Financial Planning Tips: Important changes to RSP contributions
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See Ian’s breakdown in plain English of the 2011 Federal Budget here: Part 1 Part 2
Ian Quigley: Well, the 2011 Federal budget was an interesting document. It really went after what I call ‘loophole’ busting. I podcasted earlier this year on all the various loopholes that the Canada Revenue Agency (CRA) was trying to bust with their 2011 federal budget.
And this was a way for them to increase tax revenue without increasing tax rates. One of the things I want to highlight today are some of the changes that are being now unraveled in the area of the RSP accounts.
There’s two situations where someone can put shares of a private company into their RSP account, and this is not uncommon. It is a way for those wanting to invest in private companies, non-public companies, to do so with their RSP funds. So, there was sort of two rules for this prior to the 2011 Federal Budget. The first rule was if the RSP annuitant invested money into a private company and they invested less than a 10% position, so they held less than 10% of the shares of the company, then they were allowed to do that with their RSP subject to some other rules and conditions.
The second group of people were those who earned a position greater than 10%, so maybe they had 20 or 30%. But it couldn’t be a control position, so as long as they had less than 51%, and they had invested less than $25,000, they also could put those shares into their RSP account. So that was the situation prior to the federal budget.
Post federal budget they changed the rules and said any tax payer that has greater than 10% of the shares of a private company in their RSP, that will now be considered prohibited. And they had some pretty severe penalties if you went into that position. So if you didn’t dispose of those shares, which you have until 2013 to do that, they’re going to impose a 50% penalty tax on that particular position, plus other penalty taxes on other future growth in those positions.
So they came in with a very severe set of new rules saying no longer are they going to allow those who have invested more than 10% in a position in a company to hold those in the RSP accounts. So now that legislation has unraveled. And I want to impress that this is not obscure. This could be a lot of Canadian taxpayers and something if you are advising small business owners, that you want to probably be sort of plugging this a little bit, probing a little bit to find out if they have a case.
Let’s look at a business case with this: We have five friends starting a business taking RSP funds to provide some initial working capital. And let’s say they invested, remember, less than the $25,000, so they each put in $20,000; which gives each of them a 20% stake in the company. So this is the exact situation that is now considered prohibited from the RSP account, and they’re going to be subject to a 50% penalty tax on those positions if they don’t get those shares out of their RSPs by 2013.
So how are they going to do that? Well, they have to do it. There is no way around that by the looks of it; and the best way to tackle this is to look for a swap transaction. CRA is going to allow in these instances an annuitant to swap other property or cash for these shares. So let’s say the shares have increased in value to $60-$70 thousand dollars per share; they would have to take 60 or $70 thousand in cash or other property; put that into the RSP and then take out the shares of the private company.
There wouldn’t be any negative tax consequence for doing that swap, but unfortunately the practicality of that is going to be a bit of a challenge. They have to get those private shares valued by a bona fide valuator to show CRA that they did the swap at fair market value; not at the initial purchase price, but at the current fair market value.
So that’s something to look for when you’re out advising small business owners. And be aware, any future growth in these shares is also going to be subject to penalty tax. This is an issue you want your clients to tackle sooner rather than later.
Other titles in this series:
Important changes to Canada Pension Plan
Registered Education Savings Programs
Small business owners Employee Profit Sharing Programs
Small business owners Individual Pension Plans
Ian Quigley is a senior consultant with innovative financial advice firm Qube Consulting . He is an expert in investment, insurance and tax strategies and has developed numerous online courses dealing with these subjects. Find Ian’s courses online at ILScorp. All 12 are included in an Annual Life Subscription or are available for individual purchase. Visit ILScorp’s catalog.
