• Limitations on RRSP Investments in Private Company Shares
  • February 15, 2013
  • Law Firm: Perley-Robertson Hill McDougall LLP/s.r.l. - Ottawa Office
  • Registered Retirement Savings Plans (RRSP) allow savings for retirement to grow tax free in a special savings plan registered by the Canada Revenue Agency. An annuitant can also deduct from taxable income the amount contributed to the RRSP every year (up to the annual contribution limit). It is therefore a key financial tool to plan for retirement which also allows for the flexibility to invest in various financial products, including shares of private corporations.

    Recent amendments to the Income Tax Act have made the rules for RRSP investments in private company shares much more restrictive than before. Under the old rules, an investment in private company shares for an RRSP account could be considered a qualified investment if, at the time of purchase, the private company was a specified small business corporation, and the annuitant and non-arm’s-length persons held less than 10% of the company’s shares. In addition, the 10% rule did not apply if the annuitant dealt at arm’s length with the company and the original cost of the investment was less than $25,000.

    Generally, a specified small business corporation is a Canadian corporation that meets the following requirements:

    • it is not controlled, directly or indirectly, in any manner whatever, by one or more non-resident persons; and

    • it uses all or substantially all of the corporation’s assets principally in an active business carried on primarily in Canada.

    Under the new rules the following investments in a private company are now “prohibited investments” for an RRSP:

    • a share or a debt of a corporation in which the annuitant and non-arm’s-length parties own, directly or indirectly, at least 10% of the issued shares of any class of the capital stock of the corporation or a related corporation;

    • a share or a debt of a corporation in which the annuitant does not deal at arm’s length;

    • an interest (or, for civil law, a right) in, or a right to acquire a share or a debt in a corporation described in paragraph (1) or (2); and

    • a share of a corporation that was a specified small business corporation at the time the acquisition by the RRSP no longer meets the definition of specified small business corporation.

    The new rules are much more restrictive with respect to investments in private company shares. To avoid private corporation shares from becoming a prohibited investment, the corporation must now meet the specified small business corporation requirements at all times, not only at the time of acquisition. The shares of a private corporation can become a prohibited investment if, for example, the corporation becomes controlled by non-residents or if all or substantially all of the fair market value of the assets of the corporation are no longer attributable to assets used principally in an active business carried on primarily in Canada. This could occur, for instance, if the corporation accumulates excess cash over time. The $25,000 exception has also been removed.

    If a prohibited investment is acquired or an existing investment becomes a prohibited investment, the RRSP annuitant is required to pay a 50% tax on the fair market value of the prohibited investment, and a 100% percent tax applies on any income and capital growth in respect of the prohibited investment. Proposed amendments released recently by the Department of Finance provide for grandfathering provisions that may alleviate some of the consequences of holding an investment that was not prohibited prior to March 23, 2011.

    As a result of these new rules, investments in an RRSP that were previously qualified investments may have become prohibited investments, which can give rise to a significant tax liability for the annuitant. In addition, an investment in private company shares by an RRSP which constituted a qualified investment at the time of acquisition of the shares can become a prohibited investment if the company is not able to meet the specified small business corporation requirements. These investments will thus have to be monitored at all times to ensure that the RRSP does not hold prohibited investments.