Tax Factor 2012-03

June 13, 2012

The 2012-03 issue of the Tax Factor is available for download. In this issue we cover:

RDSPs — the basics and key changes you need to know about
Employee benefit change for group sickness or accident insurance plans
Mandatory electronic filing of tax returns starting in 2013
New Ontario tax rate for individuals earning over $500,000
New test for trust residency confirmed
Update on the refund hold policy for tax-exempt corporate entities

RDSPs — the basics and key changes you need to know about

In 2007, the government introduced the Registered Disability Saving Plan (RDSP), a vehicle designed to provide long-term financial security for individuals with disabilities. Since becoming available in 2008, RDSPs have become instrumental in protecting the financial security of those with severe disabilities and their families.

Given that the rules associated with RDSPs are somewhat complicated, we thought that as an individual with disabilities or as a parent or family member of someone with severe physical or mental challenges, you would benefit from a better understanding of how the RDSP rules work, including recently proposed changes.

What is an RDSP?

Generally speaking, an RDSP is a savings plan that allows a plan holder (and others authorized by the plan holder) to make contributions for the benefit of the plan beneficiary. Under the terms of the plan, contributions are made over a period of years and the plan issuer (often a financial institution) will manage the contributions, including government assistance, along with the income earned on the contributions. The issuer will also make payments from the plan to the beneficiary, within certain limits.

Who can be a plan holder?

The beneficiary of a plan who has reached the age of majority and can legally enter into contracts will generally be the plan holder. However, if the beneficiary is a minor, then the plan holder can be a legal parent of the beneficiary; an individual who is legally authorized to act for the beneficiary (i.e. a guardian); or a public department, agency, or institution that is legally authorized to act for the beneficiary. Note that the legal parent(s) can remain as plan holders, with the beneficiary added as a plan holder, once the beneficiary has reached the age of majority, but other plan holders must be removed.

In cases where the beneficiary has reached the age of majority but is not competent to enter into an arrangement, another person can be the plan holder if they are an individual who is legally authorized to act for the beneficiary such as a guardian, tutor, or curator of the beneficiary; or a public department, agency, or institution that is legally authorized to act for the beneficiary.

Note also that a legal parent who would not otherwise be able to open an RDSP for an adult beneficiary (in cases where the beneficiary is competent or if the beneficiary is not competent but the parent has no legal authorization over the beneficiary’s affairs) may do so if the parent is, at that time, the holder of a pre-existing RDSP for the beneficiary. This rule helps ensure that the parent can make a transfer to a new RDSP.

It is worth noting that although the plan holder does not have to be a resident of Canada, they must hold a valid Social Insurance Number or Business Number.

Who can benefit from an RDSP?

A plan holder can open an RDSP for a beneficiary who is eligible for the disability tax credit (DTC), is a resident in Canada, has a valid Social Insurance Number and is under age 60. (This age limit does not apply when a beneficiary’s RDSP is opened as a result of a transfer from the beneficiary’s former RDSP.) In order to apply for the DTC, a qualified practitioner must complete Form T2201, which is available on the Canada Revenue Agency’s (CRA’s) website. It essentially certifies that the individual has a severe and prolonged physical or mental impairment that limits the activities of daily living. The form must also be approved by the CRA. RDSPs can be set up at banks or financial institutions, which can usually provide the proper forms as well. Note that at any given time, a beneficiary can only have one RDSP.

What are the benefits of an RDSP?

An RDSP is a tax-deferred savings plan. Earnings on RDSP investments accumulate without tax. This is beneficial since savings compound more quickly if the investment return is not subject to tax. Generally, tax will not be payable until payments are made from the plan to the beneficiary.

As well, an RDSP allows you to take advantage of certain government programs. Specifically, the RDSP works in tandem with the Canada Disability Savings Grant (CDSG) and the Canada Disability Savings Bond (CDSB) programs under which the federal government provides grants/bonds to an RDSP based on certain limitations. Specifically, through the CDSG, the government matches contributions made to an RDSP by as much as 300% until the end of the year in which the beneficiary reaches age 49, depending on your family’s income and the amount that is contributed to the fund. The maximum grant amount that can be received is $3,500 per year to a lifetime maximum of $70,000. The CDSB provides even more financial help to people with disabilities from low-income families as qualified beneficiaries can receive a government bond in their RDSP of up to $1,000 per year until the end of the year in which the beneficiary reaches age 49, regardless of whether RDSP contributions are made, to a lifetime maximum of $20,000.

