Principal Issues: Treatment of legal fees and recovered funds.
Position: Funds recovered in a legal action which relates to the investment owned by the RRSP should be deposited into the RRSP. No amount will be required to be included in the annuitant's income for the taxation year as a result of the monies derived from the settlement of the legal action provided that the amounts are paid directly or through a solicitor to the trustee of the RRSP. Any legal fees should be paid from the RRSP.
Reasons: The trust governed by RRSP is owner of the debt obligation secured by the mortgage.
XXXXXXXXXX 2009-034180 Andrea Boyle, CGA April 13, 2010
Dear XXXXXXXXXX :
Re: RRSP Investment - Tax Treatment of Mortgage Foreclosure
This is in reply to your letter of May 26, 2009 in which you asked whether legal fees can be paid by a trust governed by a Registered Retirement Savings Plan ("RRSP") and if funds recovered as a result of legal actions have to be deposited in the trust governed by an RRSP in the following situation.
A debt obligation that was secured by a mortgage was held as a qualified investment in a trust governed by an RRSP. Further to the mortgagor's default, legal fees were paid by the trust governed by the RRSP to foreclose the mortgage property. As a result of the foreclosure, some funds were recovered. Sometime later, it was learned that the shareholder of the debtor had committed fraud by forging documents related to the mortgage and the annuitant of the RRSP commenced legal action to recover funds. Consequently, other legal fees were incurred and additional funds were recovered including principal and interest.
The particular situation outlined in your letter appears to relate to a factual one, involving specific taxpayers. Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant tax services office. We are, however, prepared to offer the following general comments, which may be of assistance.
All statutory references in this letter are references to the provisions of the Income Tax Act, R.S.C. 1985 (5th supp.) c. 1, as amended ("Act").
A trust governed by an RRSP is a separate person from the annuitant of the RRSP. Therefore, in the situation you described, the trust governed by an RRSP would be the owner of the debt obligation secured by a mortgage. Consequently, where, upon the mortgagor's default, legal fees are incurred for a foreclosure of the mortgaged property, those legal fees would represent expenses relating to the trust governed by the RRSP since it relates to property of the trust. In fact, if these expenses were paid by the annuitant of the RRSP or the spouse of the annuitant, they would be treated as contributions to the RRSP under the definition of "premiums" in subsection 146(1). If the expenses were paid by someone other than the annuitant of the RRSP or the spouse of the annuitant, the payments would be considered gifts to the RRSP.
It is also our view that all the funds recovered from the foreclosure by a trust governed by an RRSP to satisfy the unpaid debt obligation of the trust should be deposited into the RRSP. Any amounts not deposited into the RRSP would be considered withdrawals from the RRSP and would be included in the income of the annuitant in the year of the withdrawal.
When an RRSP experiences an actionable loss on an investment, any damages are the property of the RRSP and should be paid to the RRSP. If the damages are paid to the annuitant, we are of the view that the annuitant receives a taxable benefit under subsection 146(8).
Therefore, the funds recovered in the second legal action which relates to the investment owned by the RRSP should be deposited into the RRSP. No amount will be required to be included in the annuitant's income for the taxation year as a result of the monies derived from the settlement of the legal action provided that the amounts are paid directly or through a solicitor to the trustee of the RRSP. The legal fees should be paid from the RRSP.
We trust that these comments will be of assistance.
Yours truly,
Louise J. Roy, CGA
Manager
for Acting Director
Ontario Corporate Tax Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch