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: Various questions concerning a mortgage as an RRSP qualified investment
Position: General comments provided
XXXXXXXXXX
2009-031926
D. Wurtele
December 8, 2010
Dear XXXXXXXXXX :
Re: RRSP Qualified Investments - Mortgages
This is in reply to your letter of April 21, 2009 regarding the eligibility criteria in paragraph 4900(1)(j) of the Income Tax Regulations (the "Regulations") for a proposed mortgage investment for a trust governed by a registered retirement savings plan ("RRSP trust").
You have described a situation where an RRSP trust would lend money to an arm's length entity for the purpose of purchasing raw land. The loan would initially be secured by the land in the form of a first mortgage ("RRSP mortgage"). At a later stage, the entity would borrow additional funds from a financial institution for the purposes of funding the construction of residential or commercial buildings on the land. The construction lending would take precedence over the RRSP lending thereby reducing the RRSP mortgage to a second mortgage. The fair market value ("FMV") of the land would exceed the initial loan provided by the RRSP trust, but would be less than the construction loan provided by the financial institution. However, the FMV of the completed development and land would exceed the total lending provided by the RRSP and the financial institution that remains outstanding.
You have expressed concern over the possibility that the mortgage investment might not be "fully secured" at certain times during the construction stage as required by paragraph 4900(1)(j) of the Regulations and thus would temporarily cease to be a qualified investment for the RRSP trust. Although the loan would be fully secured by the mortgage when the loan was issued, you note that this position may vary over the life of the development depending on when and how the security position is measured.
Our Comments
Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. We are, however, prepared to offer the following general comments, which may be of assistance.
Paragraph 4900(1)(j) of the Regulations provides that a debt obligation is a qualified investment if it is fully secured by a mortgage in respect of real property situated in Canada and the debtor is not a connected person under the governing plan of the plan trust (i.e., the debtor cannot be the annuitant under the RRSP or a person not dealing at arm's length with the annuitant). These conditions apply on an on-going basis, except that any decline in the FMV of the real property after the debt obligation was issued can be ignored in determining whether the "fully secured" condition is met.
You have asked the following questions regarding the application of the "fully secured" condition to your situation.
1. What is the meaning of the expression "fully secured" in paragraph 4900(1)(j)?
In general, a mortgage loan would be considered to be "fully secured" if the value of the real property, pledged by the borrower to the lender should the borrower default on repayment of the loan, is sufficient to cover the full amount of the principal and interest outstanding on the loan. This is a question of fact in each case.
2. Is the construction "work-in-progress", which forms part of the security for the lending, considered to be real property?
In general, according to the accepted legal meaning of the term "real property", construction work-in-progress constitutes real property to the extent that it can be considered attached to or erected on the land. Again, this is a question of fact in each case.
3. Is a periodic assessment of the value of the real property security versus the balance of the loan sufficient, and if so, what does the CRA consider appropriate for such timing (annual, monthly)? Are third-party valuations required? What valuation methodology should be used?
We are not in a position to provide much guidance with regard to these questions as they do not involve an interpretation of the law and thus fall outside of our Directorate's purview.
In general, we would note that RRSP issuers are expected to take reasonable steps in monitoring the on-going status of qualified investments. In the context of mortgage investments, it would seem to us that a change in ranking of the RRSP mortgage or the issuance of additional debt that has priority over the RRSP mortgage would necessitate an assessment by the RRSP issuer of whether the investment continues to satisfy the eligibility criteria in paragraph 4900(1)(j) of the Regulations. Depending on the circumstances, this may require the RRSP issuer to obtain a current valuation of the real property security and a confirmation of the total amount of debt in priority to the RRSP mortgage.
Should you wish to discuss in more detail particular RRSP issuer obligations with respect to qualified investments, we would suggest that you contact the Compliance Division of the Registered Plans Directorate of the CRA. For information on valuation procedures, you may wish to contact your local Tax Services Office.
4. Alternative arrangement
Your final question relates to a variation to the arrangement described above. In this alternative, the RRSP trust would finance both the purchase of the land and the development of the project. Periodic advances would be made by the RRSP trust and it would have a first mortgage over the land and project. As you note, the issues with this alternative are similar to those discussed above in that the "fully secured" condition would need to be satisfied at all times in order for the mortgage investment to be a qualified investment for the RRSP trust.
We trust these 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
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