Are Your RRSP Investments "Qualified"? – Tax Authorities – Canada – Mondaq

The so-called “RRSP season” ended on March 1 this
year. That was the last date you could make RRSP contributions
eligible for a 2021 deduction. But the urgent push to get you to
contribute through February is something of a long-standing
marketing gimmick by financial institutions to persuade you to give
them more of your money. It works, because many people simply
ignore their RRSPs through the year and then scramble to come up
with funds in February. In truth, because of the magic of long-term
compounding, RRSPs work a whole lot better if you contribute
regularly through the year with some type of automatic deposit
plan.

Getting the best return on your RRSP investment is the ultimate
objective, of course. But you can only do that by ensuring that
whichever investments you choose actually qualify as an RRSP
investment. The tax rules and regulations specify that if any of
your investments are not on the Canada Revenue Agency’s (CRA)
qualified list, you could face a tax of 50% of the fair market
value of the investment at the time it was acquired or became
non-qualified – even though it’s held within your RRSP.
Although this tax is refundable in certain circumstances, it is
best to avoid these investments at the first place. (Similar
requirements for qualified investments apply to RESPs and
TSFAs.)

Of course, the government does not list each and every qualified
investment – they’re listed by category. Some types of
investments are fairly straight forward – shares of
corporations listed on qualifying stock exchanges, for example. For
most stock-market-type investments, your broker should be able to
tell you whether or not they’re qualified.

But sometimes the rules aren’t clear – and that’s
where you can get into hot water. Much as they would like you to
believe otherwise, financial institutions and investment advisors
can be wrong about RRSP-qualified investments. If you’re
investing in anything offbeat, and your financial institution or
advisor says it’s qualified for RRSPs, my advice is to get this
confirmed in writing, just to be safe.

So here’s a look at some of the more common qualified
investments (note, though, that this list is not meant to be
exhaustive):

Money and Canadian bank, trust company, or credit union
deposits, including GICs

According to CRA, money denominated in any currency is a
qualified investment in an RRSP. However, the value of
“money” cannot exceed its stated value as legal tender.
This is to prohibit investments in “collectibles” such as
rare coins or gold “Maple Leaf” coins.

Canadian government bonds, debentures, or similar
obligations

This includes bonds, debentures, notes, mortgages, or similar
obligations of the Government of Canada (or guaranteed by the
Government of Canada); a provincial government (or its agent); a
municipality in Canada; most Crown corporations; an educational
institution or hospital if repayment is made, guaranteed, or
secured by a province. Included are strip bonds or coupons if the
bond itself would qualify. (Canada Savings Bonds, which have been
discontinued, and the last of which matured in December 2021, may
have been included in some RRSPs in previous years).

Shares or units of listed securities

To qualify, units or shares must be listed on a
“designated” stock exchange, such as the Toronto Stock
Exchange, the TSX Venture Exchange, the Aequitas NEO Exchange, the
Montreal Exchange, the New York Stock Exchange, Nasdaq, London
Stock Exchange, and many others. (See the complete list on
the Ministry of Finance website.) Listed
securities include the following:

• shares of corporations
• put and call options
• warrants
• debt obligations
• units of exchange-traded funds
• units of real estate investment trusts
• units of royalty trusts
• units of limited partnerships

Also included are all types of listed preferred or common shares
(for warrants and rights, see below). Although over-the-counter
shares do not qualify under this category, they may be qualified
investments if they meet other criteria.

Foreign shares

These qualify as RRSP investments if they are listed on a
designated foreign stock exchange (see above). Not that securities
quoted on the Nasdaq Over-the- Counter Bulletin Board, and other
over-the-counter shares are not considered to be qualified
investments. It appears that you can write an option on these
qualifying shares, provided it is “covered.” If a plan
sells short, CRA could (among other things) take the position that
the RRSP is actively engaged in a business, resulting in certain
tax penalties.

Warrants or rights

These types of securities give the owner a right to acquire a
qualified investment. This appears to include Canadian
exchange-traded call options, provided that the underlying
investment is qualified, i.e., a call option for a Canadian-listed
company. However, CRA has indicated that a put option would not
qualify.

