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Lock in family income-splitting loans before prescribed interest rate increase

Tuesday May 24, 2022

There is a window closing June 30th on prescribed rate loan planning. On July 1, 2022, the CRA’s prescribed rate of 1% for family income-splitting loans will rise to 2%, and may continue to rise in the quarters and years ahead. But if you act quickly, you can still lock in the current 1% prescribed rate and potentially save thousands on your tax bill.

Income splitting transfers income from a high-income family member to a lower-income family member. With Canada’s graduated tax rates, the overall tax paid by a family is reduced when income is taxed in a lower-income earner’s hands.

Family income splitting using prescribed rate loans allows you to take advantage of an exception to the CRA’s attribution rules and can effectively lower your family’s annual tax bill on investment income.

How it works
Attribution rules in the Income Tax Act prevent certain types of income splitting by ‘attributing’ income earned on money transferred or gifted to a family member back to the transferor. Similarly, if you lend funds to a spouse (or to a family trust set up for minor children) the attribution rules can also still apply, in which case any income earned from investing the loaned amount would be taxed in the hands of the higher-income lender.

But this rule does not apply under certain conditions:

If the loan is governed by a written agreement, and the interest rate on the loan is set (at a minimum) at the prescribed rate in effect when the loan was made, and the interest on the loan is paid annually by January 30th (starting the year after the loan was made), the rule will generally not apply. As a result, any investment return on the loaned amount above the prescribed rate would be taxed in the hands of the lower-income family member to whom the loan was made. Note: the prescribed rate is set quarterly by the CRA and is directly tied to the yield on three-month Treasury Bills.

So, if you establish a prescribed rate loan by June 30, 2022, it may be possible for all investment income from the loaned amount over 1% to be taxed at a lower-income family member’s tax rate indefinitely, as the 1% rate would be locked in for the full duration of the loan, regardless of any future prescribed rate increases.

Example with spouse
Jane is taxed at the highest tax rate and her husband John is taxed at the lowest rate. Jane loans John $250,000 at the current prescribed rate of 1%. The loan is formalized by a written agreement. John invests the money in a portfolio of Canadian dividend-paying stocks with a yield of 4%. Each year, John earns $10,000 in dividends, of which $2,500 is used to pay the 1% interest due on the loan from Jane.

The dividends are taxed in John’s hands at the lowest tax rate instead of in Jane’s hands at the highest tax rate. And although the $2,500 paid to Jane as interest on the loan is still taxable at the highest rate, John can claim a tax deduction on the amount as the interest was paid to earn dividend income. Result? There is a significant net savings to the couple.

Example with minor children
Let’s say Jane formally loans the $250,000 at the 1% prescribed rate to a family trust with her two minor children as beneficiaries of the family trust. The funds are then invested in a portfolio of Canadian dividend-paying securities with a yield of 4%, similar to the above example. The trust can deduct the $2,500 of interest expense, and $7,500 of investment income can be paid out to the minor children or used for their benefit. If the children have zero or little other income, this income can perhaps even be received totally tax-free.

Ensure you do it right
It’s important to confirm that the tax on split income (TOSI) rules do not apply before entering into a prescribed loan arrangement. You also need to ensure that your documentation is properly established and maintained. Our dedicated team is here to support you. Please call us at 905-821-9215 or email us at if you have any questions or require any assistance.

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