The federal government is targeting RRSP and RRIF accounts with large balances, looking for those holding non-qualified or prohibited investments, under a reporting measure slated to take effect in 2023.
The new reporting regime will allow the Canada Revenue Agency (CRA) to identify accounts that have grown significantly year over year, said Carol Bezaire, vice-president of tax, estate and strategic philanthropy with Mackenzie Investments in Toronto: “You blew the lights out with your RRSP and, all of a sudden, you have this huge FMV [fair market value]. The CRA wants to see what it is and how you did that.”
In the 2022 federal budget, the Liberal government proposed requiring financial institutions to report annually the total FMV of property held in RRSPs administered by those institutions. The information, which would be determined at the end of each calendar year, is meant to help the CRA “in its risk-assessment activities regarding qualified investments held by RRSPs and RRIFs,” the government stated. The proposed measure, which was still in draft legislation following the fall economic statement, would be effective for 2023 and subsequent years.
Non-qualified and prohibited investments (see “Qualified, non-qualifying and prohibited investments,” below) held in an RRSP are subject to punitive taxation. (All references to RRSPs also refer to RRIFs.)
Financial institutions are currently required to report payments out of and contributions to RRSPs, but not the accounts’ FMV. In contrast, firms have had to file a detailed annual return for TFSAs they administer — including the FMV — since the account’s inception in 2009. The CRA has used this information to conduct audits of large TFSAs.
Expanding the reporting requirements for RRSPs is “an overdue step,” said David Rotfleisch, co-founding partner and tax lawyer with Rotfleisch & Samulovitch Professional Corp. in Toronto. The CRA needs this information regarding non-qualified investments in RRSPs, he said, because “right now, they don’t know if they have a problem or not.”
While some individuals may hold non-qualified investments deliberately, hoping to fly under the CRA’s radar, most clients have little to worry about from the expanded reporting, Bezaire said: “The CRA is trying to close loopholes, trying to find revenue, but at the end of the day, especially if you have an advisor, you’re not trying to cheat the CRA out of anything.”
However, some investors — particularly self-directed ones — may acquire non-qualifying investments in their RRSPs inadvertently, Rotfleisch said.
Jamie Golombek, managing director of tax and estate planning with CIBC Private Wealth in Toronto, said he believes the CRA will apply statistical analysis to identify “outlier” accounts for possible review, plugging in information such as the RRSP annuitant’s age, total contribution room available and contributions made, and reasonable rates of return over time — and then compare those with the FMV.
In many cases, RRSPs enjoy significant growth in a “perfectly legitimate” way, such as due to an investment in a penny stock that shoots up in value, Golombek said. However, where “you have some thinly traded, illiquid stock or, in particular, private company shares [held in an RRSP], the government might want to look at that just a little bit closer.”
An investment can become a prohibited investment while it’s held in an RRSP. For example, shares in a private corporation are considered a prohibited investment once the RRSP annuitant owns a 10% or more interest in the corporation. A takeover or reorganization of the corporation can cause the RRSP annuitant to own 10% or more of the shares.
However, RRSP annuitants who have built up large balances in their accounts through day trading are probably not at risk of being subject to taxes, even if the new reporting regime is enacted. While a TFSA is taxable if the CRA determines that it is “carrying on a business” of the active trading of securities, an RRSP is only subject to tax if the RRSP is determined to be actively trading non-qualified investments.
Nevertheless, under the new reporting rules, the CRA would have more data about large RRSPs — and may use that data to identify instances when significant growth was the result of the active trading. “They’re going to look at it,” Bezaire predicted.
Qualified, non-qualifying and prohibited investments
The rules governing registered plans allow RRSPs and RRIFs 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.
However, investments such as land, general partnership units and cryptocurrency are non-qualifying investments. (A cryptocurrency ETF is qualified if it’s listed on a designated exchange.)
A prohibited investment is property to which the RRSP annuitant is “closely connected.” This includes a debt of the annuitant or a debt or share of, or an interest in, a corporation, trust or partnership in which the annuitant 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 RRSP annuitant does not deal at arm’s length also is prohibited.
An RRSP that acquires or holds a non-qualified or prohibited investment is subject to a 50% tax on the FMV 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 annuitant acquired the investment knowing it could become non-qualified or prohibited.
Income from a non-qualified investment is considered taxable to the RRSP at the highest marginal rate. Income earned by a prohibited investment is subject to an advantage tax of 100%, payable by the RRSP annuitant.
A non-qualified investment that is also a prohibited investment is treated as prohibited.