CRA pursues RRSP Strip

Just a few years into his retirement, Edward Baker decided to attend a tax seminar for Canadians held in Cancun, Mexico, in 2001. There, he struck up a conversation with a presenter, a man named Claridge.

He offered Baker the opportunity to invest in Kelso Securities, a small public company in the transportation manufacturing field. It appeared to be on the cusp of a breakthrough in rail brake technology. Baker claims he spoke with the company’s CEO about the business, and its lawyer, who stated its shares were RRSP-qualified.

Baker opened a self-directed RRSP account, and transferred $100,000 from an existing RRSP. With these funds, he purchased 5,000 preferred shares (eventually convertible to common shares) at $20 each.

Baker gave Claridge full discretion to negotiate the price, agreeing in advance to pay a $20,000 commission irrespective of the price. It’s not clear whether Claridge ever received his commission directly. Subsequent to the purchase, he failed to reply to Baker’s phone or email contact.

Now, almost a decade and a half later, a judge of the Tax Court of Canada expresses his own views on this chance encounter, the investment and its implications for the RRSP (the case is Baker v The Queen, 2014 TCC 204).

Limits to RRSP transactions

RRSPs allow us to save for retirement by placing before-tax dollars in a tax-sheltered environment. The taxpayer only pays tax when funds are withdrawn, whether voluntarily or when there is a deemed withdrawal. It’s the latter that’s relevant in this case.

As the judge points out, if there are any losses in an RRSP, all taxpayers lose too, because the government ultimately receives less tax revenue.

If RRSP losses result from an adverse market experience, that’s one thing. But it’s another matter when such losses arise out of suspect transactions, regardless of the awareness or intention of the RRSP annuitant. To safeguard RRSPs from abuse, where an RRSP trust purchases property for more than it’s worth, or sells property for less than it’s worth, there will be an income inclusion pursuant to ITA section 146(9)—the value of the RRSP is taxed immediately.

MORE RRSP ROOM NEEDED, SAYS IIAC

IIAC is asking the federal government to increase annual contribution limits for TFSAs and RRSPs in the 2015 budget.

The investment association made the recommendation in a letter to the House of Commons’ Finance Committee, which is holding pre-budget consultations. As part of the request to raise limits, IIAC asks that the government also allow for people who have lost their jobs, gone back to school, or stopped working to raise a child to be able to make compensatory contributions to their registered accounts without being penalized.

IIAC made four other recommendations in its submission. It asks for:

adoption of a “rollover” provision for deferral of capital gains tax on the asset sold, conditional on the purchase of common shares of small, listed Canadian companies within six months of the asset sale;
implementation of a tax incentive program for new and emerging businesses (this program is modeled after the UK Enterprise Investment Scheme);
deduction of CPP and EI payments for employer and employee contributions to group RRSPs;
elimination of the minimum annual withdrawal requirement from RRIFs.

The budget is expected in February or March of 2015. It is scheduled to be the last budget before the scheduled fall election.

An in-credible witness

The judge says even a brief Internet search would’ve revealed that more than 140,000 of the same class of shares had been issued by the company in the preceding two years at $1 apiece. One such issuance occurred after Baker’s purchase.

Meanwhile, the common shares (into which the preferred might eventually be converted) were trading at between $0.07 and $0.11 in the month following Baker’s purchase.

In addition, a CRA auditor testified that the seminar in question was offered by the Institute of Global Prosperity, an organization that promotes an aggressive anti-tax philosophy. In fact, before paying $8,000 to attend the Cancun seminar, an attendee would’ve had to purchase a six-disk audio set for $1,500. This cast doubt on Baker’s claim of being unaware of the subject matter and tenor of the seminar before arriving.

Inclusion conclusion

The defence contended Baker had neither directed nor intended a transaction at less than fair market value. The judge declined this submission, and criticized Baker’s lack of due diligence in the affair. Worse, he concluded Baker must have been complicit in the scheme to acquire the Kelso shares at greater than fair market value.

The judge was particularly taken by the fact that Baker, having apparently lost his entire investment, had made no effort to pursue Claridge or either of Kelso’s representatives.

On the whole, the court says there must have been a promise of some sort made to Baker that did not ultimately materialize, suspecting “that someone else made off with the funds.” The implication appears to be that the judge had little sympathy for someone who seeks out a tax avoidance scheme, and who gets burned by the promoters in the end.

The judge ruled that s.146(9) applies to the case, and determined that fair market value was $5,000. Therefore, Baker had to add the difference between the consideration paid ($100,000) and fair market value, or $95,000, to his 2001 regular income.

ACTION STEP Know that RRSP property bought at inflated prices could be taxed immediately.