6 September 2012 External T.I. 2012-0446031E5 - Prohibited investments and convertible securities

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Whether an RRSP or RRIF annuitant would be subject to the 50% tax on prohibited investments if the RRSP or RRIF were to exercise conversion rights and exchange a pre-March 23, 2011 prohibited investment for a new prohibited investment.

Position: Yes.

Reasons: Section 207.04 applies to RRSP and RRIF investments acquired after March 22, 2011 and the exchange would result in a new acquisition of a prohibited investment after that date. The same result would apply in the context of options, warrants and other exchanges of securities.

XXXXXXXXXX
2012-044603
D. Wurtele

September 6, 2012

Dear XXXXXXXXXX:

We are writing in response to your letter of May 2, 2012 in which you requested a technical interpretation with respect to the application of the 50% tax on prohibited investments in section 207.04 of the Income Tax Act (the "Act") in the following situation.

A registered retirement savings plan (RRSP) currently holds a debt issued by a public corporation. The terms of the debt include a conversion feature that entitles the holder to convert any outstanding portion of the debt into shares of the corporation at a specified price per share. The RRSP annuitant has significant interest in the corporation and therefore the debt constitutes a prohibited investment for the RRSP. However, since the RRSP had acquired the debt before March 23, 2011, the 50% tax on prohibited investments does not apply. You have asked whether the 50% tax would apply if the RRSP were to exercise its conversion rights and exchange the debt into shares.

Our Comments

Your letter describes a factual situation involving a specific taxpayer. As explained in Information Circular 70-6R5, it is not our practice to comment on the tax consequences applicable to a specific taxpayer in particular circumstances except in the form of an advance income tax ruling. We can, however, offer the following general comments.

If a trust governed by an RRSP or a registered retirement income fund (RRIF) acquires a prohibited investment or if an existing investment becomes prohibited, subsections 207.04(1) and (2) of the Act provide that the RRSP or RRIF annuitant is subject to a tax equal to 50% of the fair market value of the investment. The tax applies only to RRSP and RRIF investments acquired after March 22, 2011, subject to certain exceptions that are not relevant to the question at hand.

When an RRSP or RRIF trust exercises a conversion right attached to an existing security and exchanges it for a new security, the RRSP or RRIF trust is considered to have acquired the new security. Consequently, if the new security is a prohibited investment for the RRSP or RRIF trust and the acquisition occurs after March 22, 2011, the 50% tax on prohibited investments will apply, based on the fair market value of the new security at the time of acquisition. The fact that the tax did not apply to the existing security, because it was acquired before March 23, 2011, is not relevant to this determination. The same result would apply in the context of options, warrants and other exchanges of securities.

We trust our comments will be of assistance.

Yours truly,

Mary Pat Baldwin, CA
for Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch