Insurance Journal – Page 21

RRSP mortgages and interest deductibility

At issue

Generally a mortgage secured against real estate in Canada is a qualified investment for an RRSP. An annuitant may even choose to hold a mortgage on his or her own property, though the qualification criteria are more stringent in such situations.

Essentially, where annuitant and debtor are not at arm’s length, the Income Tax Act requires that the mortgage be administered by an approved lender and that it must carry mortgage insurance. While there are costs associated with these requirements, in a high interest rate environment a RRSP mortgage may be preferable to making payments to a commercial lender, as the interest contributes to the RRSP’s investment return.

Of value to those with rental properties, in the right circumstances it is possible to also deduct interest charges on those mortgage payments made into one’s own RRSP.

CRA 1999-9926175E – Mortgage as a Qualified Investment

The CRA author provides a rundown of the principal sections in the Income Tax Regulations under which a mortgage may be a qualified investment for a RRSP. Though the relevant sections have since been amended and consolidated, the substance remains effectively the same today.

Included is an admonition that an annuitant cannot benefit from the existence of the mortgage. In support, the letter goes on to state that “the mortgage interest and other terms must reflect normal commercial practices.”

In context, this reinforces the purpose of the lender and insurance rules, and should not be taken to suggest that there can be no other benefits whatsoever, such as for example potential interest deductibility where a rental property is involved.

CRA 2011-0413761E5 – Interest

This CRA letter comments on a hypothetical scenario whereby a taxpayer’s RRSP uses a non-arm’s length mortgage to retire an original loan from an arm’s length bank used to purchase some rental properties. It confirms that “as long as the rental properties continue to be held by the taxpayer for the purpose of earning income from a business or property”, interest on this second loan – now held by the RRSP – will indeed continue to be deductible.

Duxbury v. The Queen, 2006 TCC 688

To invest in a business, the taxpayer borrowed from a commercial lender by mortgaging his jointly-held home. Some years later as part of a creditor protection exercise, his RRSP used a mortgage to retire the arm’s length mortgage. At the same time, the house was transferred into his wife’s name alone.

In a subsequent year, the taxpayer sought to deduct the annual mortgage payment as an RRSP contribution for that year. CRA denied this claimed deduction, and its position was upheld in this taxpayer appeal.

Given that the original borrowing had been for a business purpose, the interest would have originally been deductible. Depending on how the RRSP acquired its mortgage from the commercial lender, some or all of that deductibility could potentially have carried through to the RRSP mortgage. Unfortunately, there is no mention in the judgment of the interest component as distinct from the full mortgage payment, so it is not clear whether the taxpayer could not advance this argument based on the facts, or if the issue was simply not raised.

Practice points

The cost of non-arm’s length RRSP mortgages becomes more palatable in higher interest rate environments.
One is not precluded from deducting interest where a rental property or underlying business purpose can be shown.
Good recordkeeping will assist in tracing the use of funds, particularly where a substitute loan is employed.

Deductibility of business clothing expenses

At issue

It would perhaps be more apt to entitle this article “non-” deductibility of business clothing expenses, as fairly narrow qualification rules apply to such claims. Particularly in the circumstance of an independent financial advisor, a successful claim may be a remote possibility.

Still, it is not entirely outside the realm of possibility, and it can be instructive for one’s future reference to have an appreciation of the nature of claims that fail to qualify.

With fingers crossed then, here are some taxpayers who sought to deduct clothing costs, including one that got a little more exposure than may have been desired.

Rupprecht v. The Queen, 2007 TCC 191

Advisor had expended considerable cost building and furnishing an office in the Vancouver suburb of Langley. He testified that he needed suitable clothing to go with the office, claiming over $8,400 through the 1999 and 2000 taxation years for purchases from “Ermengildo Zegna, an exclusive men’s wear shop,” as described by the judge. In support of his position, the advisor even included a letter from a store sales associate.

As the clothing did not fall under claims for uniforms and such, its deductibility would need to rest on being a general business expense, which in turn required the judge to consider the converse condition of what constitutes a personal expense. In denying the claim, the judge held that “expenses relating to one’s personal appearance are the very essence of a personal expense” for which the cost is not deductible.

