Tax avoidance is the act of arranging your finances to reduce the amount of tax you owe. To prevent aggressive tax avoidance and the misuse of certain tax shelters, the Canada Revenue Agency has a number of anti-avoidance laws in place.
Defining Anti-Avoidance Laws
To encourage investments and donations, the CRA offers taxpayers the ability to deduct certain investments and charitable donations from their income on their tax return. When a taxpayer chooses to use these deductions, it is considered legal tax avoidance by the CRA.
However, if a taxpayer takes advantage of tax shelters in ways that violate the spirit of the tax code, the CRA may consider it is considered aggressive tax sheltering or avoidance. The CRA has anti-avoidance laws in place to help prevent these practices.
Contributing to Your Retirement Accounts
If you make contributions to a Registered Retirement Savings Plan, you may deduct your contributions from your income to reduce the amount of tax you owe. However, the CRA imposes a deduction limit for all RRSP contributions. As of 2016, you may not contribute and deduct more than $25,370.
However, if you have unused deductions from previous years, you may be able to contribute and deduct a larger amount. The CRA will send annual notifications to advise you of your deduction limits. You can also check these limits through the CRA’s My Account online service.
For example, if you have $15,000 of unused contributions from previous years, you may be able to deduct up to $40,370 on your 2016 income tax return.
In most cases, as long as you do not deduct more than your annual RRSP allowance, you don’t need to worry about anti-avoidance laws.
Understanding Non-Qualified Investments
The CRA allows taxpayers to use their RRSP and Registered Retirement Income Fund accounts for qualifying investments such as Guaranteed Investment Certificates, government and corporate bonds, mutual funds, and securities listed on a designated stock exchange.
Investments that fall outside of this list are considered non-qualified investments. If your RRSP or RRIF acquires a non-qualified investment or if one of the investments in your account becomes non-qualified, the financial institution overseeing the RRSP or RRIF trust is required to notify you. Your financial institution must send the notification by the end of February in the year following the change.
If you receive one of these notifications, you must fill out and file Form RC339 by June 30. You are required to pay a 50 percent tax on the fair market value of the non-qualified investment.
When you file this form, you must include a description of the non-qualified investment, the date it was acquired, and your RRSP or RRIF account number.
Identifying Prohibited Investments
Similarly, if you have prohibited investments in your RRSP or RRIF, these investments will also fall under the CRA’s anti-avoidance laws. You are required to pay a 50 percent tax on these types of investments and report them on the RC339 tax form.
Prohibited investments can include personal debts. They also include debts or shares of a corporation, trust, or partnership of which you own at least 10 percent. If you have shares or debts of a trust, corporation or partnership, and you own less than 10 percent but you are actively involved with that corporation, this may also be considered a prohibited investment.
For example, if you own 5 percent of a corporation and have no involvement in daily operations, you can legally own shares of that corporation in your RRSP. However, if you are involved with the corporation on a regular basis and have shares in your retirement account, your shares will be considered a prohibited investment.
If your financial institution notifies you that you have a non-qualified investment in your RRSP or RRIF, ensure that it is not also prohibited. If it is a prohibited investment, you must notify your financial institution.
In other cases, your financial institution may not be aware that you have a prohibited investment. As a result, you need to keep an eye on your investments to ensure you are at an arm’s length from them.
Paying Advantage Tax
If you earn money from non-qualified or prohibited investments in your RRSP or RRIF, the CRA will charge you an advantage tax. The CRA levies a 100 percent advantage tax and will claim all earnings from non-qualified or prohibited investments.
If you want to keep money earned from your investments, be sure to diligently monitor your retirement accounts for any non-qualified or prohibited investments. If you acquire them, speak with a tax adviser about the best course of action.