In past blogs, we discussed income splitting arrangements available to individuals who wish to loan funds to his/her lower income spouse or adult child, or in the case of minor children, a discretionary family trust. Such loans would be used to invest in income producing properties such as marketable securities, mutual funds, real estate income trusts (to name a few). The income from these properties less the interest paid on the loans would be claimed by the spouse, beneficiaries of the trust, thereby providing tax savings to the family overall.
The loan(s) must carry the appropriate rate of interest (i.e. at least the prescribed rate of interest pursuant to the Income Tax Act) and the interest on the loan must be paid by a certain date every year.
In response to the liquidity crisis created by the Covid-19 pandemic, the Bank of Canada (BofC) has lowered interest rates. The prescribed rate of interest is based on Government of Canada T-Bill rates (influenced by BofC rates), accordingly, the quarterly prescribed interest rate set by the Canada Revenue Agency will decrease from 2 per cent to 1 per cent effective July 1, 2020.
Combine this with the recent downturn of values in the marketplace for most capital properties (e.g. securities, real estate), thus reducing the value of the loan needed to invest, this appears to be another ideal moment to consider an intra-family loan to initiate an income splitting arrangement.
If you have an existing loan, you may want to consider refinancing the existing loan when the new rate applies. However, you can’t simply modify the existing loan for the reduced rate. You may need to liquidate the investments acquired and then use the proceeds to payback the existing loan. A careful analysis of the costs associated with doing this including the impact of realized gains or losses must be evaluated.
If you chose to enter into such arrangement to invest in the family business, you must carefully review the tax on split income (TOSI) rules as there are limits on the tax benefits of income splitting where the related family member receiving the income has not made significant contributions to the family business.
As previously mentioned, you can approach your employer for a low interest loan (to buy a house for instance). Your employer can charge you interest at the prescribed rate at the time of the loan and the rate of interest could be locked in for a full five years.
As featured on All About Estates Blog where Baker Tilly WM Partner, Steven Frye, is a regular contributor.
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