Make Tax Efficient Spousal Loans

Evelyn Jacks

One interesting and potentially beneficial financial strategy to grow the family’s wealth is to draw up an interspousal loan. With interest rates coming down again the plan may have more appeal again. Here’s how to make it work to stay onside with CRA, and some of the benefits:

The Backdrop. The CRA frowns on the transfer of income or assets between family members to shift the tax burden from high income earners to lower ones. Under the “attribution rules”, any income earned from money transferred from one spouse, typically the higher-income spouse, to the other, is deemed to be taxable in the hands of the transferor, and at that person’s higher marginal tax rate. Income splitting opportunities are therefore firmly thwarted.

However, interspousal loans are an important exception to this rule, as long as they are set up 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, six things need to happen:

• The loan must be documented properly in writing, for example with a promissory note, including repayment terms, following normal commercial lending rules.
• The lending spouse must charge the other spouse interest at least equal to Canada Revenue Agency’s prescribed rate (currently at 3 percent for the final quarter of 2025 and the first quarter of 2026).
• The spouse receiving the loan must pay the interest owing to the lender every year within 30 days after year end (that’s right - by January 30, not January 31). Failure to meet this condition will undo the plan – and the normal attribution rules will kick in.
• The lending spouse is required to report the interest received as income on his or her income tax return.
• The borrowing spouse can deduct the interest paid on his or her tax return, as long as the loan was used to purchase income-producing assets with the potential of earning passive investment income (interest, dividends, rents or royalties), within in a non-registered account.
• The spouse receiving the loan is required to pay back only the interest due; there is no requirement to repay the principal.

Bottom Line: If one spouse has a much higher income than the other, there are numerous benefits to setting up interspousal loans, especially when prescribed interest rates are low. They are locked in for the life of the loan. And that’s a bit of good news in an otherwise volatile economic scenario for the new year. Advisors and their clients will want to discuss this strategy in the new year. 

Additional Educational Resources:  Check out the DMA™ Personal Tax Services Designation Program to become a specialist in helping Canadians plan to keep more of their hard earned money.

The courses in the program include: Program Guide