The types of investments allowed in registered plans could soon change.
In the federal budget, the Department of Finance launched a 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.
“It’s a useful and probably much needed exercise,” said Carl Hinzmann, partner with Gowling WLG in Toronto. “If they can get the [qualified investments definitions] down to a singular definition, I think it would be significantly easier for the investment community that’s trying to provide advice and develop products.”
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 consultation asked stakeholders to consider whether updated rules should favour Canada-based investments. Hinzmann likened this to the debate about whether pension funds should invest more domestically.
“I don’t think tax legislation is the appropriate way to tell pension funds to invest their money, so why [do that to] ordinary Canadians?” he said.
To achieve the goal of favouring Canadian investments, Hinzmann said the government could either require a certain percentage of domestic investments or treat domestic investments more favourably within a plan. Canada had a foreign content limit for RRSPs and RRIFs from 1971 to 2005, which ranged from 10% to 30%.
The budget acknowledged that the qualified investment rules “can be inconsistent or difficult to understand” due to their many updates since their introduction in 1966.
For example, different plans have slightly different rules for making investments in small businesses; certain types of annuities are qualified investments only for RRSPs, RRIFs and RDSPs; and certain pooled investment products are qualified investments only if they are registered with the Canada Revenue Agency.
“There’s no good policy reason” for the inconsistencies, Hinzmann said, adding that the purpose of the rules is to ensure registered plans hold stable, liquid products and that the planholder does not gain a personal tax advantage.
By having unwieldy, inconsistent rules, “all you’re really doing is increasing costs for the people offering these investment services to Canadians,” he said.
The budget asked for suggestions on how to improve the regime. In addition to questioning whether the rules should favour Canadian investments, the budget asked stakeholders to consider the pros and cons of harmonizing the small-business and annuities rules; whether crypto-backed assets should be considered qualified investments; and whether a registration process is indeed required for certain pooled investment products.
Hinzmann said the consultation’s highlighting of crypto-backed assets suggests the government may be questioning whether investment funds that hold cryptocurrency should be included in registered plans, though he acknowledged the government also could wish to expand the types of crypto products allowed.
Cryptocurrency itself is a non-qualifying investment in registered plans.
The qualified investments consultation ends July 15.
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.