RDSP – Page 2 – Doug Carroll

Your quinquennial retirement check-in: A five-year tax retrospective

No, “quinquennial” is not part of my everyday vocabulary. It is however a handy milestone for evaluating retirement planning progress, if not on an immediate personal basis then at least in terms of changes in the tax landscape.

By its nature, the retirement/tax system evolves incrementally, principally in step with the annual federal budget process. To those of us involved day-to-day in the financial advisory field, at times such change may seem to flow as slow as molasses in January. By contrast, the general population might only contemplate these matters periodically – often only when prompted by their advisors – so developments may appear more momentous once brought to their attention.

However, over the most recent five-year stretch, it could be argued that the sum of these developments is nothing short of astounding, whether planning your own retirement or advising others. With that in mind, consider how the following items will affect retirement planning conversations today compared to a mere quinquennium ago.

2008 – Pension income splitting

Technically a little outside the timeframe, pension income splitting was announced in the Halloween 2006 Economic Statement and introduced in the 2007 Budget. The first opportunity to elect to split up to 50% of such income with a spouse would have been in filing one’s 2007 tax return in/by April 2008.

In addition to the obvious potential to push income to a lower bracket spouse, the maneuver could help preserve the pensioner’s age credit, fend off OAS clawback and assist in making fuller use of the spouse’s pension credit.

2009 – Tax-free Savings Account

Introduced in the 2008 Budget, Canadian residents over the age of 18 received their first $5,000 annual allotment of TFSA room on January 1, 2009.

The structure allows for contribution of after-tax funds, with any subsequent growth and withdrawals being tax-free. In addition, there is a dollar-for-dollar credit on those annual withdrawals that increases contribution room the next January 1st. Apart from being a welcome gift for those with excess cash to invest, the TFSA offers lower bracket individuals a more viable alternative or complement to the traditional RRSP structure.

The indexing formula boosted the annual dollar limit to $5,500 beginning in 2013.

2010 – Canada Pension Plan

While it is patently obvious that this is not a new program, the 2009 triennial review proposed significant changes to the CPP. These changes were legislatively approved in 2010.

With the elimination of the work cessation test, it became administratively simpler to commence a retirement pension, and all future pensions will be marginally improved as the low earnings drop-out increases from 7 to 8 years. However, the decision as to when to commence that pension has become more complicated with new mandatory premium payments for working beneficiaries (voluntary after 65), an increased monthly early take-up penalty from 0.5% to 0.6%, and an increased monthly deferral premium from 0.5% to 0.7%.

2011 – Registered Disability Savings Plan

The RDSP was actually introduced in the 2008 Budget, but took 2 or 3 years of tweaking before those in the target population could fully avail themselves of the program.

A key benefit is the access to matching Grant and free Bond support money. The 2010 Budget made provision for carryforward of unused Grant and Bond entitlements. Perhaps the most important modification occurred in the 2011 Budget with the relaxation of stringent rules that up to then would have forced mass repayment of Grant and Bond money at inopportune times.

The RDSP is now coordinated in many ways with the beneficiary aspects of RRSPs, RRIFs and RESPs, making for much more flexible planning options for individuals and families with disability planning needs.

2012 – Old Age Security

The 2012 Federal Budget will probably be most remembered for raising the OAS qualification age from 65 to 67. Those born prior to April 1958 will remain eligible at 65, with those born after January 1962 having to wait all the way to 67. The rest of us will be somewhere in between, with the phase-in period ranging from April 2023 to January 2029.

As well, as of July 2013 an eligible individual may defer OAS pension for up to five years, in exchange for a 0.6% increase in the pension amount per month deferred.

2013 – Pooled Registered Pension Plan

As we head into the next quinquennium, the PRPP warrants mention before signing off.

Discussed since 2010, the program is aimed at encouraging workplace savings where no current pension arrangement is in place. The federal tax amendments out of the 2012 Budget are now passed, but there is yet to be any concrete action from the provinces. As the program design dovetails contribution room with RRSPs, ever more opportunities and trade-offs may lie ahead, further feeding those retirement planning conversations.

Nil tax assessment … No RDSP

As a matter of clarity and efficiency, the implementation of new legislation is often layered upon existing law. Otherwise, there could be unnecessary duplication of definitions, parallel procedures and potentially inconsistent results.

With respect to the relatively new registered disability savings plan (RDSP), a recent court decision illustrates how such a logical approach may nonetheless lead to unexpected outcomes, and leave a court handcuffed in its desire to fashion a remedy.

