2 February 2012 External T.I. 2011-0430141E5 - Waiver of prohibited investment and advantage tax

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 CRA has authority to waive taxes imposed under sections 207.04 or 207.05 in respect of RRSP or RRIF prohibited investments and advantages. If so, what are the procedures for requesting a waiver?

Position: 1. Yes. 2. Outlined waiver procedures established by CRA Assessment and Benefit Services Branch.

Reasons: 1. Subsection 207.06(2) of the Act gives the Minister of National Revenue authority to cancel or waive all or part of the taxes on prohibited investments and advantages in appropriate circumstances, taking into account factors such as reasonable error and whether the transaction or series of transactions that gave rise to the tax also resulted in another tax being payable under the Act. In the case of a waiver of the advantage tax, subsection 207.06(3) requires that the annuitant withdraw an amount from their RRSP or RRIF without delay equal to the amount of the tax being waived. 2. Application of administrative policy.

XXXXXXXXXX 						2011-043014
							D. Wurtele

February 3, 2012

Re: Waiver of tax on prohibited investments and advantages

This is in response to your email of December 5, 2011 concerning the rules for prohibited investments and advantages in relation to registered retirement savings plans (RRSPs) and registered retirement income funds (RRIFs) that were recently enacted as part of Bill C-13. Your letter highlights a situation that you believe warrants administrative relief.

Our Comments

If an RRSP or RRIF trust acquires a prohibited investment or if an existing investment becomes prohibited, subsection 207.04(1) of the Income Tax Act (the "Act") provides that the RRSP or RRIF annuitant is subject to a tax equal to 50% of the fair market value of the investment. The tax is refundable under subsection 207.04(4) of the Act in cases of inadvertence provided that the investment is disposed of before the end of the following year (or such later time as is permitted by the Minister of National Revenue). In addition, any income or capital gain attributable to a prohibited investment is treated as an advantage and is subject to a 100% tax, payable by the annuitant, under section 207.05 of the Act. Other types of transactions, including transactions that have the effect of artificially shifting value into or out of the RRSP or RRIF, are also subject to the advantage tax. The terms "advantage" and "prohibited investment" are defined in subsection 207.01(1) of the Act.

The extension of these taxes to RRSPs and RRIFs generally applies to transactions occurring, income earned, capital gains accruing and investments acquired, after March 22, 2011. Transitional relief is available under subsection 207.05(4) of the Act for prohibited investments held by an RRSP or RRIF on March 23, 2011.

Subsection 207.06(2) of the Act gives the Minister of National Revenue authority to cancel or waive all or part of the taxes on prohibited investments and advantages in appropriate circumstances, taking into account factors such as reasonable error and whether the transaction or series of transactions that gave rise to the tax also resulted in another tax being payable under the Act. In the case of a waiver of the advantage tax, subsection 207.06(3) of the Act requires that the annuitant withdraw an amount from their RRSP or RRIF without delay equal to the amount of the tax being waived.

All requests for waivers are handled by the Assessment and Benefit Services Branch of the Canada Revenue Agency ("CRA") and not the Income Tax Rulings Directorate. Taxpayers or their authorized representatives can make a request for a waiver in writing to:

Canada Revenue Agency
Assessment and Benefit Services Branch
Individual Returns Directorate
Pensions and Partnership Projects Section
25 McArthur Road, 3rd floor
Vanier Tower "C"
Ottawa, ON K1A 0L5

It is important that taxpayers provide CRA with a complete and accurate description of their circumstances to explain why their situation should merit relief. To support a request, taxpayers should provide all relevant information including the following, where applicable:

• the name, address, telephone number and social insurance number of the taxpayer;
• the name of the RRSP issuer or RRIF carrier and the plan number;
• the amount of tax for which a waiver is being requested and the years involved;
• a full description of the investment and any income or other related transactions that gave rise to the tax, including name of the investment entity, percentage ownership, date of acquisition, date of disposition, cost, proceeds of disposition, fair market value of investment at March 22, 2011 (if applicable);
• a complete history of events including what measures were taken (e.g., withdrawal from the RRSP of the prohibited investment income or disposition of the prohibited investment) and when they were taken to resolve the non-compliance;
• the facts and reasons supporting that the transactions that gave rise to the tax were mainly caused by factors beyond the taxpayer's control or by reasonable error; and
• whether the transactions that gave rise to the tax also gave rise to another tax.

