Compliance Bulletin No. 4
For the past several years, the Registered Plans Directorate has used its Compliance Bulletins to inform industry professionals about non-compliance relating to registered plans. Compliance Bulletins No. 2 and No. 3 addressed the issue of abusive registered retirement savings plan (RRSP) arrangements.
The number and complexity of questionable RRSP and registered retirement income fund (RRIF) arrangements have increased. As a result, we are devoting this Compliance Bulletin to this topic to further emphasize the severe consequences for annuitants and trustees of entering into these types of arrangements.
In this bulletin, we use the term “RRSP” to refer to both RRIFs and RRSPs. In situations where there are differences between the two, a complete reference is given and the differences are discussed.
RRSP strip issue
Trust companies that hold RRSP funds are being used to facilitate arrangements for withdrawing funds tax-free from RRSPs. These arrangements are marketed by promoters to individuals, often through advertisements in newspapers and seminars offering so-called financial planning services and information. Typically, individuals (annuitants) are instructed to transfer their RRSP to a self-directed arrangement with a trustee and then to purchase shares in a specified company controlled by the promoter. The investment is not a “qualified investment” as defined under the Income Tax Act, even though the promoter may arrange for a lawyer or accountant to “certify” that the shares are considered a qualified investment. These shares are worth only a fraction, if any amount, of the price paid. The promoter retains a portion of the funds as a fee and directs the remaining amount to be paid to, or secured for, the annuitant. The funds may be directed back to the annuitant through a loan, deposited in an offshore account, or placed on a debit/credit card. In some cases, the promoter retains all the funds and cannot be found, and the annuitant loses his or her entire retirement savings. The way the scheme is executed may vary. For example, an inflated mortgage may be used in the place of the company described above.
With the increase in questionable arrangements noted by auditors and compliance officers, the CRA will be stepping up its compliance activities and audits of trust companies with respect to self-directed RRSPs.
Auditors identified the following topics for discussion during trustee audits. The consequences of non-compliance with the sections of the Income Tax Act mentioned below are general in nature and apply to RRSP strip situations and all other cases of non-compliance. For example, the consequences described for the acquisition of non-qualified investments below would apply even if the objective was not a tax-free withdrawal from the RRSP.
- Acquisition of non-qualified investment
Subsections 146(10) and 146.3(7) provide that, when a trust acquires a non-qualified investment, the fair market value of the non-qualified investment at the time it was acquired by the trust is included in computing the income of the taxpayer who is the annuitant under the plan.
Trustees may also be affected by these transactions. Part XI.I deals with tax in respect of deferred income plans. Generally, Part XI.1 imposes a tax at the end of each month on a plan trust for its property that is not a qualified investment. An RRSP or a RRIF is required to pay a 1% tax each month on the fair market value at the time of acquisition of the property that the trust holds that is not a qualified investment. However, Part XI.1 tax does not apply to propertythe fair market of which has been included in the income of the annuitant.
Under subsection 207.2(1), a taxpayer to whom Part XI.I applies must file a return, estimate the amount of any tax payable, and pay the amount due to the Receiver General within 90 days after the end of each year. Under subsection 207.2(2), if a trustee of a trust that is liable for such tax does not remit the amount due within the time specified, the trustee is personally liable to pay the full amount of the tax on behalf of the trust. The trustee is entitled to recover this amount from the trust.
- Acquisition of property for more than fair market value (FMV) or disposition of property for less than FMV
Subsection 146(9) provides that, where a trust governed by a RRSP disposes of property for less than the FMV of the property at the time of the disposition, or acquires property for a consideration greater than the FMV of the property at the time of the acquisition, the difference between the FMV and the consideration is included in computing the income of the annuitant under the plan.
Subsection 146.3(4) provides that, where a trust governed by a RRIF disposes of property for less than the FMV of the property at the time of the disposition, or acquires property for a consideration greater than the FMV of the property at the time of the acquisition, then two times the difference between the FMV and the consideration is included in computing the income of the taxpayer who is the annuitant under the fund.
In these situations, taxpayers risk having the full amount of the funds invested being included in their income, whether or not they have actually received the amount.
- Part XIII – Tax on income from Canada of non-resident persons
As discussed above, when a trust acquires a non-qualified investment, the fair market value of the non-qualified investment at the time it was acquired by the trust is included in computing the income of the taxpayer who is the annuitant under the plan. If the taxpayer is a non-resident, Part I of the Income Tax Act does not apply, and therefore subsections 146(10) and 146.3(7) cannot apply.
In such cases, paragraph 214(3)(c) of Part XIII deems the payment to have been paid to the taxpayer as a payment under an RRSP. Subsection 212(1), together with paragraph (l) of the same subsection, requires that every non-resident person pay an income tax of 25% on a payment out of or under a RRSP. The person who is responsible for deducting or withholding the required amount is liable for payment of this tax. Subsection 227(8) imposes a 10% penalty of the amount that should have been deducted or withheld. If the failure to withhold or remit the amount as required was made knowingly or under circumstances amounting to gross negligence, the penalty is 20% of the amount.
- Liability of purchaser
Subsection 116(5) provides that a purchaser who acquires taxable Canadian property from a non-resident has to pay the Receiver General a specified amount unless one of two exceptions apply:
(a) the purchaser had made reasonable inquiries and had no reason to believe that the non-resident was not resident in Canada; or
(b) a certificate for the property disposed of was issued to the purchaser by the Minister for the property.
In cases where neither exception is met, the purchaser is liable for and has to remit to the Receiver General 25% of the amount, if any, by which the cost of the property acquired exceeds the certificate limit fixed by the certificate issued under subsection 116(2). Subsection 227(9) imposes a 10% penalty of the amount that should have been remitted or paid. If the failure to remit or pay the amount as required was made knowingly or under circumstances amounting to gross negligence, the penalty is 20% of the amount.
- Third-party civil penalties
Third-party civil penalties for misrepresentation in tax planning arrangements may be imposed under section 163.2. The penalty is applied to tax preparers and planners who know or reasonably ought to know that they have made, furnished, or participated in a false statement, or have caused another person to make or furnish a false statement that could be used for a purpose of the Income Tax Act by another person. The amount of the planner penalty is whichever is more: $1,000 or the total of the person's gross entitlements for the planning or valuation activity. Where the taxpayers who have used the false statement for a purpose of the Income Tax Act have been identified, the penalty to the planner could be as high as the penalty to which the taxpayers would be liable under subsection 163(2).
New types of questionable arrangements continue to be discovered, and trustees are reminded to be vigilant in administering RRSP accounts and ensuring that investments held in RRSPs are qualified investments. The Registered Plans Directorate will apply the taxes and penalties described above where appropriate.
How to contact us
Contact us at the Registered Plans Directorate if you have any questions about these types of arrangements or have information regarding questionable arrangements.
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 613-954-0419
For service in French, call 613-954-0930
Toll free elsewhere in Canada:
For service in English, call 1-800-267-3100
For service in French, call 1-800-267-5565
Issuers of retirement savings plans and carriers of retirement income funds who need guidance on specific registration issues can write to us at the Registered Plans Directorate, Ottawa, ON K1A 0L5, or fax us at 613-952-0199.
Owners of self-directed RRSPs should use caution with tax-free withdrawal schemes (2005-11-10)
We welcome feedback on this bulletin, as well as any comments related to compliance activities. Email your comments to: RPD.LPRA2@cra-arc.gc.ca.
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