My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant and a partner with a National Accounting Firm in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog are written solely in my personal capacity and cannot be attributed to the accounting firm with which I am affiliated. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned. Please note the blog posts are time sensitive and subject to changes in legislation or law.

Monday, July 18, 2011

1% Prescribed Interest Rate Loan- A great income-splitting opportunity

The Canada Revenue Agency (“CRA”) has set its prescribed interest rate for the third quarter of 2011 and it remains at 1%, unchanged from the first and second quarter of 2011. This continuing historically low interest rate, offers yet another opportunity to income split with your spouse and/or children.

Generally, the income attribution rules in the Income Tax Act restrict any attempts to shift income from a higher income individual to a lower income individual by attributing the income back to the higher income earner.

Thus, if you transfer assets to your spouse or minor children, any interest, dividends and capital gains, in the case of a spouse, and any interest and dividends, in the case of a minor child, are taxed in your hands as if you earned the income.

The exception to the above attribution rules applies where an individual makes a loan to a spouse or minor child and interest is charged on the loan at a rate at least equal to the CRA’s prescribed interest rate at the time the loan was made. Where the loan is made at the prescribed interest rate, the attribution rules will not apply. For the loan to be valid, the interest owing must be paid each year within 30 days after the end of the year (January 30th).

Income Splitting

 So why is this a great income splitting opportunity? Because, if your spouse or child is in a low income tax bracket and you are at the highest marginal tax bracket, there could be upwards of 46% in income tax savings on investment income if a prescribed rate loan is used.

If you make a loan to your spouse or minor child between July 1st and September 30th, 2011, the 1% rate is locked for the life of the loan. For example, say you loan your spouse $50,000 and he or she earns 3% on a long-term GIC; he or she will earn $1,500 and have to pay you $500 in interest, netting out $1,000. If your spouse has no other income and you are a high marginal rate taxpayer, you would save almost $500 in taxes. If interest rates recover over time, the benefit could become two or threefold. For those more adventurous, the money can be used to purchases stocks, ETFs, etc. and if you achieve an 8% return, you could be up to $1,500 ahead income tax wise.

Key points to consider

1. The loan agreement must be documented.

2. The CRA’s administrative position is if you have a current prescribed rate loan, you cannot repay it  and issue a new loan.

3. On loans to minors, any income earned legally belongs to the child.

4. The loan interest must be paid by January 30th of the following year.

It should be noted that trusts are typically used for income splitting with minors because minors generally cannot enter into an enforceable contract. Professional advice should be sought before setting up any type of prescribed loan.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.