Granted, the federal conservatives inherited several unresolved proposals to amend the Income Tax Act from the previous Liberal government. But, sadly, the Tories are not showing any interest in tackling them.

Meanwhile, because proposed tax legislation is generally considered law as soon as it is announced, even if several years pass while it is repeatedly amended, advisors are becoming increasingly frustrated. And there is no end in sight to the uncertainty.

“There’s a batch of legislation affecting financial planning that’s in limbo,” says Ted Ballantyne, director of advanced policy for the Conference of Advanced Life Underwriting in Toronto.

Some of the issues have been stuck in tax purgatory for several years, including interest deductibility, return-of-premium options on critical illness insurance, protection against creditors for RRSPs and offshore trust rules. Much of the outstanding proposed legislation is highly complex.

These issues don’t seem to be a high priority with the present government, says Ballantyne: “It doesn’t mean they agree or disagree with what’s there. But this government is there to get re-elected.”

This attitude was reflected in the 2006 budget, which showed a minority government willing to pass small tax breaks geared toward garnering votes. This fall’s tax amendment bill, for example, “picked up bits and pieces from the spring budget, such as the tool tax credit,” says Robin MacKnight, tax partner with Wilson Vukelich LLP in Markham, Ont., and chairman of the technical committee of the Society for Trust and Estate Practitioners (Canada) .

The Investment Funds Institute of Canada has prepared a straightforward, five-point submission in anticipation of the annual fall pre-budget consultations. A few of IFIC’s points revive earlier tax-change ideas, but there are some new twists:

> Tax-Prepaid Savings Plans. IFIC advocates TPSPs, which first were raised a few years ago by Toronto-based C.D. Howe Institute. Unlike RRSPs, TPSPs give no deduction for contributions; instead, when planholders eventually make withdrawals, they are not taxed.

This idea caught fire at the Department of Finance under the Liberals, and was discussed in the 2003 and 2004 federal budgets. In 2004, Ottawa said: “[Finance] is continuing to examine and assess TPSPs and other approaches to improve the tax treatment of savings.”

But the fire has flickered out. There was no mention of TPSPs in the Liberals’ 2005 budget, nor have the Con-servatives shown any interest in the idea.

IFIC suggests that Ottawa take the idea a step further to help Canadians save for their retirement, says Jamie Golombek, vice president of taxation and estate planning at AIM Funds Management Inc. in Toronto and chairman of the IFIC tax issues committee, by giving low-income Canadians a matching grant — 20% on the first $1,000 contributed annually — similar to the grant given to assist RESP contributors.

“When they go to withdraw, the whole amount would be tax-free,” says Golombek.

> Tax Treatment Of Capital Gains. IFIC wants Ottawa to overhaul the treatment of capital gains.

One of the Conservatives’ campaign promises was to eliminate taxation of capital gains that were reinvested within six months. Tax experts still support some variation of this idea. For example, the C.D. Howe Institute proposes that Ottawa adopt what it calls “capital gains deferral accounts.” A CGDA would allow a taxpayer to roll over investments within the account, deferring tax until assets are withdrawn from it.

To minimize the impact on federal coffers, and “provide greater benefit to small investors,” the institute proposes a lifetime contribution limit of $150,000.

“IFIC supports the CGDA conceptually,” says Golombek, “but is concerned that it would be administratively complex to manage. This idea needs to be studied further and refined.”

One simple solution IFIC suggests is to reinstate the lifetime capital gains exemption for all investments. (The present version applies mainly to investment in “qualifying small business corporations.”)

> Raise RRSP Conversion Age deadline. The age limit by which an RRSP must be converted to a RRIF or annuity should be raised to 72 from the present 69. People are living longer, Golombek says, and may not need to take out the money at 69 — and pay taxes.

> RRSP/RRIF Clawback Exemption. Holders of such accounts should be exempt from the clawback of the guaranteed income supplement. (See page B6.)

“Removing this from the GIS calculation would encourage all Canadians to save for their own retirements,” says Golombek. Otherwise, many lower-income Canadians don’t have the incentive to make RRSP contributions.

@page_break@> Increase RRSP Contribution Limits. The limits have not kept up with income increases among high earners, Golombek says.

Whether IFIC’s proposals make it into a new budget — let alone get passed into law by a minority government before another federal election — remains to be seen.

