Principal Issues: (1) Does the existing CRA position regarding settlement payments made to RRSPs and RRIFs also apply to payments made to TFSAs, RESPs and RDSPs? (2) Whether a settlement payment gives rise to an advantage?
Position: (1) Yes (2) Generally no
Reasons: (1) Surrogatum principle. (2) See below.
February 25, 2021
Assessment, Benefit, and Service Branch HEADQUARTERS
Individual Returns Directorate Income Tax Rulings Directorate
Investment Plans Section
Ottawa ON Darren Odubella
(343) 571-3364
Attention: Richard Ho
2020-086564RE: Settlement Payments to Registered Plans
We are writing in reply to your email of October 5, 2020, in which you asked us whether the CRA’s position regarding the income tax treatment of settlement payments made to RRSPs and RRIFs also applies to payments made to TFSAs, RESPs and RDSPs. You also asked that we consider the potential application of the advantage tax rules.
Our comments
A. Existing position for RRSPs and RRIFs
The CRA’s long-standing position regarding the tax consequences of a settlement payment made to an RRSP or RRIF in respect of an actionable loss suffered on a plan investment is that the payment will not constitute a contribution or gift to the plan and will not result in an income inclusion to the annuitant. The same applies if the payment is made to the annuitant but returned to the plan within a reasonable time. Generally, we consider a reasonable time to be the later of six months from the time the payment is received and the end of the tax year in which it was received. If the plan no longer exists or has matured, the payments may be made into another RRSP or RRIF of the annuitant. However, if the settlement payment is retained by the annuitant, we consider the annuitant to have received the payment as a benefit under the plan. The payment is included in the annuitant’s income under subsection 146(8) (footnote 1) (RRSPs) or subsection 146.3(5) (RRIFs).
The position is based on the surrogatum principle, which generally provides that the tax consequences of a settlement are based on the nature and purpose of the settlement and the amount it is intended to replace.
B. Application of position to TFSAs, RESPs and RDSPs
Consistent with this position, there will be no adverse tax consequences where a settlement payment is made to a TFSA, RESP or RDSP either directly or indirectly by the holder, subscriber or beneficiary returning the payment to the plan within the timeframe discussed above. The payment will not be treated as a contribution to the plan and will not be income to the holder, subscriber or beneficiary. However, if the settlement payment is retained by the holder, subscriber or beneficiary, we would consider the recipient to have received the amount as a payment under the plan. The income tax treatment depends on the type of plan.
In the case of a TFSA, the settlement payment would not be taxable as TFSA distributions are not taxable.
In the case of a RDSP, the income tax treatment depends on who receives it. If the payment is received by a holder of the plan who is not the beneficiary, the payment would not by definition be a disability assistance payment (DAP) and therefore would not be included in income under subsection 146.4(6). However, it would give rise to an advantage (as discussed below). If the payment is received by the beneficiary of the plan, regardless of whether they are also a holder, the payment would be a DAP and would be included in the beneficiary’s income under subsection 146.4(6).
In the case of an RESP, assuming that the settlement payment was made to the subscriber of the plan, the payment would be an accumulated income payment (AIP) and would be included in the subscriber’s income under subsection 146.1(7.1). As an AIP, it might also be subject to additional tax under Part X.5.
In none of the cases would the retention of the settlement payment jeopardize the plan’s registration.
C. Advantage tax rules
The CRA’s general views on the advantage tax rules are set out in Income Tax Folio S3-F10-C3, Advantages – RRSPs, RESPs, RRIFs, RDSPs and TFSAs, which is available on the canada.ca website.
Generally, section 207.05 imposes a special tax if certain supplementary advantages are provided in relation to a RRSP, RESP, RRIF, RDSP or TFSA (“registered plan”). The tax is equal to the amount of the advantage and is usually payable by the annuitant, holder or subscriber of the plan (“controlling individual”). These rules mainly target abusive tax planning arrangements that seek to artificially shift value into or out of a registered plan while avoiding the statutory limit for contributions or the income inclusion for withdrawals (as applicable). They also apply to benefits and loans that are conditional on the plan, with exceptions for normal investment activities and conventional incentive programs.
Settlement payment made directly or indirectly to registered plan
Provided that the settlement payment is made on arm’s length terms to compensate for the actual damages suffered by the registered plan, the payment would not give rise to an advantage (as defined in subsection 207.01(1)). The payment simply restores the plan to the financial position it would have been in had it not incurred the loss.
Settlement payment not returned to registered plan
With one exception, none of the provisions in the advantage definition would apply where a settlement payment is made to the controlling individual of a registered plan and not returned to the plan. In the situation where the settlement payment is made to an RDSP holder who is not the beneficiary of the plan, the payment would be a registered plan strip (as defined in subsection 207.01(1)) and therefore an advantage under paragraph (d) of the advantage definition. The registered plan strip definition would not apply in any of the other situations because of the exceptions in the definition for TFSAs and for amounts included in income.
We trust our comments will be of assistance.
Yours truly,
Dave Wurtele
Section Manager
for Division Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
FOOTNOTES
Note to reader: Because of our system requirements, the footnotes contained
in the original document are shown below instead:
1 Unless otherwise stated, statutory references in this document are to the Income Tax Act (the “Act”).