Introduction
Taxpayers can make deductions under their registered retirement savings plans (RRSP) deduction limit for 2008 with respect to contributions they have made or are going to make in the first 60 days of 2009. The Income Tax Act (the Act) is quite flexible with respect to the types of investments that can be included in an RRSP. Collectively, these investments are called “qualified investments.”
For RRSP purposes, “qualified investments” are defined under subsection 146(1) of the Act and section 4900 of the Income Tax Regulations (the Regulations).
There are restrictions for investments under an RRSP. One of the significant restrictions pertains to private company shares. There are two common types of private company shares that may constitute qualified investment for RRSP purposes; the shares of a small business corporation (SBC) and the shares of an eligible corporation (EC).
Shares of Small Business Corporations
A qualified investment for RRSP purposes includes shares of an SBC (other than a cooperative corporation). An SBC is defined as a Canadian corporation (other than a corporation that is controlled at that time, directly or indirectly in any manner whatsoever, by one of more non-resident persons) for which all, or substantially all, of the fair market value of the total assets is attributable to assets that are:
- Used principally in an active business carried on primarily in Canada by the corporation or by its related corporation(s);
- Shares or indebtedness of connected SBC’s; or
- A combination of the above.
Please note that for the above purpose, “Canadian corporations” are not limited to Canadian-controlled private corporations.
To satisfy the requirements of a qualified investment for RRSP purposes, a corporation does not have to be an SBC at all times. It must be an SBC only at the time that its share is acquired by an RRSP trust or at the end of the last taxation year of the corporation before the share is acquired. Moreover, if the corporation ceases to be an SBC after the share is acquired by an RRSP trust, the share will not, as a result, cease to be a qualified investment.
Another important condition must be satisfied for a share to be considered a qualified investment: Immediately after the share is acquired by the trust, each person who is an annuitant, beneficiary, or subscriber under the RRSP trust must not be a connected shareholder of the corporation.
A connected shareholder of a corporation is defined under subsection 4901(2) of the Regulations as a person who owns, directly or indirectly at that time, 10% or more of the issued shares of any class of the capital stock of the corporation or of any related corporations. In determining if a person owns 10% or more, there are some look-through rules for shares owned by trusts, partnerships, and personal services business corporations.
However, if a person is dealing at arm’s length with the corporation and the total cost amount of all shares of the corporation and any other related corporations is less than $25,000, that person is not considered to be a connected shareholder of the corporation.
In determining whether an annuitant meets the 10% and $25,000 tests, the annuitant is deemed to own the shares that are owned by a person with whom they do not deal at arm’s length. Also, any share that the annuitant has a right to acquire is included in the calculations of the 10% and $25,000 tests.
Eligible Corporations
A qualified investment for RRSP purposes includes shares of an eligible corporation’s capital stock. According to the definition in subsection 5100(1) of the Regulations, an EC includes a corporation that is a taxable Canadian corporation for which all or substantially all of its property is:
- Used in qualifying active business carried on by the corporation or a corporation it controlled at that time;
- A share or debt obligation issued by a related EC; or
- A combination of the above.
Another important condition must be satisfied for a share to be considered a qualified investment: Each person who is an annuitant, beneficiary, or subscriber under the RRSP trust must not be a designated shareholder of the corporation throughout the period the shares are held by the RRSP trust. A designated shareholder generally includes a connected shareholder as defined above. In determining whether an annuitant meets the 10% and $25,000 tests, the above mentioned non-arm’s length rule and right-to-acquire conditions apply here as well.
A qualifying active business is defined under subsection 5100(1) of the Regulations as any business carried on primarily in Canada by a corporation, but the definition does not include a business that has the principal purpose of deriving income from property or a business that derives gains from the disposition of property (other than property in the inventory of a business). However, a qualifying active business may include a business that leases property other than real property.
SBCs vs. ECs
There are similarities between an SBC and an EC, but one major difference is the timing requirement. As mentioned above, the condition that a corporation be an SBC must be satisfied only at the time the share is acquired by the RRSP trust or at the end of the corporation’s taxation year ending before the share is acquired. However, for the shares of an EC to be considered a qualified investment, they must be shares of an EC throughout the period that they are held by the RRSP trust.
From a tax planning perspective, it is arguably preferable to qualify as an SBC, as it is a one-time test measured when the property is acquired. If a corporation is not an SBC, various purification techniques can be employed. Once the SBC conditions are satisfied at the time the shares are acquired by the RRSP trust, the annuitant of the trust does not need to worry if the corporation is still an SBC subsequent to the acquisition.
Conclusion
Therefore, it comes down to a question of facts. Tax practitioners must sometimes review court cases and the CRA’s technical interpretations to determine the filing position for their clients with regard to whether the assets are active business assets. If the corporation does not qualify as an SBC due to an excessive amount of non-active assets, tax practitioners can implement purification strategies for the clients.
A determination of the fair market value of the shares is required in the case of non-arm’s-length transactions, such as when an annuitant sells shares to their RRSP. Further, the relationship of the shareholders listed on the share register has to be reviewed to determine if the 10% and $25,000 tests are met. In some cases, a representation letter from clients may be required that states their relationship with other shareholders listed on the share register.
If you should any questions with respect to the above, please do not hesitate in calling me at 905-528-0234 or email Joe at [email protected].
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