Tax case illustrates government’s motivation in IPP change
New rules in the 2019 federal budget crack down on commuted value transfers
Individual pension plans (IPP) can be a great way for people who operate small businesses through a Canadian-controlled private corporation (CCPC) to save for retirement. An IPP is essentially a defined benefit (DB) registered pension plan with fewer than four members, at least one of whom is the controlling shareholder of the corporation that sponsors the IPP.
But IPPs have also been used by employees who wish to take funds from a DB pension with them when they leave their employers. Upon leaving a DB plan, the tax rules typically allow an employee to transfer, on a tax-deferred basis, the entire commuted value of their accrued benefits to another DB pension plan of another employer, or a far lesser amount (often only 50%) to the employee’s own RRSP.
To get around this limitation, some employees would incorporate a new CCPC and immediately set up an IPP to receive the full commuted value from their former employer’s pension plan. Last month’s 2019 federal budget announced changes that would permanently stop this type of planning.
Before reviewing the budget announcement, let’s take a look at a Federal Court of Appeal case (Mammone v. Canada, 2019 FCA 45) decided in March, which sheds light on exactly the type of planning the government has attempted to stop.
The recent case involved a mechanic employed by Toronto Fire Services from 1981 until his retirement in 2009. During this period he belonged to the Ontario Municipal Employees Retirement System (OMERS) pension plan.
On Jan. 1, 2009, the taxpayer incorporated a numbered company that established an IPP called the Pension Plan for Senior Executives of (the Company). The taxpayer was the only member. It was registered as a pension plan pursuant to the terms in the Income Tax Act and, on June 23, 2009, the commuted value of the taxpayer’s OMERS pension—just over $640,000—was transferred to the IPP.
Under the Income Tax Act, a taxpayer is required to include in income an amount received “on account or in lieu of payment of, or in satisfaction of […] a superannuation or pension benefit.” This includes indirect payments, such as payments that the taxpayer directs to someone else for the taxpayer’s benefit. However, there is no income inclusion when amounts are transferred between DB registered pension plans (RPP). An RPP is a pension plan registered by the Canada Revenue Agency (CRA) whose registration has not been revoked, including IPPs.
In 2013 the CRA moved to revoke the taxpayer’s IPP registration “on the basis that the plan did not satisfy registration requirements,” issuing a notice of revocation retroactive to Jan. 1, 2009. On the same day, the agency reassessed the taxpayer’s 2009 tax year to include the commuted value of the OMERS pension in his income, based on the belief that the IPP’s registration had been retroactively revoked and therefore the commuted value of the pension was transferred to a non-registered plan, making it taxable.
While the taxpayer ended up winning his case on a technicality (the CRA erroneously issued its revocation before the required 30-day notice period had passed), the government sought to put an end to this “inappropriate planning” in its 2019 federal budget.
To stop this type of planning, the 2019 budget proposed to prohibit IPPs from providing retirement benefits for past years of employment that were pensionable service under a DB pension plan of a prior employer. Any assets so transferred on or after March 19, 2019 will now be considered to be a non-qualifying transfer that is required to be included in the employee’s income.