Qualification for the RDSP

The disability tax credit (DTC) is a longstanding component of the Income Tax Act. Obviously, the introduction of the RDSP is directed at the same constituency of individuals and families eligible for the DTC.

In fact, in order to be entitled to open an RDSP, a person must qualify for the DTC.

Specifically, a person must be a “DTC-eligible individual,” which is defined within the RDSP provisions under the Income Tax Act as “… an individual in respect of whom an amount is deductible … under section 118.3 in computing a taxpayer’s tax payable . . . ”

The implications of not falling under this definition are stated explicitly in later provisions prohibiting contributions being made to a RDSP “if the beneficiary is not a DTC-eligible individual in respect of the taxation year”.

Effect of a nil assessment

In an October 26, 2010 case from the Tax Court of Canada (TCC), the interaction between DTC entitlement and RDSP eligibility came under scrutiny.

In February 2009, taxpayer GT had a medical doctor complete a Disability Tax Credit Certificate, which was then forwarded to the Canada Revenue Agency (CRA). But the CRA denied the disability tax credit.

In an effort to seek redress, GT sought to use the Informal Procedure in the TCC to appeal his nil tax assessment for 2008.

To be clear, however, GT was not contesting any assessment of tax, but rather seeking a route to contest the CRA’s refusal to allow him disability tax credit qualification upon which he could establish his RDSP eligibility.

Jurisdiction of the TCC

Where a taxpayer is dissatisfied with a tax assessment, an appeal may be made to the TCC. The disposition of that appeal is set forth in the Income Tax Act, allowing the court to dismiss or allow the appeal, vacate or vary the assessment, or refer the matter back for reconsideration and reassessment.

That said, the point of law before this court was not the appeal itself, but rather a motion by the Crown to dismiss GT’s appeal as being from a nil assessment.

Recent case law indeed holds that there can be no appeal from a nil assessment, so the judge was compelled to allow the Crown application and dismiss GT’s appeal.

What now for the disentitled?

The required disposition clearly doesn’t sit well with the Judge, who stated, “It is simply not right for the Crown to act behind a nil assessment to prevent [GT] from applying for a disability savings plan.”

Although there is likely a procedure under the Federal Courts Act for GT to have CRA administrative actions reviewed, this again is not entirely satisfactory to the judge. He opines that, “[i]deally this Court should be a ‘one stop’ Court for persons who have claims under the [Income Tax Act],” expressing particular concern for low-income taxpayers.

The Judge went on to raise the question of whether Parliament and the legislative draftsmen may simply not have anticipated GT’s situation.

Given the spirit and purpose of the RDSP initiative, it will be interesting now to see what legislative response may come out of this case, and how soon.

ED NOTE: Shortly after this case was reported, Finance Minister Jim Flaherty announced that appropriate legislative amendments would be introduced to address this problem.

2008 An Investor’s Tax Year in Review

Whether you’re inclined to say, “It’s not about the income, it’s about the outcome,” or maybe, “It’s not how you make out, it’s what you take out,” tax is the difference between the top line and the bottom line.

As 2008 comes to a close, here is a look back at the significant tax developments that have occurred over the last year or so.

Federal Budget 2007 – Holdovers

Pension splitting

Announced in last year’s Budget, pension splitting became a tangible reality in 2008 for pensioners preparing their 2007 tax returns. The rules allow for up to 50% of eligible pension income to be split over to the pensioner’s spouse.

Apart from potentially shifting income to a lower bracket taxpayer, related benefits may include reducing clawbacks on Old Age Security and the age 65 credit, and doubling up access to the pension credit if the receiving spouse does not already have his or her own eligible pension income.

While the change certainly provides relief for many seniors, there remains a sore spot: For pensioners under 65 to qualify, the income must originate from a registered pension plan (or via a pre-deceasing spouse’s RRSP, RRIF or DPSP). Indeed, in its submissions this past summer for the 2009 Federal Budget, the Investment Funds Institute of Canada suggested that pension splitting be allowed at age 55 for all registered plans. This would certainly level the playing field for those not having the benefit of a registered pension plan.

Whatever may happen, this is welcome development, and likely a standing feature of our tax system for the foreseeable future.

RDSPs

The Registered Disability Savings Plan was announced in the 2007 Budget, to be available for deposits beginning in 2008. These plans will allow for deposits of up to $200,000 to grow tax-sheltered for qualified disabled beneficiaries. As a further boost, deposits will be augmented by federal matching grants of up to 300% of deposits, as well as free bond money being available based on family net income.

