Income Split by Taking Advantage of Low Interest Rates
With interest rates back down to historic lows, now is the time to make sure that you’re maximizing your benefits from income splitting. Income splitting involves redirecting income within your family group to take advantage of lower tax brackets, deductions and credits available to each family member.
You can achieve income splitting by transferring an income-producing asset, such as a treasury bill, to your spouse or minor children who are earning lower amounts of income.
The total tax on your family’s income will be the lowest when each member earns approximately the same level of income.
Is Income Splitting That Easy?
No, it’s not. Canadian tax law includes some complicated attribution rules that are designed
to prevent you from income splitting. However, if you make an investment loan to a spouse or a minor child, and charge interest on the loan at the “prescribed rate,” then the net income that they earn will not be subject to the attribution rules.
Interest at the Prescribed Rate
Based on 90-day treasury bill rates, the prescribed rate is used by the Canada Revenue Agency (CRA) for many purposes. In the case of the attribution rules, as long as the interest rate on the loan you make to a family member is not lower than the prescribed rate at the time of the loan, then the attribution rules won’t apply. In addition, the interest payable on the loan each year must be paid during the year, or within 30 days from the end of the year. For example, for 2009, all interest must be paid on or before January 30, 2010. If an interest
payment is late, the prescribed rate exception will be lost, and the attribution rules will apply.
Timing is Critical
Because of recent interest rate reductions, the prescribed rate for the first quarter of 2009 is only 2%. That means that if you loan money to your spouse or a child between January 1, 2009 and March 31, 2009, and charge interest at 2%, they will be taxed on any income they earn on the funds (net of the interest expense) and you won’t be. It should also be noted that it is possible that the prescribed rate could fall to 1% for the second quarter of 2009 – the CRA will make an official announcement in March. Due to this, you may want to wait for this announcement before making a prescribed rate loan (it is unlikely that the prescribed rate will go up).
The Benefits
The benefits from these loans are clearer with an example. Assume that your spouse realizes a 5% return on a mortgage, which they acquired with funds that you loaned to them. After they pay you interest on the loan (we’ll assume interest is charged at the prescribed rate for the first quarter of 2%), which they will deduct on their tax return, they will be left with a 3% return on which they will be taxed. You will pay tax on the interest you receive from them. Should the prescribed rate rise at some point in the future, and it likely will, you still only have to charge interest at 2% for the term of the loan to avoid the attribution rules. Therefore, the income splitting benefits of the loan will almost certainly increase over time.
This is the time to ensure that you have maximized the benefits of income splitting. Ask your BDO advisor for more information, and to recommend an income splitting plan that works for you.
Next Section: What's New at the CRA?