Rioux v. The Queen, 2007 TCC 82

Advisor sought to deduct just over $2,000 for clothing expenses in each of the 2001 and 2002 taxation years. The claims were based in part on advisor’s argument that he was self-employed, despite his commissions being characterized as employment income on his T4 slip from Canaccord Capital Corporation, and he having likewise disclosed those commissions as employment income in reporting his income in those years.

On appeal, the advisor produced an agreement from 1994 purporting to show a self-employment relationship with the predecessor company that was acquired by Canaccord in 1999. The advisor alleged that Canaccord was bound by the former agreement, but provided no proof of this assertion, and therefore he failed to satisfy the threshold requirement of being self-employed for the judge to even consider the claimed deduction.

Hamper v. Commissioner of Internal Revenue (United States Tax Court Summary Opinion 2011-17)

While lacking precedent value in Canada, cases from other jurisdictions can be illuminating.

In what has infamously become known as the “thong deduction” case, an Ohio television anchorwoman sought to claim various items of clothing allegedly necessary to perform her job duties. In deciding whether an item should be claimed as a deductible business expense, she asked herself “would I be buying this if I didn’t have to wear this” to work. She proposed ‘yes’. The judge replied ‘no’.

Practice points

The cost of uniforms and other clothing consumed in the workplace may be deductible.
As is mentioned in almost all the cases, clothing is prima facie a personal expense, and it is the taxpayer’s onus to prove otherwise.
Undergarments? Hard to imagine, and harder to explain to your clients if you’re later exposed on the evening news.

Advisor fraud and investor taxation

At issue

Fraud can rear its ugly head in any area of commercial activity, and the financial advisory field is certainly no exception. Indeed, the highly interpersonal nature of the advisor-client relationship can make it an especially fertile ground for the unscrupulous ‘con’fidence man.

Defrauded individuals may feel doubly victimized when the tax assessment shoe drops, with the potential for particularly harsh results when registered money is involved. Even the judges in the first two cases below suggest that Ministerial discretion may be warranted for these losing taxpayer-litigants.

On the other hand, fraudulent activity can lead to some anomalous results, as the last case demonstrates.

Mignault v. R. 2011 TCC 500

Advisor had Mr. Mignault withdraw $287,920 from his RRSP over four years, with the net $202,794 paid to the advisor’s corporation. It was the last Mr. Mignault saw of those funds.

While the judge acknowledged that Mr. Mignault may have believed that he was only reinvesting within an RRSP, the documents (prepared by the advisor) and his own testimony supported the factual finding of a withdrawal. He was liable for tax on the RRSP withdrawals, with $85,126 already having been withheld.

Penalties for two of the years were also upheld as Mr. Mignault could not show that he met either the objective or subjective standard for a due diligence defense.

St. Arnaud v. R., Braun v. R, Patenaude v. R., 2011 TCC 536

These three taxpayers were not directly connected to one another, but had the same advisor – to their mutual misfortune.

Each taxpayer moved RRSP or RRIF funds into new self-directed accounts to purchase shares of corporations purportedly poised for lucrative initial public offerings. Semi-annual statements were issued for 4 or 5 years before it came to light that the shares were worthless from the start, and otherwise not qualified for RRSP/RRIF investment.

For RRSP and RRIF acquisitions, consideration paid in excess of fair market value is brought into a taxpayer’s income. The judge found that though these taxpayers had done nothing wrong themselves, the purchasing funds “left the sheltered environment and so must, under the scheme of the Act, and its specific provisions, be subject to tax.”

Johnson v. R., 2011 TCC 540

The taxpayer was an innocent participant in a $45 million Ponzi scheme, being one of the ‘up’ investors. She was assessed for amounts she received in excess of what she had provided, totaling $614,000 and $702,000 for the 2002 and 2003 taxation years, respectively.

The scheme of the Income Tax Act requires that income must derive from a source. On the facts, the judge held that while Mrs. Johnson received something, there was an insufficient connection between the capital she provided and her receipts. Thus, as the capital was not a source, the receipts could not be characterized as income. [Ed. note: Case since reversed on appeal]

Practice points – for investor due diligence

Verify the credentials, licensing and professional ‘good standing’ of your advisor and the financial organization he or she represents.
Be aware of what reports and statements you are entitled to receive, be sure that you do receive them, and be careful to store them securely.
Review, respond and act immediately upon correspondence with the Canada Revenue Agency, and be prudent in deciding whether and who to appoint to communicate with CRA on your behalf.