Are there any restrictions on the CDSG or CDSB?

You should be aware that any CDSGs or CDSBs paid into an RDSP are subject to a 10-year repayment rule, under which certain events will trigger a payback of funds to the government. This rule is in place to encourage you to keep savings, grants and bonds in the RDSP for at least 10 years in order to better accumulate savings. Under current rules, a required payback will occur when any amount is withdrawn from the RDSP, the RDSP is terminated or deregistered, or the RDSP beneficiary dies or ceases to be eligible for the DTC. With this rule, RDSP issuers must set aside an assistance holdback amount which is equal to the total CDSGs and CDSBs paid into the RDSP in the preceding 10 years less any CDSGs and CDSBs already repaid in respect of that 10-year period. The CRA keeps a running tally of contributions and payouts for the 10-year period, and, as a result, you can expect to repay any amounts for which the terms of eligibility are not satisfied. Note that there is an exception to the 10-year repayment rule for beneficiaries with shortened life expectancies; however, other plan rules will apply.

Are contributions to an RDSP deductible?

No, contributions to an RDSP are not tax deductible. You should note that you can make contributions until the end of the year in which the beneficiary is age 59 and only if the beneficiary is a resident of Canada. As well, there is a $200,000 lifetime limit on contributions for each beneficiary. Contributions that are withdrawn are not included in income for the beneficiary when they are paid out of an RDSP. However, the CDSG, the CDSB and investment income earned in the plan will be included in the beneficiary’s income for tax purposes when they are paid out of the RDSP.

Are there any conditions on payments made from an RDSP?

A plan holder and, if applicable, the beneficiary may request that either a Lifetime Disability Assistance Payment (LDAP) or a Disability Assistance Payment (DAP) be made from an RDSP, depending on the terms of the plan. As a bit of a background, an LDAP is a payment that is part of a series of periodic payments and is generally made on an annual recurring basis. A DAP is a singular payment that is often requested on an ad hoc basis by the plan holder. Both types of payments are subject to a number of limitations. For instance, an LDAP or DAP cannot be made if, after the payment, there would not be enough property in the plan to cover the assistance holdback amount. As well, once an LDAP is requested, payments must continue until the plan ends or the beneficiary dies. The restrictions governing payments made from an RDSP are quite complex so talk to your BDO advisor if you have any questions or require more information.

What is new for RDSPs?