Unfortunately, to date no plans have been able to be put in place as the financial service industry awaits necessary administrative details from the federal government. During an informational program attended by the writer in late spring, a representative from Human Resources and Social Development Canada (HRSDC) stated that those details will be delivered by December, 2008, so we may see plans made available by early 2009.

RRIF conversions

The end of 2008 will also see the end of the transitional period related to the move of the commencement of mandatory RRIF withdrawals from age 69 to age 71. In 2007 and 2008, these rules allowed for RRSP or RRIF re-contributions for certain age 70 and 71 individuals. In 2009, we will again simply need to be aware that those RRSP annuitants attaining age 71 in the calendar year must convert their RRSP to a RRIF, purchase an annuity or cash their RRSP.

Federal Budget 2008

TFSAs

By far the most significant development of the last year was the announcement of the new Tax-Free Savings Account. In this writer’s opinion, it is in fact the biggest change in how Canadians will manage money since the creation of the RRSP in 1957, and time may prove it out to be even bigger yet.

As stated in the Budget document, “This flexible, registered, general-purpose account will allow Canadians to watch their savings – including interest income, dividend payments and capital gains – grow tax-free.”

Beginning in 2009, each Canadian resident taxpayer age 18 or older will be entitled to place up to $5,000 annually into a TFSA account. This limit will be indexed annually, but will only increase when the resulting figure rounds up to the next $500 level. Unused contribution room may be carried forward indefinitely.

In contrast to the RRSP/RRIF regime where deposits are pre-tax and withdrawals are taxable, the TFSA receives after-tax funds and withdrawals are 100% tax-free. (Of course both types of plans allow tax-sheltered accumulation.) The additional benefit of the TFSA structure is that the non-taxable withdrawals have no effect on income tested tax credits, nor do they contribute to the clawback of Guaranteed Income Supplement or Old Age Security.

Interest is not deductible on money borrowed to contribute to a TFSA (like RRSP loans), but TFSA account value may be pledged as security for further borrowing.

From a spousal wealth and estate planning perspective, a high rate taxpayer may contribute into a spouse’s TFSA without being subject to the income attribution rules. Furthermore, at death (or at separation), a TFSA account may rollover to a spouse and remain tax-sheltered in the receiving spouse’s hands.

For many, the most surprising and valuable feature is that when a TFSA holder makes a withdrawal, there is a dollar-for-dollar recovery of contribution room for making future deposits.

RESP changes

Some of the time limits associated with RESPs have been extended to provide additional flexibility to students.

The time period for allowable contributions to a plan is extended from 21 to 31 years following the year in which the plan is entered into. Similarly, the termination date for a plan is extended from 25 to 35 years following the opening of the plan.

The government also relaxed the rules surrounding Educational Assistance Payments. Rather than requiring that the student be currently enrolled in order to obtain an EAP, an RESP beneficiary may receive EAPs for up to a six-month “grace period” after ceasing to be enrolled in a qualified program.

Unlocking Federal LIFs

Canadians who have funds “locked up” inside of federal Life Income Funds (LIFs) will now have greater access to their money beyond the current annual maximum withdrawal limits.

Small balance withdrawal – Individuals who are at least 55 years of age with LIFs worth less than $22,450 (to be indexed to the average industrial wage) will be able to wind up their accounts or convert them to another tax-deferred savings vehicle, such as an RRSP or RRIF, in which there are no maximum withdrawal limits.

Financial hardship withdrawal – Any LIF holder, regardless of age, facing “financial hardship” (low-income individuals or individuals with high disability or medical-related costs) can unlock up to $22,450 (also to be indexed).

One-time unlocking – Individuals who are at least 55 years of age may “unlock” up to 50% of their LIF holdings and transfer the funds into another tax-deferred savings vehicle, such as an RRSP or RRIF, in which there are no maximum withdrawal limits.

Interest deductibility – Lipson case

Being able to deduct interest charges on borrowed money is at the heart of both simple and complex tax-assisted investment leveraging. On April 23, 2008, the SCC heard arguments in the Lipson case, with the judgment expected imminently this fall.

As background, recall the Singleton decision of the Supreme Court of Canada from 2001. Mr. Singleton withdrew funds from his law partnership, used those funds to buy a house, mortgaged the house, then deposited the mortgaged funds back into the partnership. The SCC held that the mortgage interest was deductible as the use of the borrowed funds could be traced into a business or income-producing asset.

In Lipson, Jordanna Lipson borrowed money from a bank which she used to purchase some shares of the family investment company from her husband Earl. Earl used that money to buy a house, mortgaged the house, then used the mortgaged funds to pay off Jordanna’s loan. The government was successful at both the Tax Court of Canada and the Federal Court of Appeal, arguing that the interest deduction (and other tax benefits originally claimed) could not stand as the series of transactions offended the general anti-avoidance rule, or GAAR.

