Oct 03, 2016
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“The ‘prohibited investment’ rules… have significantly impacted RRSP and RRIF holdings of private company shares.”
Shares of private corporations held by individuals in their RRSP or RRIF may now be considered to be “prohibited investments” and subject to significant tax penalties if the individual, together with non-arm’s length persons, own 10% or more of the outstanding shares of any class of the corporation.
The “prohibited investment” rules which were introduced in the 2011 federal budget have significantly impacted RRSP and RRIF holdings of private company shares. Before the change, it was possible to own private company shares in an RRSP or RRIF, even if the individual owned more than 10% of the outstanding shares, provided the individual and related persons did not control the company and the cost of the shares was less than $25,000.
Under the new rules prohibited investments in an RRSP or RRIF may attract a 50% tax on the fair market value of the prohibited investment on the date it is acquired. (See Tax Tip 12-06) Furthermore any income or capital gains earned after March 22, 2011 (the date of the original budget announcement) from a “prohibited investment” in an RRSP or RRIF is considered to be an “advantage” taxable at 100%. There is some relief from the full advantage tax on income and capital gains arising from previously qualified investments that became prohibited investments under the new rules. This relief is available until December 31, 2021.
Under the transitional rules, the advantage tax can effectively be reduced from 100% to the individual’s normal marginal tax rate on any income or gains accruing from March 23, 2011 to December 31, 2021, provided the income or gain is withdrawn and paid to the individual within 90 days after the end of the year in which the income is earned or the capital gain is realized.
To take advantage of the transitional rule, an individual must file Form RC341, Election on Transitional Prohibited Investment Benefit for RRSPs or RRIFs by June 30, 2012.
Under the transitional rules, a prohibited investment can also be removed from an RRSP or RRIF by December 31, 2021 by exchanging it for cash or other property with the same value. It is important to ensure that the exchange takes place at fair market value, which may require an independent valuation.
TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.
The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.