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Redirecting Income

First Posted: July 8, 2009

By Bennett Gold LLP, Chartered Accountants

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It's hard to believe that there is any good news in this recession, but when it comes to tax strategies there is one bright spot, at least until June 30.

Canada Revenue Agency's (CRA) prescribed interest rate for the current quarter has dropped to the historical low of one per cent, opening the door for such long-term tax planning strategies as:

Income-splitting spousal loans and
Renewing home purchase loans with employers.

To provide some idea of how advantageous the current rate is, it was two per cent in the first quarter and has ranged from two per cent to six per cent in the past decade. There is no telling what the prescribed rate will be after June 30. (RedFlagDeals.com Editor's Note: Per the CRA website, the prescribed interest rate remains 1%.)

Meantime, the Bank of Canada lowered its key benchmark rate to 25 basis points and said it would "conditionally" remain at that level until June 2010. That may lead some homeowners to consider refinancing their mortgages. (See right-hand box.)

Income Splitting with Spousal Loans

Normally, the Income Tax Act bars family members from splitting income through attribution rules. Those regulations state that any earnings, including capital gains, from money transferred within the family must be taxed back to the individual who made the transfer. If you give money to a lower-income spouse or common-law partner to invest, for example, the earnings or capital gains related to those investments are taxed in your name at your tax rate.

This is not the case, however, if you lend money to your spouse or common-law partner. With a loan, the lower tax bracket individual agrees to pay interest at the current prescribed rate. The borrower then invests the money into something that is expected to generate returns higher than one per cent. The investment returns are taxed at the lower-income spouse's tax rate.

The borrower must pay the annual interest on the loan to the lender by January 30 of each year, but can deduct the amount as a loan interest expense.

Here's an example of how a spousal loan works:

Marie is in the 45 per cent tax bracket while her husband, Bob, is in the 22 per cent bracket. Marie lends Bob $100,000 at one per cent interest.

	Without Loan	With Spousal Loan
	Marie: 45% Tax Rate ($)	Marie: 45% Tax Rate ($)	Bob: 22% Tax Rate ($)
Principal Loan	100,000		100,000
4% Investment Return	4,000		4,000
1% Interest on Loan		1,000	-1,000
Net Income	4,000	1,000	3,000
Individual Tax	1,800	450	660
Total Family Tax	1,800	1,110

If Marie had invested the money herself, she would have had to pay $1,800 in taxes. By lending the money to Bob to split income, the family tax bill drops 38 per cent to $1,110, saving $690.

If you already have a spousal loan you can still take advantage of the lower rate. The borrowing spouse repays the loan and takes a new one. Repaying the money may require selling investments, but remember, any capital gains would be taxed at the borrower's lower tax rate.

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