What you need to know
If you hold a prohibited investment in your RRSP or RRIF, you may be subject to a 50% penalty tax on its value. This tax applies to prohibited investments acquired after 22 March 2011, and those acquired before 23 March 2011 that became prohibited after 4 October 2011. In certain cases, this tax may be refunded.
You may also be subject to a 100% advantage tax on any income (including realized capital gains) reasonably attributable to a prohibited investment in your RRSP or RRIF that was earned or accrued after 22 March 2011.
Some transitional relief is available for income and gains attributable to a prohibited investment held on 23 March 2011, but only for income earned and gains accruing after 22 March 2011 and earned or realized before 2022.<>To take advantage of the transitional relief, you must file Form RC341, Election on Transitional Prohibited Investment Benefit for RRSPs or RRIFs, on or before 30 June 2012, and each year you must withdraw the qualifying income or gains from your RRSP or RRIF within 90 days after the end of the calendar year in which they were earned or realized.
If you owe tax under these rules, you must file Form RC339, Individual Return for Certain Taxes for RRSPs or RRIFs, no later than 30 June of the following year (e.g., 30 June 2012 for the 2011 taxation year).
What is a prohibited investment?
A prohibited investment is generally an investment to which the annuitant of an RRSP or RRIF is closely connected such as the following:
- A debt obligation of the annuitant
- A share of, interest in or debt of a private or public corporation, trust or partnership in which the annuitant (or a non-arm’s-length person) has a significant interest (generally 10% or more)
- A share of, interest in or debt of a corporation, trust or partnership with which the annuitant, or any entity in which the annuitant has a significant interest, does not deal at arm's length.
Specifically excluded from prohibited investments are certain regulated mutual fund investments and certain insured mortgages (and similar instruments).Under this definition, certain private company shares that may have been qualified investments for RRSP/RRIF purposes prior to the introduction of these rules may now be prohibited (e.g., a private company share investment representing a greater than 10% interest in the company but costing less than $25,000).
Tax on prohibited investments
The new prohibited investment rules impose a penalty tax of 50% of the fair market value of a prohibited investment held by the RRSP or RRIF. This tax applies to prohibited investments acquired after 22 March 2011 and those acquired before 23 March 2011 that became prohibited after 4 October 2011.
This tax does not apply to a pre-23 March 2011 prohibited investment that is transferred to another RRSP or RRIF of the same annuitant after 22 March 2011.
This 50% penalty tax may be refunded if the investment is disposed of by the end of the year following the year in which the tax applied (or such later time as the minister of national revenue considers reasonable), unless the annuitant knew or should have known when acquiring the investment that it was, or would become, prohibited.
If an investment held by an RRSP or RRIF was subject to this penalty tax and subsequently ceases to be a prohibited investment, the RRSP or RRIF is deemed to have disposed of the investment for proceeds equal to fair market value and to have reacquired it at a cost equal to that fair market value.
Non-qualified investments are subject to similar rules. If an investment is considered to be both a prohibited investment and a non-qualified investment, the rules ensure the annuitant is not subject to double tax by deeming the investment to only be a prohibited investment.
Under transitional rules, a prohibited investment can be removed without tax from an RRSP or RRIF by swapping the investment for cash or other property of equal value before the end of 2021. After 2021, a swap transaction may still be used to remove a prohibited investment from an RRSP or RRIF, but only in situations where the annuitant is entitled to a refund of the 50% penalty tax (e.g., where the annuitant didn’t know at the time the property was acquired that it was, or would become, a prohibited investment).
A 100% tax applies to the value of certain “advantages” received in relation to an RRSP or RRIF. Advantages include benefits that constitute income (including capital gains) that are reasonably attributable, directly or indirectly, to a prohibited investment held in a RRSP or RRIF.
The advantage tax applies to income earned, and realized capital gains accruing, after 22 March 2011, regardless of when the prohibited investment generating the income or gain was acquired.
Transitional relief available via election
Some transitional relief from the advantage tax is available for income and gains attributable to a prohibited investment held on 23 March 2011, but the annuitant must file an election to qualify.
In particular, the 100% advantage tax will not apply to any income earned after 22 March 2011 and before 2022, nor to any capital gain on the investment accruing after 22 March 2011 and realized before 2022, as long as the amount of the advantage is withdrawn from the RRSP/RRIF. The total income and gains qualifying for this relief is reduced by any capital losses realized on the same investment, and the qualifying amount is referred to as a “transitional prohibited investment benefit.”
To take advantage of the transitional relief, the annuitant must do the following:
- File Form RC341, Election on Transitional Prohibited Investment Benefit for RRSPs or RRIFs, on or before 30 June 2012
- Withdraw the qualifying income or gains from the RRSP or RRIF within 90 days after the end of the calendar year in which they were earned or realized
- Ensure the withdrawal is not paid by way of a transfer to another registered plan of the annuitant
The transitional prohibited investment benefit is included in the annuitant’s income for the year in which it is withdrawn, and is subject to the annuitant’s marginal tax rate (just like any regular RRSP or RRIF withdrawal).
Possible waiver of tax
The Canada Revenue Agency (CRA) may, at its discretion, waive all or a portion of the 50% penalty tax or 100% advantage tax in certain circumstances if it considers it just and equitable to do so. In the case of the advantage tax, the amounts that gave rise to the tax must be withdrawn from the RRSP or RRIF without delay.
To request a waiver, the annuitant must send a letter to the CRA explaining why the tax liability arose, and why it would be fair to cancel or waive all or part of it.
Locked-in retirement accounts
In the case of a locked-in retirement account (LIRA) where the annuitant is not allowed to make withdrawals before a certain age, it may not be possible to obtain a refund or waiver of the penalty tax or transitional relief from the advantage tax.
Restrictions on withdrawals from a life income fund (LIF) or locked-in retirement income fund (LRIF) may also make it difficult to withdraw amounts giving rise to the penalty or advantage tax.
This issue has been raised with both the CRA and the Department of Finance.
Excluded from Part I tax
To avoid double tax, any amount withdrawn from an RRSP or RRIF that was subject to the 50% prohibited investment tax or the 100% advantage tax under Part XI.01 of the Income Tax Act (and for which no waiver, refund or cancellation is granted) is excluded from the annuitant’s income for Part I income tax purposes.
The financial institution will still withhold tax on the withdrawal, and the amount withheld may be applied against other taxes payable for the year or refunded when the annuitant files his or her personal tax return for the year.
Tax return filing requirement
If an annuitant owes tax under the new anti-avoidance rules for a particular calendar year, he or she must file Form RC339, Individual Return for Certain Taxes for RRSPs or RRIFs, for that year. The return must be filed, along with the payment of any tax, no later than 30 June of the following year.