What’s Your Tax Issue? Using RRSP Funds for Private Company Investment

The Tax Issue:

Can I use the funds in my RRSP to invest in shares of a private company?

The Answer:

Let’s get one thing out of the way from the top: you cannot use your RRSP funds to invest in a corporation which you control. Now, for those of you that are still with us, the following explains the rules involved.

Small Business Corporation (“SBC”) Test

Generally, an SBC is a corporation that meets the following conditions:

(a)    the corporation must use all or substantially all (i.e. 90%) of its assets principally in an active business carried on primarily in Canada. Shares or debt of connected qualifying corporations are also eligible assets.

(b)    The corporation must be a Canadian corporation that is not controlled any manner by non-residents. This control test includes control in fact, as well as legal voting control.

Any investment in an SBC will qualify as long as investor is not connected with the corporation

A shareholder is considered connected if he or any related person owns, directly or indirectly, at least 10% of the shares of any class of the corporation or a related corporation.

A connected shareholder could still invest in a SBC as long as the total investment (including investments by related persons) is less than $25,000, and the investor deals at arm’s length with the corporation.

Eligible Corporation (“EC”) Test

Most RRSP investments in private companies will fall within the rules described in the SBC test above. The EC test is an older rule that still applies. It is similar to the SBC test, but more restrictive, so let’s not bore you with the details.

Suffice to say that anyone contemplating an investment in a private company with RRSP funds should not do so without first consulting a tax professional.

What’s Your Tax Issue? – Gift of RRIF on Death

The Tax Issue:

My Mom passed away very recently. She had indicated designated beneficiaries of her RRIF with varying percentages – none to the estate. One of these is her church, a charitable organization.  My understanding is that I can not claim the RRIF amount to the charity as a charitable donation (because it has not passed through the estate), although I’m not sure exactly why.

No one seems to be able to answer this and, in fact, the whole income tax issue on RRIF’s at death was quite befuddling – with each person I asked (ie. financial planner, lawyer) pointing me in another direction 🙂

If you have any thoughts on this, could you please pass them along? Thanks.

The Answer:

Well, yes, the subject of RRIF’s on death is indeed befuddling, as I pointed out in a previous post, and I always get excited when a question begins with the phrase “no one seems to be able to answer this…”

There are two parts to the answer. The first is, who gets taxed on the proceeds from the RRIF? Upon death, the general rule is that the full amount coming out of the RRIF is taxable unless it qualifies for a rollover. The church is not a qualified beneficiary, so the full amount of the RRIF will be a taxable amount to be added to your Mom’s final tax return.

Next question: can the amount that goes to the church be claimed as a tax credit for gifts? Under rules that have existed since the olden days, a gift made to a registered charity by virtue of an individual’s will is deemed to be a gift made by the individual immediately prior to her death, and may be claimed on her final return. Your advisors are confused because the gift is a direct designation in the RRIF, and not made by virtue of the will.

We have come a long way since the olden days. In 2004, the law was amended to give similar treatment to gifts made as direct designations through a RRIF. The only stipulation is that the transfer of funds must occur with 36 months of death.  Accordingly, although the RRIF is taxable in your Mom’s final return, her estate will also benefit from a corresponding tax credit for the gift made to the church.

The RRIF administrator should issue a T4A in the name of your mother for the full amount of the RRIF. The church should issue a charitable donation receipt to the estate for the amount it receives.

Rollover of RRSP’s and RRIF’s on Death – Don’t Take It For Granted

If you are the executor of an estate, or you are perhaps advising your client on his will, you should be aware of the rules regarding RRSP’s and RRIF’s on death.

I’m surprised at the number of people, executors and plan administrators alike, who work on the often erroneous assumption that these plans simply roll over tax-free when the surviving spouse is named as the beneficiary.

In fact, the opposite is true. While capital property automatically rolls over tax-free to a spouse on death, a RRSP/RRIF does not. The general rule is that it is taxable in the hands of the deceased annuitant. From there, a number of possibilities can occur.

If the spouse is named as the “successor annuitant”, then the capital in the plan is not paid out. The plan simply continues and the spouse replaces the deceased as the annuitant. There is no tax to the estate and no reporting is required. The successor annuitant can be named in the plan itself or in the will. The successor annuitant can also be established in other cases if the executor and the plan administrator agree.

If there is no successor annuitant, then the proceeds of the plan are realized and they are taxed either in the hands of the surviving spouse or the estate, depending on the circumstances. If the spouse is designated as the plan beneficiary in the contract, the payment of funds is made to the spouse upon death of the annuitant, and the spouse adds the amount to income. The spouse then has until 60 days after the end of the year to transfer the funds to his or her own RRSP/RRIF to obtain an offsetting deduction.

If the spouse is named as a beneficiary in the will alone (which will likely be the case in Quebec), then the payment of funds is made to the estate. The executor and the spouse must then agree and file an election (form T2019 for RRSP’s  or T1090 for RRIF’s) to have the proceeds added to the spouse’s income, and be eligible for rollover into his or her plan.

What if the spouse refuses to sign the election?

Take the case where a deceased man is survived by his second wife, has children from a former marriage and the leaves a RRIF to the spouse in the will, with no clear instructions regarding the taxes. The residue from the estate goes to the children. The executor must receive the funds from the RRIF and pay them to the spouse under the terms of the will. No taxes are deducted from this amount. The spouse can then choose not to make the election. She will receive the entire amount of untaxed capital from the RRIF and she will not have to roll it into her own plan, thus avoiding future taxes on withdrawal. The taxes will be borne by the deceased, and be taken from the residue of the estate, thus providing a possible unintended benefit to the spouse, and most likely some very disgruntled children.