by June Yee | 29 Mar 06 |

Qualifying criteria, currency restrictions remain unchanged.

Despite the elimination of the foreign content limit in RRSPs, RRIFs and other registered retirement plans, Canadians still face some roadblocks in their quest for greater foreign exposure in their registered plans.

To be clear, the end of the 30% restriction does not mean that any foreign property is now okay in an RRSP. In fact, the rules governing qualified investments remain intact, and investors who go offside with their foreign holdings risk significant tax penalties.

The monthly penalty for unqualified property -- foreign or domestic -- in an RRSP is 1% of the value of the investment for as long as it's held. As well, the fair market value of the offending investment at the time it's acquired will be added to the plan holder's income for that year.

Although these are "nasty consequences," says Heather Clarke, director of tax and estate planning for Investors Group in Winnipeg, such mistakes can be easily rectified. "If you fix it in the same year by getting rid of the unqualified investment and acquiring a qualified one, you get a deduction that will offset the income-inclusion penalty," says Clarke.

In general, foreign stocks and bonds must meet the same qualifying criteria for RRSPs as their domestic counterparts, says Gena Katz, a senior principal with Ernst & Young's national tax practice in Toronto. The main condition is a listing on a prescribed exchange.

For foreign stocks, most major exchanges in the U.S. -- from the New York Stock Exchange to more obscure markets such as the Intermountain Stock Exchange and the Midwest Stock Exchange -- are acceptable. Investors may also hold listed stocks from various overseas markets, including recognizable exchanges like the UK's London Stock Exchange, the Tokyo Stock Exchange and the Hong Kong Stock Exchange, and lesser-known operations like Finland's Helsinki Stock Exchange and the Singapore Stock Exchange.

Not all popular markets are eligible, however. Notably, none of India's six major stock exchanges appears on the prescribed list, and over-the-counter markets are also excluded.

Although many publicly traded foreign stocks qualify, foreign mutual funds are still RRSP no-nos. That's because the Income Tax Act defines mutual fund trusts as "residents in Canada," explains Jamie Golombek, vice-president, taxation & estate planning, at AIM Trimark Investments in Toronto.

"Even if you owned it when you were in the U.S. [for example], you still couldn't transfer it to an RRSP account here," says Golombek.

The exceptions are some exchange-traded funds (ETFs) that are based on stock exchanges and not actively managed. The popular Standard & Poor's 500 Depositary Receipts (SPDRs) and Dow Jones Industrial Average units (Diamonds), for example, are qualified investments.

Meanwhile, the new foreign property rules do not change the fact that Canadians often stumble over industry limitations when it comes to holding foreign currencies in their RRSPs. Investors who wish to do this have generally found their financial institutions unwilling to allow it, despite the fact that foreign currency (other than money held for its collectible value) has long qualified for registered plans.

Instead, banks, brokerages and other RSP carriers often opt to convert foreign-denominated money to Canadian or, in the case of U.S. cash, to divert these balances to a U.S.-dollar money market fund. For investors this has meant penalties in the form of currency conversion costs or, in cases where investors chose to maintain cash exposure to the U.S. dollar, mutual fund management fees.

"There's no reason for [disallowing foreign currency in an RRSP] under the Income Tax Act," says AIM Trimark's Jamie Golombek. Administrative hurdles are likely the main reasons why foreign cash is usually forbidden, according to Heather Clarke. "It's probably restricted by internal roles or capacity for what [a company's] internal system can handle," she says. For most companies, adds Clarke, it doesn't make economic sense to administer every type of RRSP-qualified investment.

Indeed, part of the cost to financial institutions for allowing their clients to hold foreign currency in their registered accounts has been a surcharge stemming from industry rules that classified such deposits as "non-allowable" assets because they don't qualify for Canadian deposit insurance.

This changed recently with a move in March by the industry's self regulator, the Investment Dealers Association of Canada (IDA), to change the classification on RRSP-held foreign currency cash balances as long as the firm is a member of the Canada Deposit Insurance Corporation (CDIC), or the Autorité des marchés financiers (AMF) (formerly the Quebec Deposit Insurance Board.). IDA vice president of regulatory policy, Richard Corner, described the change as a "housekeeping" measure.

At a time when the flow of foreign currency into RRSPs is expected to increase, said the IDA in a bulletin to its members, the changes are designed to "correct the inconsistent and inappropriate treatment of these funds." Even so, whether and how soon RRSP investors will have the option of direct foreign-currency exposure will continue to depend on their financial institutions.

June Yee is a researcher, writer and editor who has been covering investment funds for 15 years. She is a co-author of the managed funds sections of the Canadian Securities Course, and has authored or co-authored articles for numerous media and research organizations, including the Toronto Star, National Post, 50Plus magazine and BellCharts Inc. She is a founding member of the Canadian Investment Funds Standards Committee.