The inscrutable Income Tax Act

Zoomer | November 22nd, 2009

In a recent edition of The Globe and Mail, columnist Neil Reynolds wrote about the heavy burden imposed on Canadian corporations and individuals by our byzantine and at times inscrutable Income Tax Act. In his article, he bemoaned the complexities and ambiguities in the Act and the lengthy delays in making badly needed technical changes and obtaining rulings.

The column was right on the mark. In fact, it could have been written 40 years ago and, except for changing a few names and dates, it would have been on target then too. I worked as a correspondent in the Parliamentary Press Gallery from 1966 to 1970 and the same complaints were being voiced way back then.

In fact, the Liberal government of the day even went so far as to set up a Royal Commission on Taxation under Kenneth Carter. He recommended a complete overhaul of the Canadian tax system in his 1967 report, based on the principle that, for tax purposes, “a buck is a buck is a buck”. Despite negative public reaction, Pierre Trudeau’s Finance Minister, Edgar Benson, attempted to implement some of the Carter Commission’s recommendations in a 1969 White Paper. Most of his proposals were eventually discarded.

Another Liberal Finance Minister, Allan MacEachen, made a stab at comprehensive tax reform in his 1981 budget. It was an unmitigated disaster and the government was eventually forced to scrap most of it. Since then, all major changes to the tax system have been introduced on a piecemeal basis. No wonder the Act is so cumbersome.

The problem is not only what is in the Act. It’s also in the interpretation and I know from experience that different departments can and do offer contradictory opinions on the meaning of a specific aspect of tax law. For example, when I was writing my first book on Tax-Free Savings Accounts in the autumn of 2008, I was told in no uncertain terms by the Department of Finance that swaps would not be allowed in TFSAs. However, the Canada Revenue Agency interpreted the legislation otherwise and said TFSA swaps would be treated the same way as RRSP swaps. When I went back to Finance for clarification, all I received was a group shrug and a comment that once tax legislation takes effect it is the prerogative of the CRA to interpret it.

(Incidentally, Finance eventually got its way on this one. In late October, Finance Minister Jim Flaherty announced changes to the rules governing TFSAs that included disallowing swaps.)

Another practical example of inconsistencies in the Tax Act and the myriad of regulations surrounding it came to my attention a few weeks ago. A reader of my Internet Wealth Builder newsletter wrote to ask about Lynas Corp., an Australian company that had been mentioned in one of the articles.

“I have been following this stock and purchased it in my investment account as I believed that as an OTC (over-the-counter) stock it could not be RRSP eligible. I was later told by my financial advisor that if you call CRA they will identify certain OTC stocks that are permissible in an RRSP. Since Lynas trades on the ASX (Australian Securities Exchange), which is a designated exchange, I thought perhaps this is a possibility so I made the call to CRA. The individual I spoke to stated that no OTC stocks are eligible due to the designated exchange requirement, which seems realistic. However, have you ever heard that CRA does indeed identify certain OTC stocks as eligible in a registered plan?”

This question raises an important point of tax interpretation. The Australian Securities Exchange is indeed approved by the Canada Revenue Agency as a designated exchange. On that basis, the shares of Lynas appear to be eligible for RRSPs and other registered plans. But stocks that trade over-the-counter are specifically stated to be ineligible for RRSPs, etc. So what is the situation with a stock that is listed on a designated exchange but purchased over-the-counter elsewhere, such as through the Pink Sheets in the U.S.?

I didn’t know so I asked the Canada Revenue Agency, through their media office, for clarification on this point. It took a couple of weeks, but not the months or even years that Neil Reynolds complained about. On November 12, I finally received this reply, prepared by an expert deep within the bowels of the CRA and forwarded to me by a communications officer who stayed on top of the file until she got an answer:

“A security that is listed on a designated stock exchange is generally a qualified investment. There is no income tax requirement that the security actually be acquired through a trade on the stock exchange on which the security is listed in order for the security to be a qualified investment.”

This is highly significant. Many securities that are listed on foreign exchanges can be purchased through the Pink Sheets, which are more easily accessible to Canadians then trying to trade directly in Australia, South Korea, Brazil, or wherever.

Of course, CRA interpretations are not legally binding, as they’ll be the first to tell you. But this one makes such good sense that I suggest investors can act on it with confidence.

This article originally appeared in the Internet Wealth Builder, a weekly e-mail newsletter that provides timely financial advice from some of Canada’s top money experts. For more information about becoming an Internet Wealth Builder member, click here.