This Collins Barrow Tax Alert Tax Savings Opportunity is also available in PDF format.
On October 1, 2013, the Canada Revenue Agency’s prescribed rate of interest will increase for the first time in over four years, from 1% to 2%.
The current low interest rate of 1% offers significant tax savings opportunities for income-splitting loan arrangements with family members.
Income-Splitting Loan Arrangements with Family Members
Historically, income-splitting strategies have been used as a basic tax planning technique to reduce a family’s overall tax liability. As individuals are taxed in Canada at graduated rates, income-splitting strategies are used to shift income to a low-income spouse or to a minor child or grandchild (by way of a family trust) where it is subject to tax at their lower rate.
In a typical income-splitting loan arrangement with for instance a spouse, the higher-income spouse loans money to the lower-income spouse and charges the prescribed rate of interest. The lower-income spouse invests the borrowed funds and the income earned (net of the interest paid to the spouse) is effectively shifted to and taxable to the lower-income spouse at their lower rate.
Absent any planning, the investment income would normally be “attributed” to the lender, included in their income and taxed at a higher rate. However, provided the loan is administered by a written agreement stipulating the terms of repayment and charging a minimum rate of interest (i.e. the Canada Revenue Agency’s prescribed rate of interest) then the attribution rules will not apply. Note that the interest must actually be paid by January 30 following the end of every subsequent year during which the arrangement continues.
Where interest rates are rising, an opportunity is available to lock in family loans at the historically low prescribed interest rate of 1% while investing in assets that are expected to produce a return that is well above the minimum rate.
To lock in the 1% rate and reduce your future tax burden, all arrangements must be finalized by September 30, 2013.
Contact your Collins Barrow tax advisor to explore this and other valuable tax planning opportunities.
Gina Pak CPA, CA is a Tax Manager in the Toronto office at Collins Barrow.