Does your client hold prohibited investments?

If you have clients who own a hefty chunk of a listed company in their registered accounts, you’d better get on the phone with them—and a tax expert.

The Department of Finance has drafted legislation which proposes substantial penalties on newly classed “prohibited investments”.

These include holding 10% or more of any class of shares in a company within an RRSP or RRIF. The client does not need to own that stake alone—they can be part owners, along with a non-arms length person, such as a spouse.

The same goes for partnerships and trusts.

If the legislation is passed, it would be retroactive to March 22, 2011. There are two penalties the investor could face.

The first is a tax equal to 50% of the fair market value of the investment on the date the investment is purchased. The investor can recover the tax if they dispose of the investment by end of the calendar year following the year in which the tax arose.

The second penalty tax is equal to 100% of the income or capital gains attributable to the prohibited investment, and applies to any income or capital gains accrued after March 22, 2011.

The CRA is offering a special transitional measure for previously legal investments already held in RRSPs and RRIFs, which have become prohibited: the penalty rate is slashed to 42.9% if the investor files an election by June 30, 2012, and the income is earned or capital gains are realized before 2017 and are paid out of your RRSP or RRIF within 90 days after the end of the year in which the income or gains were earned or realized.

A PWC Tax Memo offers this piece of advice: “If your RRSP or RRIF disposes of the security to you or to a person with whom you do not deal at arm’s length, to avoid additional potential adverse tax consequences, special care should be taken to ensure that the security is transferred at a price equal to its fair market value at the time.”

There is still some hope for investors, however: the legislation is open for comment until September 16, 2011.

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.