Do you make contributions to your Registered Retirement Savings Plan (RRSP)? Did you know that without careful consideration as to where the funds used to make contributions originated, unintended future tax results may be encountered?
In order to understand the issue and potential consequences, let's examine the situation of Mr. and Mrs. Jones. Both individuals are employed and have available RRSP contribution room. Mr. Jones does not have cash available in his personal account to make a contribution to his RRSP account. Mrs. Jones, on the other hand, has sufficient cash on hand in her personal account to cover both her and her husband's contribution room. Accordingly, she gifts the necessary funds to Mr. Jones so that he can make his RRSP contribution.
While you may see this as act as a loving gesture between spouses, the Canada Revenue Agency (CRA) does not share the same warm feelings in this situation. Although there have been questions about enforceability, readers should note that the CRA has adopted a reasonably rigid attitude towards the subject, which may be surprising. The CRA has published various technical interpretations stating that attribution rules would apply in this situation because the CRA considers an RRSP to be property under Canadian tax law. Attribution rules under Canadian tax law apply to income from property, attributed back to the spouse providing the cash for acquiring the property.
As a result, when Mr. Jones makes a withdrawal from his RRSP to which Mrs. Jones provided the contribution funds, the amount withdrawn should be attributed back to Mrs. Jones and included in her taxable income. This also results in double tax, since the original funds Mrs. Jones provided would have been after-tax dollars. In the situation where Mr. Jones' RRSP comprises contributions from his own funds as well as Mrs. Jones' funds, a reasonable allocation of the income between spouses is technically required to be made.
In order to avoid the potential application of attribution rules, there may be a variety of solutions. Mr. Jones could borrow money from his bank to make his RRSP contribution, although his interest expense would not be deductible for tax purposes. He could also borrow the money from Mrs. Jones at the prescribed interest rate set by the CRA; however, the interest received by Mrs. Jones would be taxable to her and Mr. Jones would not be entitled to a tax deduction for his interest expense. Another option may be for Mr. Jones to transfer assets currently held in his personal portfolio to his RRSP, recognizing that this may trigger capital gains tax on any appreciated assets, while any capital losses would be denied for tax purposes.
Alternatively, the following strategy may be used to achieve a favourable result. Mrs. Jones could give Mr. Jones cash in an amount equal to his contribution limit. Mr. Jones would then use those funds to contribute to a spousal RRSP for the benefit of Mrs. Jones. Since RRSP withdrawals would be made by Mrs. Jones and included in her income, the attribution rules are not a factor in this situation. Next, Mrs. Jones would make contributions up to her deduction limit to a spousal RRSP for the benefit of Mr. Jones. Provided that Mr. Jones waits three years following the last spousal contribution, the withdrawals will be taxable income to him. Thus, this strategy allows both Mr. and Mrs. Jones to make RRSP contributions up to their deduction limits without attribution rules applying.
As the Jones' situation has demonstrated, it is necessary to think about the source of funds used to make RRSP contributions in order to avoid a potentially undesirable tax result.