Miklos is a friend of mine who came to Canada from Hungary five years ago with his wife, Anna. The couple are in their sixties.
Miklos has had some bad luck recently. Two weeks ago he was in a car accident.
Last week, Miklos ran into more bad luck. He mentioned to me that Anna was entitled to contribute $10,000 to her registered retirement savings plan for 2007. He then told me that Anna didn't have the money, so he gave her the $10,000, and she made the contribution. Then Miklos asked me if that was the right thing to do.
Arguably, giving cash to Anna to make an RRSP contribution was the wrong thing to do. You see, the Canada Revenue Agency has a surprising opinion about the gifting of cash to your spouse to make contributions. Let me explain.
the interpretation
Picture this. Your spouse is short on cash to make his or her RRSP contribution. So, you give your spouse the cash, your spouse makes that contribution, and claims a deduction on his or her tax return for it. Two technical interpretations (941179 and 9431235, which a tax pro can access for you - the CRA won't be of help here) written by the CRA confirm that, in this situation, withdrawals from the RRSP to which your spouse contributed will be taxed in your hands.
This is bad news for Miklos and Anna. Miklos could face tax on all the withdrawals Anna makes from her own RRSP. By the way, the CRA has said that where Anna's RRSP includes contributions made partly with her own money, and partly with Miklos', the department will accept "all reasonable allocating methods" to determine just how much of Anna's RRSP withdrawals should be taxed in Miklos' hands.
What's the rationale for this tax treatment? The CRA says an RRSP is considered to be "property" under subsection 248(1) of Canadian tax law. Therefore, any withdrawals from an RRSP are considered to be "income from property." The attribution rules in our tax law, found in subsection 74.1(1), apply to "income from property" so that the income will be attributed back to the spouse who gave the cash to acquire the property.
the nonsense
This particular interpretation of Canadian tax law by the CRA makes no sense, for three reasons.
First, Miklos could face tax on every cent withdrawn by Anna from her RRSP, and not solely on the growth over and above what he gave her. Normally, the attribution rules apply to tax only the income earned on property transferred to a spouse.
Second, Canadian tax law condones one spouse helping the other to build RRSP assets. The spousal RRSP rules provide for this. So it doesn't follow that Miklos should be penalized for helping Anna.
Finally, Miklos is going to face double tax, since he has already paid tax on the funds he gave to Anna (he gave her after-tax dollars), and he's going to pay tax on those dollars again when they are withdrawn from her RRSP. Our tax law usually tries to avoid double taxation.
the solution
There may be some consolation here. According to CRA officials in Ottawa, they generally have not been enforcing this ugly interpretation. So, do I tell Miklos and Anna that they have nothing to worry about? No, it's not entirely true. CRA officials themselves refuse to say that couples like Miklos and Anna are out of the woods.
Hey, if the CRA is apologetic about its own debatable interpretation, then it should be changed. Better yet, the Department of Finance could solve the whole problem by excluding RRSPs from the attribution rules altogether.
In the meantime, consider the following ideas if your spouse is short on cash for RRSP contributions this year.
Your spouse should consider contributing assets other than cash (a contribution in-kind) if he or she has any, provided they are qualified investments for an RRSP.
Your spouse could borrow to contribute to his or her RRSP.
You could lend money to your spouse at the prescribed interest rate to avoid attribution (but you'd face tax on the interest paid to you, and your spouse would be unable to deduct that interest, which limits the usefulness of this idea).
You could make contributions to a spousal RRSP instead of giving cash to your spouse for contributions to his or her own plan.
