Prohibited Investment Rules: The December 21, 2012 Proposals
The technical bill released as draft legislation on December 21, 2012 includes amendments to alleviate overinclusiveness in the prohibited investment rules applicable to a registered plan--that is, a tax-free savings account (TFSA), a registered retirement savings plan (RRSP), or a registered retirement income fund (RRIF). These rules impose penalty taxes on the holder or annuitant of a registered plan where the registered plan acquires property that is a "prohibited investment."
As stated by the Department of Finance in a letter to the Joint Committee on Taxation of the CBA and the CICA on June 12, 2012, the policy intent of the prohibited investment rules is to prevent the acquisition by an individual's registered plan of investments that stream disproportionate returns into the plan (thereby circumventing contribution limits) or that facilitate an intentional devaluation of the investment (in order to avoid a later income inclusion). The rules focus on investments involving non-arm's-length relationships because Finance found that the most prevalent factor in aggressive tax planning was the ownership and control of a significant portion of a business or fund. However, Finance has noted that these rules inappropriately catch many portfolio-type investments--for example, when an individual's registered plan holds a small investment in a fund controlled by his or her employer (see the June 12 letter). The December 21 proposals are intended to alleviate these problems, effective March 23, 2011, and there are no surprises relative to the June 12 comfort letter.
The key amendment is the removal of the phrase "or with a person or partnership described in subparagraph (i)" from the definition of "prohibited investment" in subsection 207.01(1). As a result, the prohibited investment rules will not apply if the annuitant of the RRSP or RRIF or the holder of the TFSA does not have a "significant interest" in the corporation, partnership, or trust in question and deals at arm's length with the corporation, partnership, or trust.
The proposals also define "excluded property," which is property not subject to the prohibited investment rules (see subsection 207.01(1); note the repeal of regulation 5000). There are three categories of excluded property, and anti-avoidance rules (not discussed herein) apply to the first two. First, equity of a mutual fund corporation, mutual fund trust, or registered investment is excluded property during the 24-month period on the startup or windup of the corporation, trust, or registered investment, provided that, among other things, the corporation, trust, or registered investment follows a reasonable policy of investment diversification or the corporation or trust is subject to, and substantially complies with, National Instrument 81-102. In policy terms, this category is needed because a relatively small, ordinary-course investment could represent more than 10 percent of a mutual fund in these special periods of fund operation, and could otherwise trigger the prohibited investment rules. Second, excluded property includes investments that are considered to have a low risk of self-dealing. Seven conditions must be satisfied, including the condition that persons who deal at arm's length with the holder or annuitant of the registered plan hold, at a minimum, 90 percent of the fair market value of all the equity in the entity, 90 percent of the fair market value of all the equity and debt of the entity, and 90 percent of the right to cast the votes that could be cast at the annual meeting of the entity. Finally, certain insured mortgages are included in the definition of excluded property.
Bernice P. Wong
McCarthy Tétrault LLP, Calgary