Tax practitioners are hopeful that the forthcoming decision will provide some clear principles from the top court to guide those engaged in leveraged investing. At time of writing, the SCC had not yet handed down its highly anticipated judgment.

Offside IPPs

In June, CRA issued Compliance Bulletin #5 re-confirming its intention to pursue and prosecute non-compliant registered pension plans, particularly offside individual pension plans. The bulletin recounts two successful prosecutions occurring at the Federal Court of Appeal in July, 2007: Jordan Financial and 1346687 Ontario.

Both cases involved a pre-retiree’s creation of a corporation and an associated pension plan to receive the value of a public service pension plan entitlement. The FCA found that neither was a true pension plan, resulting in deregistration and immediate taxation of the originally transferred amounts of $754,513.47 and $564,478.56, respectively.

The Bulletin lists further negative tax consequences that may result from deregistration, including interest and penalties. As well, notice is given that new applicants may be required to confirm the bona fides of a plan in writing prior to registration being granted. No doubt this is intended to both dissuade questionable structures and ease later prosecution.

RRSPs in bankruptcy

On July 7, the long awaited amendments to the federal Bankruptcy and Insolvency Act were proclaimed in force. The amendments give RRSP, RRIF and DPSP type plans the same protection that is afforded to registered pension plans in bankruptcy, with the exception that deposits made within a year of the bankruptcy will be available to creditors.

Prior to the amendments, a bankrupt with an RPP could carry it out of bankruptcy, but protection for RRSPs, RRIFs and DPSPs depended on the law of the province where the bankrupt was located. These amendments assure that there is a base level of consistency across the country, though stronger creditor protection may be available in some provinces, including the additional protection within insurance based plans where an appropriate beneficiary designation is in force.

Charities

Redeemer Foundation

On July 31, the Supreme Court of Canada issued its judgment in the Redeemer Foundation case. Redeemer was seeking judicial review to resist a CRA request to disclose donor lists. The SCC held that CRA may indeed use its audit powers to obtain a donor list, and further may use that list to identify and audit those donors.

ICAN

On August 9, CRA revoked the charitable status of International Charity Association Network. ICAN failed to provide adequate documentation for $464M of charitable receipts it issued in 2006. In its press release announcing the revocation, CRA stated that it is “reviewing all tax shelter-related donation arrangements, and it plans to audit every participating charity, promoter and investor.”

Snapshot – Current brackets and rates

Absent a further Fall Economic Statement by the incoming federal government or any of the provinces, the three exhibits below summarize the tax brackets and rates we will be using to report our taxes next April (or June if you run a business).

A few brief notes:

Whereas in 2007 we saw a mid-year downward adjustment of the lowest bracket from 15.5% to 15%, we end 2008 with the same federal rates that we began with

The graph format in Exhibit 2 provides a side-by-side visual comparison of how a taxpayer moves up through to top marginal rates, with as few as 6 brackets in Alberta and as many as 10 in BC, Ontario and Nova Scotia

Exhibit 3 shows that the top marginal rate on eligible dividends is below the rate on capital gains in four provinces in 2008, though those eligible dividend rates will generally rise through 2012 according to the federal schedule and provincial adjustments

Exhibit 1 – Federal tax brackets and rates – 2008

Basic amount to 9,600 0%

9,600 to 37,885 15%

37,885 to 75,769 22%

75,769 to 123,184 26%

123,184 to + 29%

Exhibit 2 – Combined federal/provincial tax brackets, 2008

[Graphic not rendered]

Exhibit 3 – Top marginal tax rates, 2008

Province Interest / foreign income Taxable capital gains Eligible/Ineligible dividends

British Columbia 43.7% 21.9% 18.5% / 31.6%

Alberta 39.0% 19.5% 16.0% / 26.5%

Saskatchewan 44.0% 22.0% 20.4% / 30.8%

Manitoba 46.4% 23.2% 23.8% / 37.4%

Ontario 46.4% 23.2% 24.0% / 31.3%

Quebec 48.2% 24.1% 29.7% / 36.4%

New Brunswick 47.0% 23.5% 23.2% / 35.4%

Nova Scotia 48.3% 24.1% 28.3% / 33.1%

Prince Edward Island 47.4% 23.7% 24.4% / 33.6%

Newfoundland & Labrador 45.0% 22.5% 28.1% / 33.3%