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Personal Income Tax  ->  Income Splitting -> Lend money to your spouse or child

Lend Money to Your Spouse or Child

Income Tax Act s. 74.5(2), Income Tax Regulations s. 4301(c)

If one spouse is in a higher tax bracket, it may be beneficial to lend money to the lower-income spouse.  Money can also be loaned to a child.  The funds can be used to purchase investments, and tax on the investment income will be paid by the lower-income spouse at a lower marginal rate.  A promissory note should be written for the loan, with the interest rate and principal amount specified.  Interest must be paid on the loan by January 30th of each year.  In order for attribution rules to not be applied, the interest rate charged must be greater than or equal to the lesser of:

bullet the prescribed rate set by Canada Revenue Agency (CRA) at the time the loan is made, or
bullet the rate that would, having regard to all the circumstances, have been agreed on, at the time the loan was made, between parties dealing with each other at armís length.

In order for this to work, the investments from borrowed funds should be in a separate investment account in the borrower's name.

Prescribed Interest Rates

The prescribed rates are subject to revision each calendar quarter, and can be found on the CRA prescribed interest rates page, but this is not usually updated until just before the calendar quarter to which the rate applies.  The rate to use is the rate for calculating taxable benefits from low-interest and interest-free loans to employees and shareholders.

The prescribed rate has been 1% since July 1, 2020.

Prescribed Rates
Effective
Date
Interest
Rate
Jul 1 2020 1%
Apr 1 2018 2%
Jan 1 2014 1%
Oct 1 2013 2%
Apr 1 2009 1%

Note:  The October 1, 2021 rate for 2021 Q4 will remain at 1%, based on 3-month treasury bills sold at auction in July 2021.  The rate can't go below 1% because it's rounded up to next higher whole percentage.

Any loans created from Apr 1, 2018 to June 30, 2020 will use the 2% rate throughout the loan.  Loans created after June 30, 2020 will use the 1% rate.

One cannot simply refinance an existing loan that is at a higher interest rate, using the current lower prescribed rate.  As per Tax Interpretation 2002-0143985, this would likely trigger the attribution rules.  However, if enough of the original leveraged investment is sold to pay off the original loan, then a new loan is provided to purchase investments, the attribution rules would not apply, according to the article CRA offers flexibility on prescribed rate loans, which refers to CRA comments on this at a Canadian Tax Foundation conference.

The prescribed rate for loans to shareholders, spouses and minor children is defined by Income Tax Regulations s. 4301(a) and (c), as an average of the rates for 3-month Treasury Bills sold at auction during the first month of the preceding quarter.  It is rounded up to the nearest whole percentage.

The interest received by the lender must be included in income, but is deductible as carrying charges by the borrower, as long as a loan agreement has been drawn up so that there is a legal obligation for the borrower to pay the interest.  Using joint accounts for the payment or receipt of the interest could cause problems, as there must be clear records that the spouse has paid the interest.

Example for Ontario residents:

bulletMr. A earns employment income of $80,000 per year.
bulletMrs. A earns $34,000 per year.
bulletMr. A has accumulated savings of $100,000, he and Mrs. A have no debt, he has used his maximum RRSP contribution room, and he would like to purchase investments outside of RRSPs.
bulletMr. A lends the $100,000 to Mrs. A on January 1, 2012.
bulletA promissory note is written up, specifying that the loan is made at the current prescribed interest rate of 1%.
bulletMrs. A invests the $100,000 in Canadian stocks yielding 10% (3% dividend, 7% capital gain).
bulletCanadian dividend income of $3,000 in 2013 is reported by Mrs. A on her 2012 tax return, which equates to $4,140 of taxable income because Canadian dividends are grossed-up by 38% to include in income.  The dividends are eligible for the enhanced dividend tax credit.
bulletMrs. A pays $1,000 (1%) interest expense to Mr. A on December 31, 2012.  This interest expense is deducted  on line 221of Mrs. A's 2012 tax return.
bulletMrs. A's taxable income is $37,140 (34,000 + 4,140 - 1,000).
bulletMr. A includes the $1,000 interest income on line 121 of his 2012 tax return.
bulletMr. A's taxable income is $81,000 (80,000 + 1,000).
bullet$360 in tax is saved by Mrs. A investing the $100,000 instead of Mr. A, assuming the Canadian stocks are not sold.
bulletIf the Canadian stocks are sold at the end of 2012 and 7% capital gain realized, $954 in tax is saved due to Mrs. A having the capital gain ($3,500 taxable) and dividends instead of Mr. A.

Disadvantages:

bulletThe interest on the loan for the prior year must actually be paid by Mrs. A to Mr. A by January 30th of each year, or the income from the investments will be included in Mr. A's income.
bulletIf Mrs. A has capital losses from her investments, the interest still must be paid.
bulletVery little tax is saved even when $100,000 is invested.  The savings would be even less with a 2% prescribed rate instead of 1%.

Investments in a Loss Position

If the investments have declined in value and the spouse cannot repay the loan, you may decide to forgive the loan, and debt forgiveness rules may apply.  If you want to learn more about this, you should seek the advice of a Chartered Professional Accountant (CPA) experienced in this area.

Attribution Rules

See our article on attribution rules re gifts, transfers or loans to a spouse or related minor child.  Although there are no attribution rules for a gift of funds to a spouse or minor child for any use other than purchasing income-producing investments, it must be clear that the spouse has actually paid interest on the loan.

Other Options

Another option besides lending money to a lower income spouse is for the higher income spouse to pay for all household and family expenses, and the lower income spouse can invest all income earned.  Obviously, the lower income spouse would only be able to invest as much as their net income after tax.  This would work best if there were separate bank accounts for income from each spouse, even if both accounts were joint accounts.  The important thing to remember is that records must be kept that clearly show the source of the income used to invest.

Tax Tips:

Maximize RRSPs (especially spousal for the lower income spouse).

Carefully check your own circumstances, and get professional advice.

The lending to spouse strategy saves very little tax if $100,000 or less is invested.

Revised: August 02, 2021

 

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