Based on the response to a review of RDSPs that was launched in the fall of 2011, the federal government proposed several key changes to RDSPs in the 2012 budget that are aimed at improving how RDSPs work. Here is a summary of the items that have been proposed that may be of interest to you and/or your loved ones.
  • A temporary measure has been proposed to allow certain family members to become the plan holder of an RDSP for adults who are unable to enter into a contract. Specifically, a beneficiary’s spouse, common-law partner or parent will be able to become the plan holder and open an RDSP on behalf of an adult who might not be able to open a plan due to concerns about their ability to enter into a contract. This change is to be effective from the date of Royal Assent of the enacting legislation and will be in place until the end of 2016. This timing will provide the provinces and territories sufficient time to develop complimentary legislation. 
  • A proportional repayment rule has been proposed to replace the 10-year repayment rule noted above, where a withdrawal is made from an RDSP. (The 10-year repayment rule will remain for all other events such as RDSP termination or deregistration or where the beneficiary dies or ceases to be eligible for the DTC.) The proportional repayment rule will require that, for each $1 withdrawn from the RDSP, $3 of any CDSGs or CDSBs paid into the plan in the 10-year period preceding the withdrawal be repaid, up to a maximum of the assistance holdback amount. Repayments will be attributed to CDSGs and CDSBs that make up the assistance holdback amount in the order in which they were paid into the RDSP, starting with the oldest amounts. This measure is set to apply to withdrawals made from an RDSP after 2013.
  • New rules have been proposed to provide more flexibility to make withdrawals from certain RDSPs by increasing the annual maximum withdrawal limit that applies to these RDSPs. As well, the proposals will ensure that RDSP assets are used to support a beneficiary during their lifetime by requiring a minimum amount to be withdrawn from all RDSPs beginning the year a beneficiary turns age 60 (this rule currently applies only to certain RDSPs). The maximum and minimum withdrawal measures are set to apply after 2013.
  • New rules have also been proposed to allow a tax-free transfer of investment income earned in a Registered Education Savings Plan (RESP) to an RDSP if both plans have a common beneficiary. In order to qualify for the rollover, the beneficiary must meet the existing age and residency requirements with respect to RDSP contributions.
In addition, one of the following conditions must be met: 
  • The beneficiary has a severe and prolonged mental impairment that can reasonably be expected to prevent the beneficiary from pursuing a post-secondary education;
  • The RESP has existed for at least 10 years and the beneficiary is at least 21 years of age and is not pursuing a post-secondary education; or
  • The RESP has existed for at least 35 years.
 Note that amounts rolled over from an RESP will reduce RDSP contribution room and the RESP will need to be terminated. This proposed change is subject to several other specific rules and limitations, and will apply to rollovers made after 2013. Talk to your BDO advisor to determine whether it makes sense to use this rollover. 
  • New rules have been proposed to extend the period for which an RDSP remains open when a beneficiary becomes ineligible for the DTC. These rules will allow an RDSP plan holder to make an election in prescribed form and submit it to the RDSP issuer along with written certification from a medical doctor that the beneficiary will be eligible for the DTC again in the foreseeable future. The RDSP issuer will then be required to notify Human Resources and Skills Development Canada that the election has been made. The election must be made on or before December 31 of the year following the first full calendar year that the beneficiary is ineligible for the DTC. In cases where an election is made, certain conditions will apply. This measure applies to elections made after 2013.

An RDSP that would have to be terminated under the current rules before 2014 because the beneficiary has become ineligible for the DTC, but has not yet been terminated, will not be required to be terminated until the end of 2014. Plan holders of these RDSPs may use this measure if they obtain the required medical certification and make an election on or before December 31, 2014.

Additional changes were also proposed that essentially reduce the administrative burden of RDSP issuers. For more information on these changes, please consult with your BDO advisor.

There is no doubt that RDSPs provide much needed financial support and assistance to individuals facing challenges and their families that support them. Because the rules governing RDSPs and the related government programs are quite complicated, contact your BDO advisor to help determine if you or your loved one is eligible for the benefits associated with RDSPs.

Employee benefit change for group sickness or accident insurance plans

Employee remuneration usually includes benefits and there is a very wide range of benefits that may be provided – from meals and parking to health and dental benefits, to name only a few. With such a variety of employment benefits, the taxation of those benefits can vary. In most cases, employment benefits are deductible to the employer and taxable to the employee; however, our tax rules do provide a few exceptions. For example, where the relevant conditions are met, benefits derived from employer contributions to a private health services plan are generally not taxable to the employee while the contributions are deductible by the employer. The 2012 federal budget proposed a change to the taxation of certain employment benefits related to a group sickness or accident insurance plan. This type of plan or contract of insurance provides sickness or accident insurance benefits to employees and can include wage-loss replacement benefits. Certain critical illness insurance plans may also be considered group sickness or accident insurance plans.

Under the pre-budget tax rules, employer-paid premiums to a group sickness or accident insurance plan were not taxable. Benefits paid to employees under these plans would be taxable if they were payable to the taxpayer on a periodic basis in respect of the loss of all or any part of the taxpayer’s income from an office or employment. Generally speaking, a basic critical illness insurance policy provides for the payment of a lump-sum amount in the event that the insured individual is diagnosed with a critical illness. If the policy was considered a group sickness or accident insurance plan, then generally speaking the employer-paid contributions were deductible while the lump-sum benefit received by an employee would not be taxable.

