CRA Challenging Individual Pension Plans (IPPs)
The Canada Revenue Agency (“CRA”) has recently mailed detailed audit request letters to members of certain individual pension plans (“IPPs”). The letters appear to be connected to an ongoing audit program targeting IPPs.
As background, an IPP is a defined benefit pension plan, typically established for one person. In order to achieve certain desired tax results, IPPs typically seek to be characterized as “registered pension plans” for the purposes of the Income Tax Act (“Tax Act”). In order to obtain this registration, an IPP must meet the “primary purpose” condition set out in paragraph 8502(a) of the Regulations to the Tax Act which requires that the plan’s primary purpose be “to provide periodic payments to individuals after retirement and until death in respect of their service as employees”.
The CRA’s view is that the “primary purpose” condition requires there to be a legitimate employer/employee relationship between the individual plan member and the corporate sponsor of the IPP. Further, even where a legitimate employer/employee relationship exists, the CRA will often take the position that the “primary purpose” condition is not met on the basis that the IPP was established primarily to hold funds transferred from the individual’s previous pension plan.
Specific types of IPPs are being targeting by the CRA. The typical scenario involves an individual near normal retirement age who leaves his/her public sector employer and establishes his/her own corporation. The individual is then hired by the corporation, which establishes an IPP for the individual’s benefit. After the IPP is established, an application is made to the CRA in order to have the plan classified as a registered pension plan. Once registration is approved, the individual transfers the commuted value of his/her prior pension plan to the IPP which can be done on a tax-free basis, assuming that both the previous pension plan and the IPP are registered plans.
The CRA’s method of challenging these structures has been to revoke the IPP’s status as a registered pension plan retroactively to the date that it was established. The consequences of this move can be financially devastating. In particular, depending on the specific circumstances, a revocation will typically result in the individual being reassessed as follows:
- All of the pension benefits previously transferred to the revoked IPP will be included in the individual’s income in the year of the original transfer. In many cases, the resulting tax liability (together with interest and penalties) will exceed the amount remaining in the individual’s pension, effectively wiping-out the individual’s retirement savings.
- If the individual transferred pension benefits from the revoked IPP to his/her RRSP, then the CRA will take the position that the transfer was ineligible, resulting in the individual exceeding his/her RRSP contribution limit. As a result, the CRA will impose a monthly tax of 1% on the excess contributions, plus interest and penalties.
We understand that many IPPs (which have not yet been challenged) are beginning to receive audit letters from the CRA asking detailed questions regarding: (i) the individual’s role in the establishment and administration of the IPP; (ii) whether there is a legitimate employer/employee relationship between the individual and the corporate sponsor of the IPP; and (iii) whether the individual has received any surplus payments out of the IPP.
We believe that, in many cases, the CRA’s position is unsustainable. Accordingly, if you have received an audit letter, or a notice of intent to revoke the registration of your IPP, we may be able to help.