Family income-splitting loans, which can produce significant long-term tax savings, just became more attractive.
The Canada Revenue Agency recently announced that effective April 1, the interest rate for family income-splitting loans will drop to one percent. To take advantage of this low interest rate, loans must be locked in between April 1 and June 30.
Looking back over the past 10 years, the interest rate ranged from a high of six percent in 2001 to a low of two percent for January to March 2009.
The current economic climate has reduced interest rates to their lowest level in decades, creating a rare opportunity to enter into income-splitting loan arrangements with family members.
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To be sure you can lock in loan arrangements at one percent, you’ll need to act between April 1 and June 30, though the rate may remain at one percent after June 30.
Although economic conditions may not be ideal for investors, making a family loan arrangement now will make it possible to realize income-splitting tax benefits in the future when the economy recovers and interest rates and investment returns rebound.
You may achieve significant future tax savings by locking in a family loan at the prescribed one percent interest rate and shifting income earned on the investment of the lent funds to your spouse or another family member, including a minor child, who has little or no other income and thus pays little or no tax.
Normally, if you lend funds to your spouse or another family member, the attribution rules will apply and any income that is earned on these loaned funds will be taxed in your hands.
However, the attribution rules will not apply if there is a formal written agreement that indicates the terms of repayment and an interest rate that is at least equal to the CRA’s prescribed interest rate at the time the loan is made.
In a typical arrangement, the higher income spouse lends money to the lower income spouse. Under a written loan agreement, the lower income spouse agrees to pay interest at the prescribed rate of one percent, if entered into after April 1.
The lower-income spouse invests the borrowed money and subsequently earns a higher rate, say three percent.
To generate tax savings through this strategy, the lower income spouse must earn a rate of return of one percent or greater.
Provided the lower income spouse makes annual interest payments by the following Jan. 30 of each year, two percent of the income in our example – the difference between the three percent rate of return and the one percent prescribed rate – will be taxed in the hands of the lower-income spouse.
In this example, on a $100,000 loan, the amount of income shifted to the lower income spouse would be $2,000 annually.
To maximize the tax benefits of this strategy, interest payment terms and other loan arrangements must be properly structured and other requirements met.
As a result, these arrangements should be undertaken only with appropriate professional advice. Talk to your adviser to see if this strategy will work for you.
Colin Miller is a chartered accountant and senior manager in KPMG’s tax practice in Lethbridge. His opinions do not necessarily reflect the views of The Western Producer. He can be reached at 403-380–5707 or by e-mail at colinmiller@kpmg.ca