However, its proposals are much simpler than the complex tax issues that remain unresolved:

> Interest Deductibility. Tax experts hope the proposed legislation for interest deductibility will disappear. “The cure is worse than the disease,” says MacKnight. “The proposal has created more problems than it solved.”

In October 2003, the Finance Ministry announced that it wanted to make a 20-year Canada Revenue Agency administrative policy part of the Income Tax Act. The policy disallows certain interest deductions based on a determination that a business has no “reasonable expectation of profit.”

Finance was reacting to a Supreme Court of Canada case, Ludco v. the Queen, in which the court permitted investors to write off a deduction for $6 million in interest expenses on an investment that had earned only $600,000.

The proposal replaced the “reasonable expectation of profit” test with a new “cumulative profit” test, which was to apply as of Jan. 1, 2005.

For equity investors, this test would require that dividends — not capital gains — exceed any interest expense. However, not all common shares pay dividends. And most mutual funds don’t issue distributions; they are reinvested.

An immediate outcry came from the investment community. In the 2004 budget, Ottawa backed off, extending the time for written responses until later that year. Then, in the 2005 budget, the Liberals backed off even more, promising to release an alternative proposal for comment. But, to date, Ottawa has been silent.

It would be hard for the current government to adopt such problematic legislation in its minority situation, says Golombek. “Hopefully, it will be rethought or just scrapped altogether,” he adds.

MacKnight says the present government should deal with any questionable claims for interest deductibility on a case-by-case basis rather than fixing the problem with legislation. In the meantime, his advice to advisors and their clients is simple: “Don’t be greedy. Don’t create a set of facts that will create another case like Ludco.”

> Critical Illness Insurance Return-Of-Premium Options. The unresolved question for tax officials is how to characterize CI policies that have return-of-premium options. Generally, the CRA treats CI policies without ROP provisions as accident and sickness policies because claims are paid upon diagnosis of a serious illness. But most CI policies have ROP provisions. So, the question arises: should the ROP options be subject to taxation? The insurance industry argues that they should not be taxed.

Income generated by life insurance premiums is potentially taxable under a complex set of rules in the Income Tax Act. CALU and the Canadian Life and Health Insurance Association argued in a 2004 joint submission to Finance that CI policies do not have an investment component. Therefore, there is no potentially taxable income. And since CI premiums are returned without interest, the organizations say, they should not be characterized as life policies.

Legislation is needed to clear up the ambiguity, say insurance industry advocates. “We’re trying,” says Ballantyne.

> RRSP Creditor Protection. In November 2005, before the Liberal government fell, it passed legislation protecting RRSPs from creditors in the event of the planholder’s bankruptcy.

However, insurance-based RRSPs already have extensive creditor protection under insurance law, the domain of the provinces. (The Bankruptcy and Insolvency Act is federal.)

The proposed federal legislation imposes constraints that are not part of provincial protections: a requirement to lock in the protected funds until retirement and a cap on the amount that could be protected.

The legislation has yet to be proclaimed into law because proper hearings on the legislation didn’t take place. “It’s discouraging that the Senate passed this almost a year ago, but we don’t have it in final form yet,” says Golombek. “We would hope that the bureaucrats would move expeditiously so that we can bring more parity to the protection afforded non-insurance RRSPs.”

But there has been no word from Ottawa. This file, says Ballantyne, is “still active.”

> Offshore Trust Rules. New rules regarding offshore trusts are supposed to apply retroactively to Jan. 1, 2003. As with any piece of retroactive legislation, the tax community is acting cautiously. However, even experienced trust advisors find the 350-page revision of the non-resident trust rules, released a year ago (the fifth revision since the first draft was announced in the 1999 budget), difficult to digest fully.

One of the key amendments is that an offshore trust will be deemed Canadian, and therefore taxable, even if none of the beneficiaries are Canadian.

Despite the retroactive date, there’s no legislation on the table, MacKnight says: “We haven’t heard anything.”

Like most trust advisors, he suggests the best tactic for the current government is to scrap these hopelessly complicated legislative rules. “Nobody can understand them, which makes compliance ridiculously expensive,” he says. And 97% of taxpayers are compliant, he notes: “There’s no need to create general rules that would apply only to a handful of taxpayers.” IE



Stewart Lewis is a senior reporter and tax columnist with Investment Executive. He is editor of the annual tax planning report.