In Tax Tips 04-22 and 09-09, we discussed the use of prescribed rate loans for income splitting amongst family members. These types of plans usually involve a spouse transferring income generating assets (or lending funds) to a lower income spouse or to children who are under 18 (or to a trust for the benefit of the lower income spouse or children) in exchange for an interesting bearing loan. In the case of the lending of funds the borrowed amount is used to purchase investments.
As long as the interest rate on the loan, at the time it is made, is at least equal to the “prescribed rate” in the Regulations to the Income Tax Act and the interest is paid no later than January 30 of the calendar year following each year in which the loan is outstanding, income from the invested assets will not be attributed back to the transferor spouse/parent, thereby, being taxed at lower rates. Even though the prescribed rate is calculated quarterly, there is no need to adjust the rate once you have made an income splitting loan.
From April 2009 to September 2013, we enjoyed the lowest possible prescribed rate of 1%. People were jolted out of taking this low rate for granted when, after 4.5 years, the rate increased to 2% in the last quarter of 2013 (see Tax Tip 13-12). This jump to 2% arose because the relevant calculation yielded a 1.02% interest rate. The Tax Act requires the rate to be rounded up to the nearest whole number so this .02% problem resulted in a 2% prescribed rate.
Luckily, the prescribed rate has returned to 1% for the first quarter of 2014. As a result, taxpayers have an opportunity to lock in income splitting loans at 1%, at least until March 31, 2014. Unlike investment returns, in this case history may be an indicator of future performance. We have seen that it will not take much for the prescribed rate to move up to 2% again.
Those who intend to implement such income splitting plan or who “missed the boat” last time should seriously consider implementing the plan before the end of March 2014. The prescribed rate can very well change again come April 2014.
Your TSG representative would be happy to discuss this opportunity with you.
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