Despite the proposed tax rules to substantially restrict income splitting opportunities through dividends from private companies, there are still ways for income splitting to be achieved.
One common method that is used is the use of a “prescribed rate loan”.
Using a prescribed rate loan for income splitting is a simple and effective strategy that involves a high tax bracket individual lending directly to their family members who face lower tax rates, and/or, to a family trust established for the benefit of such family members. As a result, the money can be invested and generate income that is taxed at lower rates.
Since it is the CRA prescribed rate of interest that must be paid in respect of “loans for value” (for purposes of the prescribed rate loan strategy and the related income attribution rules), the current low 1% rate provides fodder for the establishment of income splitting/prescribed rate loans. A loan to a low income spouse, majority age child, and/or family trust can achieve acceptable income splitting if the investment return exceeds the required 1% interest rate (or the relevant prescribed rate that applies at the time).
Even if the prescribed interest rate increases in subsequent years, only the rate in effect at the time of the loan will need to continue to be charged and paid. With the recent increases to the Bank of Canada rate (and corresponding increases by the banks), it is likely that the current 1% prescribed rate will increase to 2% as of April 1, 2018. If such planning has not been carried out, now is the time to do it to lock in the 1% rate. Welch LLP is here to assist you with such tax planning arrangements in advance of the anticipated prescribed rate increase.
For more information on income splitting, the use of prescribed rate loans, and whether this tax planning method is a good fit for you, please contact Don Scott, FCPA, FCA, Director of Tax Services