount in the same form as the individual would have received as lifetime retirement benefits under the RPP. The tax consequences could be severe in cases where the requirements of subsection 147.4(1) are not met. The individual is considered to have received an amount from the RPP and is required to include the value of the contract in income under paragraph 56(1)(a) of the Income Tax Act.
In certain circumstances where a plan administrator fails to comply with a duty or obligation imposed by the legislation, the plan administrator is subject to a penalty under paragraph 162(7)(b) of the Income Tax Act. The RPD intends to determine in which circumstances the application of this penalty is appropriate and to apply it accordingly.
How to contact us
Contact us at the Registered Plans Directorate if you have questions about administering a registered plan in compliance with the Income Tax Act:
- Our telephone enquiries service is available Monday to Friday from 8:00 a.m. to 5:00 p.m., Eastern Time (with a voice mailbox system to take messages outside those hours):
In the Ottawa area:
For service in English, call 613-954-5102.
For service in French, call 613-954-5104.
Toll free elsewhere in Canada:
For service in English, call 1-800-267-3100.
For service in French, call 1-800-267-5565.
- Plan administrators who need guidance on issues related to a specific plan can write to us at the Registered Plans Directorate, Ottawa, ON K1A 0L5, or fax us at 613-952-0199.
- We welcome feedback on this bulletin, as well as any comments related to auditing registered plans. Email your comments to: RPD.LPRA2@cra-arc.gc.ca
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