On July 1, 2022, the CRA’s prescribed interest rate will increase from its current one percent rate to two percent. In some cases, planning for this increase now can provide an opportunity to split income with a spouse or common-law partner, children, grandchildren or other family members, thereby saving income taxes.
Income splitting results when income from a higher-income earning family member is transferred to a lower-income earning 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 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 is 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 is made that is used in the calculation. As a result of these rules, if a loan is made on or after July 1, 2022 (which is when the prescribed interest rate will increase to two percent), the benefits of this planning technique will be reduced.
If an individual has already entered into a loan with a family member or family trust when the prescribed interest rate was one percent, the individual should consider the benefits of increasing the amount of the loan before July 1, 2022. If an individual has not yet done a prescribed rate loan, this should be considered and possibly implemented before July 1, 2022.
For further information, please contact your Lipton advisor.