CRA intends to administer the waiver provisions in a fair and flexible manner in order to promote voluntary compliance with these new rules and to encourage taxpayers to come forward and correct situations that are offside of the new rules, particularly those that involve pre-March 23, 2011 investments.

The following examples illustrate several situations in which CRA may give favourable consideration. It is not a blanket waiver. Waiver requests must be made in accordance with the procedures set out above and each request will be considered on its own merits.

Example 1

A taxpayer holds units of a private mutual fund trust in their RRSP that constitute a prohibited investment for the RRSP. The mutual fund trust distributes its income each year by issuing new units, rather than by cash. The trust will distribute its 2011 income on March 15, 2012. As the units were acquired before March 23, 2011, the income qualifies for the transitional relief. The taxpayer intends to make the election and withdraw the income amount from their RRSP before March 30, 2012. However, the new units are themselves a prohibited investment and thus will be subject to the 50% tax when issued to the RRSP. Because the taxpayer knows that the mutual fund trust is a prohibited investment at the time the new units will be issued, the taxpayer will not qualify for the refund of the tax under subsection 207.04(4) of the Act.

In this case, the distributed trust income already results in tax payable because of the mandated RRSP withdrawal under the transitional relief. Provided that the RRSP trust disposes of the newly-issued units without delay and the taxpayer satisfies the conditions to qualify for the transitional relief, CRA will generally give favourable consideration to a request for waiver of the 50% prohibited investment tax in this situation.

Example 2

A taxpayer holds shares of a private company in their RRSP. The shares were acquired before March 23, 2011 and have always been a qualified investment. The shares also do not constitute a prohibited investment for the RRSP. However, the dividend rate and other attributes of the shares are such that the dividends received and any other increases in fair market value of the RRSP attributable to the shares constitute an advantage under subparagraph (b)(i) of the definition. Since the transitional relief available under subsection 207.05(4) of the Act applies only to prohibited investments, the taxpayer is subject to the full 100% advantage tax.

CRA will generally give favourable consideration to a request for waiver of the advantage tax in this situation. To qualify, the request must be made on a timely basis with full disclosure of the facts, the RRSP must dispose of the investment without delay, and the taxpayer must withdraw from the RRSP any income earned, and any capital gains accrued and realized, after March 22, 2011 on the investment without delay.

A word of caution is warranted in this situation. If, instead of relying on the waiver procedures, the taxpayer or others were to undertake steps to wind-up or re-organize the business structure in a manner that has the effect of artificially shifting value from the RRSP directly into the hands of the taxpayer or non-arm's length person, such actions would constitute an "RRSP strip". An RRSP strip is defined in subsection 207.01(1) and is expressly included in the list of transactions that constitute an advantage. CRA will not provide a waiver of the tax in this circumstance.

Example 3

A taxpayer holds 5% of the common shares of a private company in their RRSP and another 4% of the shares outside of their RRSP. The shares are a qualified investment and are not a prohibited investment for the RRSP. In 2012, the company redeems a significant number of shares held by the principal shareholder. The taxpayer had no involvement with or any influence over the decision to redeem the shares. As a result of the share redemption, the taxpayer in combination with their RRSP now holds 12% of the company's common shares and consequently the shares become a prohibited investment for the RRSP.

Upon learning of the share redemption later in 2012, the taxpayer takes immediate action and swaps the shares out of the RSRP for fair market value consideration. From the time the shares became prohibited to the time the shares are swapped-out of the RRSP, the shares appreciate in value by $11,000. Although the taxpayer qualifies for a refund of the 50% prohibited investment tax under subsection 207.04(4), the portion of the capital gain that accrued while the shares are a prohibited investment constitutes an advantage and is subject to the 100% advantage tax.

Provided that the taxpayer withdraws the $11,000 amount from their RRSP without delay, CRA will generally give favourable consideration to a request for waiver of the advantage tax in this situation.

If you require any additional information concerning the waiver procedures in connection with RRSPs or RRIFs, please contact the Pensions and Partnership Projects Section at the address listed above.

We trust that these comments will be of assistance.

Yours truly,

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