The investment industry is hoping for clearer, more consistent rules within registered plans.
Associations stated as much in submissions to the Department of Finance’s consultation about simplifying and modernizing the definition of “qualified investments,” which are those allowed in RRSPs, RRIFs, TFSAs, RESPs, registered disability savings plans (RDSPs), first home savings accounts and deferred profit sharing plans.
The government acknowledged the qualified investment rules “can be inconsistent or difficult to understand” due to their many updates since their introduction in 1966.
The consultation, which closed Monday, asked for suggested improvements to the regime, whether updated rules should favour Canada-based investments and whether crypto-backed assets should be considered qualified investments.
In a submission, the Investment Industry Association of Canada (IIAC) recommended that registered plan issuers not be held liable when a qualified investment becomes non-qualified while held in a plan, as long as the issuer confirmed the investment was qualified when the plan acquired it.
Holding a non-qualified or prohibited investment can lead to severe tax consequences: the plan would incur a 50% tax on the fair market value of the non-qualified or prohibited investment at the time it was acquired or changed status, and the investment’s income also would be taxable.
The IIAC also recommended allowing fully paid securities lending (FPL) within registered plans, which would allow the plan to passively earn borrow fees.
The industry group argued that FPL is relatively low risk to the planholder since the lender can recall the securities at any time, and that the additional income earned will eventually create additional tax revenue for the government.
The IIAC also said disallowing FPL in registered plans disproportionately penalizes poorer and younger people, who generally invest only within such accounts.
“The arbitrary distinction on the permissibility of FPL transactions in registered versus non-registered accounts puts lower-income Canadians at a disadvantage by restricting their ability to earn additional passive income,” the IIAC’s comment stated.
The consultation also asked if the rules around small business shares should be harmonized.
Currently, one group of registered plans uses the “eligible corporation” test for shares, while another group uses the “specified small business corporation” test (and some plans use both). The IIAC recommended removing the eligible corporation test.
The industry group also recommended making the small business itself responsible for determining the value of its shares annually. At the moment, the plan issuer must sometimes determine a share’s fair market value, even though “it is the small business corporation that is in the best position to [do so],” the IIAC’s comment stated. Yet, “there is currently not a mechanism to compel the small business corporation to provide the valuation to the registered planholder.”
The IIAC addressed neither the cryptocurrency portion of the consultation nor the question of whether the rules should promote an increase in Canada-based investments.
The Portfolio Management Association of Canada (PMAC), which also responded to the consultation, focused its submission on two issues it said lead to double taxation and higher investment costs within defined-contribution (DC) plans.
The organization recommended that target-date funds (TDFs), which are often held by DC plans, be allowed to invest in securities beyond those traded on a designated stock exchange, such as overseas securities.
Under current legislation, TDFs are not considered mutual fund trusts. That means they face significant penalty taxes for investing in securities not traded on a designated exchange.
PMAC argued that this prevents TDFs from diversifying their investments outside Canada in a cost-effective manner, harming the long-term returns of Canadians who belong to DC plans relative to those with defined-benefit pension plans, which don’t face this restriction.
Currently, DC plans use vehicles that have higher fees than TDFs, such as ETFs, to obtain international exposure.
PMAC also recommended that Finance allow TDFs to merge on a tax-deferred basis.
For operational and cost reasons, DC pension plans prefer to merge TDFs with existing retirement funds as the TDFs approach their “target” years. However, under current legislation, pooled funds such as TDFs are currently not allowed to merge with other pooled funds without triggering a taxable event.
As a result, employees with these plans may be subject to double taxation: first, when their TDF is merged into the retirement fund and second, when the employee withdraws money in retirement.
Employees belonging to DB pension plans, which have a single retirement fund, or individual investors who use mutual funds, aren’t subject to a similar double taxation issue, PMAC says.
PMAC is recommending the government amend legislation to introduce the concept of a “designated plan trust” to address the double taxation issue. The organization has been in discussions with Finance over the last several years regarding the two issues affecting DC plans.
In an email response to a question from Investment Executive regarding the government’s next steps, a Department of Finance spokesperson said that Finance “is in the process of analyzing the [qualified investments] consultation submissions. Feedback from the consultation will help inform any future decisions.”
Qualified, non-qualifying and prohibited investments
Registered plans are allowed to hold a wide range of investments, including cash, GICs, bonds, mutual funds, ETFs, shares of a company listed on a designated exchange, and private shares under certain conditions. These are called qualified investments.
However, investments such as land, general partnership units and cryptocurrency are generally non-qualifying investments. (A cryptocurrency ETF is qualified if it’s listed on a designated exchange.)
A prohibited investment is property to which the planholder is “closely connected.” This includes a debt of the planholder or a debt or share of, or an interest in, a corporation, trust or partnership in which the planholder has an interest of 10% or more. A debt or a share of, or an interest in, a corporation, trust or partnership in which the planholder does not deal at arm’s length also is prohibited.
A registered plan that acquires or holds a non-qualified or prohibited investment is subject to a 50% tax on the fair market value of the investment at the time it was acquired or became non-qualified or prohibited. However, a refund of the tax is available if the property is disposed of, unless the planholder acquired the investment knowing it could become non-qualified or prohibited.
Income from a non-qualified investment is considered taxable to the plan at the highest marginal rate. Income earned by a prohibited investment is subject to an advantage tax of 100%, payable by the planholder.
A non-qualified investment that is also a prohibited investment is treated as prohibited.
Story updated with a statement from the Department of Finance.