Under the Income Tax Act R.S.C., 1985, c. 1 (5th Supp.), there are certain income-splitting arrangements that are available when a loan is made from an individual to his/her lower income spouse/common-law partner and when a loan is made to a discretionary family trust, the beneficiaries of which include minor children.
For example, an individual may loan funds to his/her lower income spouse to make an investment. In order for attribution, with respect to both income and capital gains earned on the lent property or property substituted therefor, to be avoided, interest must be charged on the loan at the prescribed rate in effect at the time the loan is made. The interest must be paid no later than January 30th following the end of a calendar year, and there can be no defaults in the payment of interest for any year. If there is a failure to pay interest in one year, there is no means to correct this error and attribution will result in subsequent years.
Additionally, an individual may loan funds to a discretionary family trust, the beneficiaries of which include minor children, to make an investment. There is no attribution of realized capital gains where a loan is made to a minor child. However, any income on the lent property or property substituted therefor will be attributed back to the parent. Therefore, in order to avoid attribution of any income earned on the lent property or property substituted therefor, interest must be charged on the loan at the prescribed rate in effect at the time the loan is made.
The prescribed rate is equal to the average annual rate on Government of Canada 3-month Treasury Bills sold at auction during the first month of the prior quarter, rounded upwards to the next percentage. The prescribed rate used to calculate taxable benefits for employees and shareholders for interest-free and low-interest loans has been 1%, the lowest possible rate, since April 2009, other than in Q4 2013 when it rose to 2%.
Take heed: the prescribed rate will again increase from 1% to 2% on April 1, 2018.
There is an opportunity to income split before the prescribed rate increases on the assumption that the property substituted for the lent property earns income and realized capital gains in excess of the prescribed rate of interest that must be paid to the lending spouse (and, in the case of a loan to a discretionary family trust, on the assumption that the property substituted for the lent property earns income in excess of the prescribed rate of interest that must be paid to the lending parent).
In order to lock in the current 1% rate on an income-splitting loan, the loan must be made by March 31, 2018. This is because the prescribed rate in force at the time the loan is made determines the interest rate. Therefore, even when the prescribed rate increases, the current rate will remain in effect for as long as the loan is outstanding.
Speak to your advisor today to take advantage of these income-splitting opportunities before the prescribed rate increases!