CRA targets RRSP, TFSA abuses in long-awaited tax document

“The IIAC has been informed by [the] CRA that [it] will again defer implementation of [its] position [until after January 2019] on the application of the advantage tax rules to investment management fees, pending completion of a review of the issue by the Department of Finance,” said Jack Rando, managing director of the IIAC, in a statement emailed to IE. “We do not have an indication as to what the new timelines look like. […] We are pleased that the government is taking the time it needs to carefully consider the comments it received on this issue.”

The CRA could not be reached for comment by press time.

The advisor community has been waiting for the CRA’s guidance since November 2016, when the topic came up at a Canadian Tax Foundation roundtable. There, the CRA told attendees it was changing its administrative position: paying registered plan fees from non-registered accounts would incur a tax penalty equivalent to the fee (e.g., if an investor pays a management fee of $500 from outside a registered plan, the investor could be taxed the full $500).

The CRA said it viewed the practice as creating an unfair advantage because it’s equivalent to a tax-free increase in the value of the registered plan. At the end of 2016, it said the position change would take effect Jan. 1, 2018.

Since then, however, the federal tax agency has not shared how it will apply its new position and has delayed releasing such guidance multiple times, citing industry consultations with groups such as the IIAC, the Investment Funds Institute of Canada and the Canadian Life and Health Insurance Association Inc.

This has unsettled the tax-planning community. For those who wish to take action now, “The conservative approach would be for investors to redirect the payment of investment management fees relating to registered plans through their respective registered plans themselves,” said Frank Di Pietro, assistant vice president, tax and estate planning, at Mackenzie Financial Corp. in a statement emailed to IE.

Representatives from the Income Tax Rulings Directorate said last year that Monday’s advantage folio would not include fee guidance; that’s indeed the case. Instead, the document says, “Comments on the tax treatment of fees and expenses incurred in connection with a registered plan […] will be included in a future update.”

Advantage folio released

Those engaged in aggressive tax planning in registered accounts will view Monday as a dark day, as the CRA released an income tax folio explaining how the tax advantage rules will apply to RRSPs, RESPs, RRIFs, RDSPs and TFSAs.

The agency calls out several practices that have always been restricted by the Income Tax Act, but that aggressive planners may have used thinking there was room for interpretation. An “advantage” in this context is, in layman’s terms, an outsized or unintended tax benefit.

Last October, representatives from the Income Tax Rulings Directorate said the folio would cover existing CRA positions and issues the agency had looked at in audits.

It seems the CRA has seen some whoppers.

The folio targets aggressive planning such as swap transactions, arrangements that artificially shift taxable amounts into registered plans, and what’s known as registered plan stripping (withdrawing money while avoiding a taxable event). The document shares several scenarios that would create a taxable advantage. In one example involving an estate freeze, a shareholder receives 1,000 shares worth $1,000. She immediately transfers those in-kind to her TFSA; the fair market value (FMV) of the shares rise to $100,000 within the calendar year, “resulting in an advantage of $99,000.”

“You can see the devious minds that operate,” says Doug Carroll, practice lead, tax, estate and financial Planning, at Meridian Credit Union. “[The CRA is] not making these things up on [its] own. Unfortunately, it makes the compliance burden much higher for the rest of us, when really, it’s a small number who play around.”

The folio also includes more mundane situations, such as when a taxpayer deliberately overcontributes to a TFSA in hopes of earning returns higher than the 1% penalty, and when taxpayers ask their dealer to reallocate fund rebates to give them the best tax advantage. Both actions would be penalized.

“None of this is surprising. It’s common sense,” says Michelle Connolly, a tax and wealth transfer expert in Toronto. “The whole reason for this folio is not for the average income tax payer. It’s for those who have been really creative, sophisticated and abusive.”

The consequences are dire. If the CRA finds a taxpayer has received an advantage under a registered plan, that person must pay a tax equal to 100% of the FMV of the benefit (and in the case of a loan, the amount of the debt; in the case of a registered plan strip, the amount of the strip). A separate tax is payable for each advantage. In the estate freeze example, the taxpayer would be penalized $99,000, as well as amounts equal to all future appreciation and dividends.

Of note for financial professionals, the folio notes advisors and issuers could also be penalized for “knowingly facilitat[ing] the holding of, or participat[ing] in, such investments or transactions.”

Advisors should pay particular attention to the rebating commentary, Connolly says. In the past, dealers may have redirected a client’s commission rebate for a non-registered account to a registered one to artificially raise the FMV, or vice versa, leading to an advantage in both instances.

“On a go-forward basis, the rebate has to be allocated on a pro-rata basis,” says Connolly. “Most dealerships, that’s how they would allocate it. [For those that don’t,] it’s now been clarified — you can’t do that.”

She cautions that while commission rebates will not be considered a plan contribution, any top-up by the financial institution will be. For instance, says the folio, a cash prize for contributing to one’s RRSP will be considered a gift or contribution. Says the CRA: “Care should be taken […] to ensure that winnings are not deposited directly into a registered plan.”

Another practice that will be penalized is charging lower investment counsel fees for registered accounts versus open accounts, since such fees aren’t deductible for registered accounts. “That [practice] provides an advantage to the registered account,” says Connolly.

Carroll says fund companies sometimes offer preferential rates across family members based on total family assets. “You have to be careful about the possibility about an advantage being given because you’ve disproportionately provided benefit.”

Don’t panic

The CRA acknowledges that “these rules do not impact the average investor.”

Carroll says he appreciates this language: “Regular RRSP loans are not a problem. They’re not trying to go after normal, commercial arrangements, particularly things that are broad-based. They’re being extra careful so that people don’t panic that they’re going to go hog wild.”

The advantage folio is the third chapter in Folio 10, Registered Plans for Individuals. Preceding it were chapters on qualified investments and prohibited investments.

Though the advantage chapter has a three-month comment period, it’s official now. The comment period ends Dec. 31, 2018.