CRA rules on group RRSP settlements

(October 2005) Advisors are no doubt familiar with the ever-looming threat of being hit with a lawsuit from a disgruntled investor who experiences losses in his or her investment account and then proceeds to sue his or her advisor for “inappropriate investing.”

A recent Canada Revenue Agency Advance Income Tax Ruling (2005-0118591R3) released last month dealt with such a case involving an employee and her employer’s group RRSP plan. The case specifically dealt with the tax consequences of a settlement being paid by her employer directly to her RRSP.

The employee, whom we’ll call Jane Doe (names of all parties are removed before a CRA ruling is publicly made available), was employed by X Corp. The company offered Ms. Doe, as a benefit of her employment, the right to participate in X Corp.’s group RRSP. Under the GRSP, X Corp. agreed to match a certain amount of Ms. Doe’s annual RRSP contributions.

The value of Ms. Doe’s GRSP account with X Corp. declined significantly and continuously over a number of years. After several years of losses, Ms. Doe complained, in writing, to her employer asking X Corp. to investigate the reasons for the significant losses in the value of her GRSP. Ms. Doe concluded that X Corp. had invested her funds into a high-risk portfolio, “contrary to her instructions.”

Ultimately, the company terminated Ms. Doe, without prior notice, advising only that for “business reasons” a decision had been made to make some “organizational changes.”

Ms. Doe proceeded to hire a lawyer to assist her in negotiating a settlement with X Corp., both with respect to her termination as well as to compensate her for the losses she sustained in her GRSP.

The company offered to settle by paying Ms. Doe some salary continuation and certain employee benefits. It also included an offer to recontribute the total contributions that X Corp. had previously made to her GRSP (i.e., the employer matching portion of the GRSP program). In return for the settlement, Ms. Doe agreed to release her claims against the company.

X Corp. proceeded to seek a ruling request from the CRA to ensure that, as long as Ms. Doe does not personally claim the company’s re-contribution to her GRSP as an RRSP contribution, the amount deposited by X Corp. as a result of the settlement would not be currently taxable to Ms. Doe.

The CRA ruled favourably, saying that no amount would be currently taxable, presumably since it will be subject to tax when it is withdrawn from the GRSP or subsequent Registered Retirement Income Fund.

While this case may have had a favourable tax result, it once again illustrates the risks in employer-sponsored GRSPs that are not properly managed with the involvement of skilled, knowledgeable and principled financial advisors.

One final note: earlier this year in another technical interpretation (2005-0112791E5), the CRA also commented on a similar situation involving non-registered accounts. In that scenario, clients, on the advice of their advisors, had made investments that “were exposed to significantly more risk” than the clients had expected.

The clients initiated legal action against the advisor and a settlement agreement was reached providing lump-sum payments to the clients. The clients wrote the CRA inquiring about the proper tax treatment of the lump-sum amounts they received in 2004.

The CRA responded that where an amount is paid under a settlement agreement to compensate an investor for losses incurred in a non-registered investment account, the amount will generally be considered to be proceeds of disposition, thereby resulting in a taxable capital gain to the recipient.

This article originally appeared in Advisor’s Edge Report. Jamie Golombek, CA, CPA, CFP, CLU, TEP is the vice-president, taxation & estate planning at AIM Trimark Investments in Toronto. He can be reached at Jamie.Golombek@aimtrimark.com.

(10/26/05)