The proposal in this year’s federal budget that impacts group sickness or accident insurance plans will therefore affect certain critical illness insurance policies. As announced in the budget, effective for payments made for coverage after 2012, the amount of an employer’s contributions to a group sickness or accident insurance plan will be included in the employee’s income in the year in which the contributions are made. Note that contributions related to coverage after 2012, which are made after March 28, 2012 and before 2013, will be included in 2013 income. This change will not apply to contributions that are in respect of wage-loss replacement benefits that are received on a periodic basis. As mentioned, benefits received from these plans are already taxable and included in the employee’s income when received.

With this change, employees may now have a taxable employment benefit from critical illness insurance plans that are considered group sickness or accident insurance plans. Specifically, employer contributions to these plans will be included in an employee’s income as noted above.

As always, it’s important for owner-managers to consider the taxability of benefits from the perspective of whether the benefits are received due to their status as a shareholder rather than as an employee. Whether benefits are received by virtue of employment or shareholdings is a question of fact. If a shareholder-employee receives a benefit because they are a shareholder, the benefit will be taxable as a shareholder benefit and the corporate employer will not be allowed a deduction in respect of the benefit despite specific rules that may apply for employee benefits. The test is fairly straight forward – would you have received the benefit in question had you not been a significant shareholder (or a relative)? In assessing this test, the Canada Revenue Agency will compare you to other employees in your company and employees in similar positions in other companies who are not shareholders. 

If you have any questions about the budget change or employment benefits in general, please contact your BDO advisor.

Mandatory electronic filing of tax returns starting in 2013

While a majority of income tax returns are already electronically transmitted to the Canada Revenue Agency (CRA), the federal government is taking steps to increase the rate of such electronic transmissions. The CRA authorizes third party service providers to send individual and corporate tax returns to them over the internet using a service referred to as EFILE. While there are some situations where returns cannot be transmitted using EFILE, according to the CRA, for individual tax returns – about 95% of all Canadians are eligible to do so.

The CRA has been looking for ways to increase the rate of electronic transmission of returns which will help the CRA cut costs. A few years ago, the government introduced mandatory EFILE rules for corporate tax returns where certain criteria are met. Most recently, the federal government introduced Bill C-38 to implement certain provisions of the budget tabled on March 29 and one of the measures contained in the document is the requirement for tax preparers to file income tax returns electronically beginning in 2013 (for 2012 and subsequent year tax returns). The rules won’t apply to those returns that are specifically excluded from EFILE. This change was a surprise since it was not mentioned in the budget.

Tax preparers will include all persons or partnerships who, in the year, accept consideration to prepare more than 10 returns of income of corporations or more than 10 returns of income of individuals (other than trusts). Tax preparers do not include employees who prepare returns in the course of their employment. If tax preparers do not comply, they will be subject to penalties starting on January 1, 2013. The penalty is set at $25 for each failure to file an individual return in electronic format and $100 for each failure to file a corporate return in electronic format. 

If you have any questions or concerns about this upcoming change, contact your BDO advisor.

New Ontario tax rate for individuals earning over $500,000

After the 2012 budget was tabled, the minority Liberal government was faced with demands made by the NDP government in order to pass the first budget vote. One of the NDP demands was for the government to raise taxes for individuals with taxable income over $500,000.

As a result, subject to approval by the Ontario Legislature, the government stated that “the top statutory Ontario income tax rate on incomes over $500,000 would increase by two percentage points — from 11.16% to 13.16%.” The government has indicated that this additional tax rate will be eliminated once the budget is balanced, which is currently forecast for 2017-18. This change will not impact a significant number of taxpayers. The government announcement suggests it will apply to approximately 23,000 taxpayers.

As this change will be effective July 1, 2012, the new rate will apply for withholding purposes after June 30, 2012 in full (i.e. 13.16%) and the top Ontario tax rate for 2012 before existing surtaxes will actually be 12.16%. In 2013, the top tax rate would increase to 13.16%.

Despite references to the new rate being a surtax when the change was first announced, this is a fourth tax bracket, and therefore, the 20% and 36% surtaxes will apply on top of the 12.16% and 13.16% rates. This means that the top combined federal and provincial tax rate in Ontario on regular income will be 47.97% for 2012 and 49.53% for 2013. Note that this change will apply to all income in 2012, including dividends received or capital gains realized prior to the announcement of the change.

If your taxable income will exceed this new threshold and you have questions, contact your BDO advisor.

