Tax Planning – Prescribed Rate Loans
On July 1, 2020 the government’s prescribed interest rate will decrease from its current two percent to one percent. In some cases, this can provide a tax planning opportunity to split income with a spouse or common-law partner, children, grandchildren or other family members.
Income splitting results when income from a higher-income family member is transferred to a lower-income family member. Due to Canada’s tax system of graduated tax rates, having the income tax paid by the lower income earner can reduce the overall tax to the family unit.
The income attribution rules contained in the Income Tax Act (the Act) are intended to prevent certain types of income from being split by “attributing” income or gains earned on money transferred or gifted to a family member back to the original transferor. However, the Act does provide an exception to this rule if the funds are loaned at the prescribed interest rate in effect at the time the loan was made and the interest is paid annually by January 30th of the following year.
For example, if the loan was made when the prescribed interest rate is one percent, any realized investment return above that rate will be taxed in the hands of the particular lower income family member. Although the prescribed rate can vary by quarter, it is the prescribed rate in effect at the time the loan was made that is used in the calculation.
If an individual entered into a loan with a family member or family trust when the prescribed interest rate was higher than one percent, the family member or family trust should consider selling its investments and repaying the loan. A new loan agreement can then be entered into using the new one percent prescribed interest rate. With respect to the loan repayment required to put this into place, any accrued capital gains or losses on the borrower’s existing investments must also be considered.
For further information, please contact your Lipton advisor.