One of the cardinal tax rules advisors must impart to clients is that they cannot use their RRSPs as collateral for tax-free loans.

Canada Revenue Agency recently issued a warning against taking part in any promotional schemes offering to use RRSP monies for tax-free loans. Investors may not see the warning, however. Advisors, on the other hand, are tuned in to this type of communication, says Jamie Golombek, vice president of taxation and estate planning at Toronto-based AIM Funds Management Inc.

“The average person doesn’t wake up wondering what’s new on the CRA Web site. Advisors should be on top of that,” he says. “They can play a huge role in steering their clients away from these schemes.”

The warning appeared on the CRA’s new taxpayer alert system, launched in November as part of Ottawa’s 2005 budget commitment to crack down on aggressive tax planning. The CRA urges taxpayers to consult with “a trusted and knowledgeable advisor” before getting into any arrangement that could hurt their financial situations.

Golombek suggests advisors use the “alerts” as opportunities to communicate with clients.

RRSP loan scams are among the most egregious that exist. Unfortunately, unsophisticated clients nearing retirement are most often the victims.

It works like this: the scam artist offers self-directed RRSP-owners the opportunity to buy shares in a private company that is supposedly a qualifying RRSP investment.

The RRSP owner withdraws the funds from his or her plan, and the promoter lends back an equal amount, minus hefty commissions.

The victim is told he or she will get the RRSP money back when the allegedly tax-free loan is repaid. What really happens is that the scam artist absconds with the victim’s savings, and the victim is hit with a tax bill for having withdrawn the funds to buy a non-qualifying investment.

For a senior who is victimized by one of these scams, the income spike could be quite large, resulting in a big tax bill. And interest would be added to any taxes left unpaid.

Robin MacKnight, a tax lawyer with Markham, Ont.-based Wilson Vukelich LLP, says one of his clients has had to return to teaching because she lost her life savings. For his client to get a tax bill on top of losing her RRSP has added insult to injury, says MacKnight.

Even more contemptible, says MacKnight, is the fact that her financial advisor directed her toward the scam. She has reported her advisor to regulatory authorities, alerted the RCMP’s commercial crime division and is threatening to sue the advisor’s firm, he says.

The Tax Court of Canada does not show much leniency toward gullible clients. The CRA’s tax alert regarding RRSP-loan scams cites a 2004 Tax Court of Canada case known as Dubuc v. The Queen. It quotes the TCC judge, who said that even though Dubuc was a “sympathetic” appellant and “may possibly have been the victim of an actual professional swindle, her appeal must be dismissed because the assessment is correct.”

Nunn v. The Queen, a TCC decision released in late December, shows the lengths to which some of these promoters will go, and how difficult it is for the average person to detect the scam.

Belleville, Ont., resident Don Nunn was the victim a “well-orchestrated scheme that was so clearly a sham,” TCC Judge Diane Campbell says in her decision. The case began in 1999, when Nunn was ill, deep in debt and unemployed. He saw an ad in the local newspaper — where these promotions are often found.

Nunn met with a representative of a company called Planification Plus, who explained that Nunn’s RRSP monies would be returned once the loan was repaid.

Perpetuating a fraud

Nunn was “anxious” about transferring his $29,000 RRSP, says Judge Campbell, and contacted his investment institution, Maritime Life Insurance Co., about the proposed transfer. “He told them not to transfer it if there was any question respecting the legality of the transfer,” Judge Campbell says. Nunn further testified that Maritime told him it would check into the matter for him. However, he didn’t hear from Maritime. Instead, he received a statement from Planification Plus.

Some advisors are not aware they are perpetrating a fraud, MacKnight says.

Nunn didn’t even receive the loan money. What was then the Quebec Securities Commission conducted a raid of the promoter’s office in August 2000, and shut down the operation before Nunn’s loan was issued.

@page_break@Meanwhile, the money was used to buy shares in another company, which, in turn, funnelled the money to another company that owned and operated a retirement home in Quebec.

Nunn received a “comfort letter” from a chartered accountant advising that the money had been used for a qualifying RRSP investment. However, the accountant shared the same office space as the promoter. This fact was uncovered by a CRA auditor who investigated the promoter, taking “many months to unravel the heavily veiled corporate modes of operendi” used by the promoter, Judge Campbell says.

“I am satisfied that any reasonable amount of due diligence, followed by an investor, would never uncover the fact that the share transfers were not qualified under the relevant provisions of the Income Tax Act,” she says. “Investors do not have the force and power of the state. The entire sham was predicated on investors being unable to get past the smokescreens and mirrors.”

Therefore, Judge Campbell ruled, Nunn should not be taxed.

This is appropriately “scathing language,” says says Heather Evans, partner and tax lawyer in the Toronto office of Deloitte & Touche LLP. However, she points out, the court’s decision is based largely on the single fact that Nunn did not receive any money.

If Nunn had received funds, says Judge Campbell, “I would have no hesitation in concluding the amount received should be taxed.

“Individuals who attempt to remove funds from locked-in RRSPs must do so within the provisions of the act or suffer the ensuing tax consequences,” she says.

The act allows money to be withdrawn tax-free from RRSPs under two programs only: the Home Buyer’s Plan and the Lifelong Learning Plan. IE