New test for trust residency confirmed

In 2009, the Tax Court of Canada (TCC) ruled on a case that resulted in a change to how the residency of a trust is determined. Prior to the TCC’s decision, a trust’s residence was generally determined based on where the trustee(s) of the trust were resident. However, a trust is an arrangement between three parties — the settlor (who sets up the trust), the trustee(s) and the beneficiary(s). A trust is not a separate legal person or entity like an individual or a corporation, so there has always been some uncertainty with respect to determining the residence of a trust for tax purposes. The 2009 court case considered the residence of a trust in a situation where the trustee was acting more as a custodian, with a limited administrative role, rather than fulfilling a “true” trustee role of controlling and managing the trust assets. Based on the case facts, it was the main trust beneficiary who was making the management and control decisions impacting the trust.

As discussed in our article titled “Tax Court Sets New Residency Rules for Trusts” (in the 2010-01 edition of the Tax Factor), the TCC decided that the common-law test that applies for determining the residence of a corporation should also apply to trusts. This means that it’s necessary to determine where the central management and control of the trust lies when concluding on the trust’s residence, as is the case when determining the residence of a corporation.

The decision in the TCC case was appealed to the Federal Court of Appeal (FCA), and the FCA agreed with the TCC decision with respect to the central management and control residency test for trusts. The taxpayers then appealed to the Supreme Court of Canada (SCC). The decision of the SCC was released earlier this year and it confirms the residency test for trusts that was set out by the TCC judge.

As a result of the decision, where the trustees of a trust and the settlor and/or the beneficiaries reside in different jurisdictions, whether it be different provinces or different countries, it will be important to determine who is managing and controlling the trust when deciding the residence of the trust for tax purposes. It will be critical to assess the activities of the trustees and their involvement with the trust. One cannot simply rely on the residence of the trustee(s) to determine the residence of the trust.

When looking at trust arrangements, if the trustees are fulfilling their usual role of managing and controlling the trust, then residency can likely be determined based on the trustees. However, if the trustees appear to be acting more as a custodian, then it will be necessary to look beyond the trustees and consider the roles of others involved in the activities of the trust to determine where mind and management is situated. If others are in fact controlling the trust, then based on the new test, residency will be based on the residence of these other persons.

When a trust arrangement involves more than one jurisdiction, the new residency test must be considered for both current trust arrangements, as well as for new trusts being set up. Taxpayers who have set up trusts in favourable tax jurisdictions abroad and in other provinces such as Alberta will need to carefully consider the new test. Of course the new test does not provide complete certainty for establishing the residence of a trust, as arrangements are unique to those involved. Your BDO advisor can help when it comes to properly establishing the residence of a trust based on the new central management and control test.

Update on the refund hold policy for tax-exempt corporate entities

As highlighted in Tax Factor 2011-02, compliance refund hold legislation requires the Canada Revenue Agency (CRA) to withhold the payment of rebates and refunds until all required returns under the Income Tax Act, the Excise Tax Act, the Excise Act, 2001, and the Air Travellers Security Charge Act have been filed. As a result, all corporations are required to file their T2 corporate income tax returns to ensure they receive payments of refunds and rebates, including corporate entities that are exempt from paying federal income tax. However, in 2008 the CRA put in place an administrative position to ease this requirement for tax-exempt incorporated municipalities, universities, schools, hospitals, non-profit organizations, federal crown corporations and Indian band councils. Under their position, the CRA will not withhold refunds or rebates because of outstanding T2 corporate income tax returns for these entities.

Beginning in 2009, an internal review of the effect of the compliance refund hold legislation on tax-exempt corporations was undertaken by the CRA. In discussions with the CRA, they confirmed that the administrative position would remain in effect until the review was completed. In April 2012, the CRA announced that its review was complete and that it has adopted its administrative position indefinitely. Therefore, refunds and rebates will not be withheld from the tax-exempt corporations noted above that have outstanding T2 corporate income tax returns. However, the CRA did highlight the fact that their administrative position does not remove the legislative responsibility of a tax exempt corporation to file an annual T2 corporate income tax return.

If you have questions concerning the CRA’s policy, contact your BDO advisor.

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The information in this publication is current as of June 1, 2012.

This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.

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