Moreover, CRA does not consider a convertible debenture to be a
“warrant or right,” although such a debenture may, of
course, qualify under another category. However, as per amendments
in 2005, the issuer of the warrant or right will be required, on an
ongoing basis, to deal at arm’s length with each person who is
an annuitant, a beneficiary, an employer or a subscriber under the
plan. Moreover, the underlying property has to be a share or unit
of the issuer or a share, unit, or debt of another person or
partnership, or a warrant to acquire such property, which at the
time of the issuance did not deal at arm’s length with the
issuer.

REITs and Income Trusts

Canadian real estate investment trusts (REITs) and income trusts
that are structured as mutual fund trusts are considered qualified
RRSP investments. While the main popularity of these trusts stems
from higher apparent yields than conventional interest- bearing
investments, the tax features can also be quite beneficial.

Corporations pay tax on their income and then distribute profits
as dividends, which are taxed again in the hands of shareholders
(with the dividend tax credit available to non-RRSP investors in
Canadian companies). Income trusts and REITs, on the other hand,
are designed so that income is reported and tax is paid by the
investor, not the trust, so there is only a single level of
tax.

In most trusts, there is a significant element of tax shelter on
cash distributions due to depreciation or similar deductions
claimed by the trust. Effectively, the benefit of this shelter will
eventually be “recaptured” when the investor sells the
trust units, but usually as a capital gain.

If income trusts and REITS are held by an RRSP, these tax
benefits will be lost. However, to the extent that distributions
from the trust generate taxable income, there will be no current
tax to the RRSP either. While loss of tax benefits may make
personal ownership preferable, the degree of shelter relative to
the taxable income will vary from fund to fund, and may decrease
over time, e.g., as assets in the trust become fully depreciated,
leaving more ongoing tax exposure. However, flipping such a fund
into an RRSP may result in significant tax exposure on the
transfer, especially since the cost base of the fund will decrease
as shelter is used.

One innovation is the use of funds that effectively bifurcate
income trusts into high-tax components (designed for RRSPs) and
low-tax units, designed for individual investment.

Options – calls and puts

CRA used to consider the writing of “naked call
options” (the short sale of a call option) as being
speculative in nature, thus resulting in the taxation of the RRSP
on its taxable income for the year. However, the amendments to the
Income Tax regulations in the fall of 2005 made certain derivatives
eligible as qualified investments for your RRSPs. These now include
call options, and put options on stocks, currencies, and ETFs.
Therefore, purchasing calls (instead of stocks), covered call
writing, and purchasing puts instead of selling stocks short are
now allowed in RRSPs.

Mortgages

Generally, a qualifying mortgage must be from people whom you
deal with at “arm’s length” – so you can’t
hold a mortgage from members of your immediate family or an in-law,
for example. And if you and your neighbour give each other a
mortgage – i.e., in a “criss-cross” arrangement,
this could also violate the “arm’s-length”
requirement. The mortgage must not exceed the fair market value of
the property (other than as a result of a decline in the market
after the mortgage was given).

Happily, there’s a second alternative – the RRSP
mortgage, which involves having your RRSP make you a loan secured
by a mortgage on your home. This can be permissible if the mortgage
loan from your RRSP is insured and you pay your RRSP interest at
market rates in effect when the RRSP loan is made.

Corporate debt

Debt obligations issued by a Canadian corporation or trust are
qualified investments, assuming that certain conditions are met.
The purpose behind the inclusion of corporate debt was to
accommodate investments in debt obligations (more commonly known as
asset-backed securities) that are backed by cash flows from pools
of loans and other receivables.

Debt obligations

Any debt obligation (e.g., bankers’ acceptance, commercial
paper, debt of a foreign government) that has an investment grade
rating and that is part of a minimum $25 million issuance.

Precious metals

Investment-grade gold and silver bullion, coins, bars, and
certificates are qualified investments.. However, these investments
must be acquired either from the producer of the investment or from
a regulated financial institution.

Previously published in The Fund Library on April 21,
2022

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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