Attribution Rules - A Review For Tax Planning Purposes

If an individual transfers or loans property either directly or indirectly, by means of a trust or any other means to a spouse or common-law partner for that person's benefit, any resulting income or loss from that property is taxable to the transferor (S. 74.1(1)).

Transfers and loans to minors

Where property is transferred or loaned either directly or indirectly to a person who is under 18 and who does not deal with the transferor at arm's length or who is the niece or nephew of the transferor, the income or loss resulting from such property is reported by the transferor until the transferee attains 18 years of age (S. 74.1(2)).

Gain or Loss Deemed That of Transferor

When property that is transferred to the individual's spouse or common-law partner generates a taxable capital gain (or loss), such gain or loss will be reported by the transferor (S. 74.2(1)).

Deemed Gain or Loss

When property that is transferred to a minor generates a taxable capital gain or loss, the capital gain or loss is deemed to be the income of the minor (S. 74.2(2)).

These rules are in place largely due to the result of Canada's progressive tax system and graduated tax rates. That is, individuals with higher income levels are subject to higher marginal tax rates. In addition, different income sources are subject to varying tax treatment. Finally, each individual in Canada qualifies at least for the Basic Personal Amount (a "tax-free zone"). When taken together, these factors provide a financial advantage when several family members earn some income, as opposed to one family member earning all of it.

If such rules were absent, the higher income family members could transfer some of their income to the lower income family members to take advantage of the lower tax brackets enjoyed by those persons. This would result in less total tax payable, and more after-tax funds for the family.

For this reason, it is always best to look at tax filing from a "family" rather than an individual perspective, and to seek the best tax result for the household, as opposed to the individual. This can be attained despite the restrictions placed upon taxpayers as a result of the Attribution Rules.

The Attribution Rules target two distinct categories - transfers or loans to a spouse and minor child. There are significant differences in the restrictions applicable to each.

Transfers - Spouse

• Assets transferred to a spouse will result in the associated income and capital gains that are earned being taxed in the transferor's hands
• Where a spouse guarantees the repayment of a loan, for investment purposes, made to the other spouse, attribution will apply to any income earned from the funds whose repayment was guaranteed.

Example: Guarantee of a Debt

Issue: Joan is a medical doctor in the highest tax bracket, and her husband Billy is a student working on his Masters degree (lowest tax bracket). To attempt to reduce their total taxes, Billy takes a $150,000 loan from their bank and invests in interest bearing securities. Because Billy has no other earnings, the bank asks for Joan's guarantee. In the current year, Billy's investment earns $9,750 in interest. How will this income be treated under the Attribution Rules?

Answer: The $9,750 of income must be reported as interest income in Joan's hands. This is because she provided a guarantee for Billy's investment loan. S. 74.5(7) treats the guarantee as if it were a loan from Joan to Billy.

Transfers - Child

• Dividend and interest income resulting from assets transferred to a minor child will be attributed back to a non-arm's length transferor, but not capital gains or losses.

Example: Loan to a Minor

Issue: Bobby (16 years old) received $15,000 from his parents. He invested in shares of a publicly traded computer company. He sold the shares 2 months later for $45,000. What capital gain will need to be reported by his parents?