OK everyone, this post gets a little technical, so I’m adding footnotes for the first time ever. If the Income Tax Act (ITA) frightens you, don’t read on.
My good friend and colleague (let’s call him “Shya”) came to me recently with an interesting problem. In 2007, his client, a former resident of Canada, died with a balance remaining in his Canadian RRSP account. At the time, the RRSP funds were transferred to the RRSP of his wife, also a non-resident of Canada. Under the normal rules for Canadian residents, the surviving spouse would simply report the “refund of premiums” on her 2007 tax return, and claim a corresponding deduction for amounts deposited into her RRSP. No tax would have applied.
Unfortunately, the administrator of the RRSP was not on top of the situation. Had they realized that the taxpayers were non-residents of Canada, they would have known that a 25% withholding tax applies to an RRSP that is paid to any non-resident. Further, since the amount was transferred directly to the spouse’s RRSP, filing a prescribed form upon the transfer of funds would have exempted the non-resident spouse from the withholding tax.
Unfortunately, the proper form was not filed, and no tax was withheld at the time of death.
Along comes the CRA two years later. Realizing what has happened, the CRA assessed the surviving spouse for the 25% withholding tax. Since the transfer to her RRSP was not done “pursuant to an authorization in prescribed form” as the law states, no exemption from this tax can apply.
Is the taxpayer out of luck? Perhaps.
Let’s go back in time once more. Had the taxpayer discovered this oversight in time, she still could have filed a special Canadian tax return under section 217 of the ITA. The section 217 return is designed to give non-resident taxpayers the option of paying tax at the normal Canadian tax rates as opposed to the flat 25%. For many taxpayers the 217 election is not advantageous, because the Canadian tax rate that applies is based on a complex calculation that takes world income into account. For a non-resident with any substantial amount of total income, the rate usually will exceed 25%.
For our surviving spouse, however, the section 217 election would have resulted in no tax, since she would be allowed to take a deduction under the normal Canadian rules for the amount transferred to her RRSP. This would bring her net Canadian taxable income down to zero, and she could claim a refund of the 25% withholding tax.
There’s just one problem left for Shya’s client. The section 217 return must be filed within six months from the end of the taxation year that income was received. In this case, that would have been June 30, 2008. Since the problem didn’t come to light until the CRA’s assessment in 2009, the taxpayer is not entitled to file the election.
Now, the taxpayer’s only hope is to request that the CRA extend the time and allow her to file a late section 217 return. The CRA has the power at any time to extend the time for filing any return. However, this administrative concession is not given lightly.
The issue has been dealt with in the past with respect to returns under section 216 of the ITA. The CRA has a published policy to give taxpayers “one opportunity” to file a late return where they have neglected to do so through ignorance or inadvertence. Perhaps this concession could be extended to section 217 returns.
If not, the CRA has issued guidelines which presumably could apply in this scenario. In essence, the taxpayer would have to convince the CRA that there were extraordinary circumstances beyond her control (other than ignorance of the law) that prevented her from filing the return on time.
The moral of the story? Always consult a tax professional when dealing with unusual transactions involving non-resident taxpayers.