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Did a few bad apples spoil RRSP swaps for everyone?

It would seem that a few investors looking to abuse a tax loophole may have created some significant collateral damage for the rest of us: Swap transactions involving RRSP and RRIF accounts could either be eliminated or restricted going forward.

A swap transaction involves trading securities or cash between two accounts to avoid commissions. For example, suppose you had $5,000 of Government of Canada bonds sitting in your non-registered account and $5,000 worth of stock in company ABC in your RRSP account. It would be much more tax efficient to hold the interest bearing security in your tax-sheltered RRSP account and the equity investment in your non-registered account. Instead of selling each security once and then buying each security again to effect the switch, which would involve four commissionable transactions, you could simply swap the two investments and pay a much smaller swap fee.

A problem that has arisen is that some investors have been taking advantage of swapping illiquid securities to and from their RRSP accounts in an ongoing manner. In one example, since an illiquid security has a big gap between the bid and ask prices, they may choose the bid price for the swap on the way in (buying it low) and then immediately swap it back out at the ask price (selling it high). And because a swap requires no RRSP contribution to be claimed or RRSP de-registration to be incurred, you can effectively create a larger and larger tax shelter without having actually generated the contribution room. Conversely, one could also take money out on a tax-free basis.

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The government is putting a stop to this by placing a 100 per cent penalty on this "prohibited advantage."

Professor Benjamin Alarie, Associate Dean of the Faculty of Law at the University of Toronto and founder of, says that "swap transactions are absolutely open to abuse and it's clear that the new prohibited advantage rules are a rational response by the government to combat this potential abuse. What isn't so clear is whether the financial institutions are going to implement the rules in a parsimonious way."

What Professor Alarie means is that there are rumblings on the street that in order to avoid unknowingly triggering the prohibited advantage rules, many financial institutions will simply stop accepting swap transaction requests The new rules became effective July 1st but any measures taken by brokerages are at their own discretion. If you were planning on initiating a swap transaction, you may want to contact your plan administrator and see if you still have the opportunity to make a clean swap.

Here is what Ram Balakrishnan, author of the personal finance blog, has to say on this subject: "I do hope brokerages don't end up banning swaps in RRSPs altogether as they did with TFSAs. At least with TFSAs, one can work around by withdrawing funds from the account and contributing another asset in-kind during the next financial year. How is one supposed to swap an illiquid asset (such as GIC) into a RRSP, which is the ideal place to hold it? Yes, the Government has a legitimate concern that swap rules are being exploited but brokerages will be throwing out the baby with the bathwater if they impose a blanket ban on RRSP swaps."

In an ideal situation, an elegant solution would be found that doesn't unfairly penalize investors. One suggestion is limiting RRSP swaps to securities that meet a certain liquidity threshold, or are listed on certain exchanges. Both scenarios seem like plausible loopholes the brokerages could build in that would preserve the role of swaps for the majority of investors while still stamping out those looking to game the system.

Preet Banerjee, B.Sc, FMA, DMS, FCSI is a W Network Money Expert. You can follow him on twitter at @PreetBanerjee

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