Beth Graddon with excerpts from EverGreen Explanatory Notes
Prescribed interest rates have remained unchanged throughout the pandemic and will remain at 1% for the fourth quarter of 2021. It’s a good idea to discuss this opportunity with clients well before year-end, while CRA’s prescribed interest rate for interspousal loans is still at this low level. It’s a tax planning ritual not-to-be-missed, especially with high net worth clients.
Under normal attribution rules, any money transferred from one spouse, typically the higher-income spouse, to another is deemed to be taxable in the hands of the transferor, at that person’s higher marginal tax rate. Income splitting opportunities are therefore thwarted.
However, interspousal loans are an important exception to this rule, as long as they are set up and adhered to correctly. With such a loan, any investment income earned from the money transferred to the lower-income spouse will be taxed at that person’s lower tax rate. This can lead to significant savings on the couple’s total tax bill. But to legitimize the transaction, certain tax rules must be followed:
Bottom Line: Tax and financial advisors can calculate the tax advantages; setting up interspousal loans now at the 1% prescribed rate locks in the rate for the life of the loan. That’s important with the real possibility of more interest rate hikes increasing as time goes on and Canada’s economy starts to recover.
Additional Educational Resources: This article includes excerpts from EverGreen Explanatory Notes, your go-to tax research library. Subscribe today!