TaxMatters@EY - September 2013
Before 30 September, review income splitting prescribed rate loans
Teresa Gombita, Maureen De Lisser and Bob Neale, Toronto
The current low interest rates present a window of tax-planning opportunity for anyone interested in income splitting with their lower-income spouse or partner and/or children or grandchildren.
Under the Income Tax Act, the income arising from an investment funded by a loan made to a spouse or partner, minor children and/or grandchildren, or to a trust for minor children and/or grandchildren, is generally taxable to the lender. There are exceptions to these income attribution rules if certain conditions are met.
The income attribution rules do not apply when the loan’s interest rate is not less than the lesser of:
- The prescribed rate of interest at the time the loan is made; and
- The rate that would be charged in similar circumstances to an arm’s-length party.
The prescribed rate is determined quarterly based on the Government of Canada borrowing rate and applies for the subsequent three-month period. The rate for the period 1 July 2013 to 30 September 2013 is 1% per annum. Effective 1 October 2013, the rate will be 2% per annum.
If you make a loan before 30 September 2013 to any of the lower-income family members noted above with an interest rate of 1% per annum, and the funds can be reinvested at higher rates of return, the difference will be taxable to your family members rather than you, which should result in an overall tax saving. To realize this result, the interest charged on the loan must be paid within 30 days of the end of each calendar year. Failure to meet this payment requirement will result in all income earned on the investment of the loan proceeds being taxable to you.
If cash is not readily available, but you have a portfolio of securities, you can sell them to other family members for consideration comprising a 1% loan equal to the fair market value of the portfolio. You will have to report the disposition of all the assets sold on your 2013 personal income tax return, so it’s important to consider the immediate tax cost of such a strategy. Any capital losses realized will be denied under the superficial loss rules, as your spouse or partner would acquire identical securities within 30 days.
For purposes of this planning, the term of the loan can be payable on demand. The interest rate will remain at 1% for as long as the loan is outstanding. Ideally, you should have a separate bank or broker account from your family member to preserve the identity and source of the investments and the resulting income.