Targets misuse of tax shelters
Your ability to rebalance your investment portfolio by swapping investments between your non-registered and registered accounts may be impaired as a result of a new tax rule that came into effect on Friday, July 1.
Under the rule, swaps done at amounts other than fair market value (FMV) could be subject to a 100% tax on the excess above or below the FMV.
A swap is a two-way transaction in which an investment in your non-registered account is swapped with an investment in your RRSP/RRIF account or vice versa. Swaps are sometimes used by investors who wish to rebalance their portfolios among their various accounts without having to incur a fee or commission that might otherwise be imposed on a sale and subsequent repurchase of the security being transferred. These swaps, if not done at FMV, could be the subject of the new penalty tax.
Note that a swap does not include a one-way transaction, such as an "in-kind" contribution to your RRSP or an in-kind RRSP or RRIF withdrawal in which a stock or security is transferred to your non-registered account.
The new rule can be traced back to fall 2009, when the government introduced the Tax Free Savings Account advantage rules. Under these rules, an advantage may generally be described as a benefit obtained from a transaction that is intended to exploit the tax attributes of a TFSA. Swap transactions are specifically listed as one such transaction.
As the government said in 2009, "These transfers, when performed on a frequent basis with a view to exploiting small changes in asset value, could potentially be used to shift value from, for example, an RRSP to a TFSA without paying tax, in the absence of any real intention to dispose of the asset."
For example, Debbie swaps $5,000 of thinly traded shares that have a bid price of 10¢ but an ask price of 30¢ from her non-registered account to her TFSA for cash, using the 10¢ price. The shares are then swapped back for cash a few hours later to Debbie's non-registered account for 30¢ per share, allowing the $10,000 "gain" to remain inside the TFSA. Under the TFSA advantage rule, the entire gain on the swap transaction would be taxed back at 100%, causing Debbie to forfeit her $10,000 profit.
The 2011 budget adopted the advantage concept from the TFSA rules to RRSP and RRIF accounts and specifically targets, among other things, swap transactions, which in this context would be a transfer of property between an RRSP/RRIF and her non-registered account.
Although the rule is meant to be effective as of July 1, draft legislation has not yet actually been released and as a result, uncertainty exists across the industry both as to what these rules will attack and how the CRA will interpret what fair market value actually is in these situations. As a result, some financial institutions have simply stopped all swaps effective July 1, so as to protect their clients from potentially being ensnared in this new 100% tax trap.