“There can be a high cost to purchasing ineligible investments in an RRSP.”
People make contributions to Registered Retirement Savings Plans (“RRSP’s”) every month and every year. They normally invest in qualified investments. Qualified investments generally include (this is not a complete list):
- cash;
- shares in companies listed on Canadian Stock Exchange and Prescribed Foreign Stock Exchanges
- some shares in private Canadian corporations
Shares of private corporations are not qualified investments if the individual and immediate family members hold more than 10% of any class of shares.
In situations where an RRSP holds property that was a qualified investment, but subsequently became a non-qualified investment, a monthly tax of 1% is imposed on the fair market value of the investment at the time that it was acquired.
Where an individual acquired shares of a private company in which ownership was less than the 10% noted above, but eventually exceeded the 10% threshold, there would be a 1% penalty per month from the date that the investment became ineligible. The penalty would be calculated on a self-assessing basis, since RRSP investment details are not reported to the CRA by the trustee of the RRSP. The beneficiary of the RRSP would have to realize that there was an issue and remit the 1% per month tax to the CRA.
If property is distributed from the RRSP, the beneficiary is subject to personal income tax.
If an RRSP were to acquire a non-qualified investment initially, the fair market value of the investment at the date of purchase would be included in the beneficiary’s income in the year of acquisition. If an individual made a cash contribution to an RRSP, which purchased an ineligible investment in the following year, the purchase of the ineligible investment would result in an income inclusion to the individual in the year of purchase.
In addition to penalties, an RRSP that holds non-qualified investments will become subject to income tax at the top marginal rate on the income earned from such investments, including tax on 100% of any capital gains (not 50%) and 100% of otherwise exempt capital dividends.
TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.
The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.
