Many of you have been reading my newsletters for years and have read many postings from me about family income splitting using low rate inter-family loans. Most recently, in January, I wrote about the need to be aware of the possible increase in the prescribed rate.
There are rules in the Income Tax Act, referred to as the income attribution rules, which will, in certain circumstances, attribute income earned by one taxpayer to another. For example, if I give money or other property to my spouse or to a minor, the Act will attribute the investment income earned to me and tax it in my hands.
There are some notable exceptions to the income attribution rules. Although income and capital gains will be attributed from a spouse, there is no attribution of capital gains from a minor. So, if, for example, I give or lend money to a minor to invest in a mutual fund generating capital gains, there would be no attribution. The same investment in the hands of my spouse would trigger attribution of the capital gain.
One often forgotten exception to the income attribution rules is using gifted or loaned funds to generate business income, as opposed to investment income. If I give or lend money to my spouse or to a minor to be used for business purposes, the business income is not attributed.
There is often a fine line between income from business and income from property, so professional advice should be obtained to ensure that the use of the funds will avoid the attribution rules.
However, if the funds are loaned to a lower rate taxpayer, or to a family trust, AND interest is charged at the prescribed rate and actually paid, the investment income and any capital gains generated will be taxed in the hands of the borrower, not in the hands of the lender. This is the case even where the funds are used for investment purposes.
Since 2009, with the exception of 1 quarter in 2013, the prescribed rate for inter-family loans and certain other benefits, has been 1%.
I have been saying since September, 2017, that the prescribed rate was poised to go up.
As of April 1st, 2018, the prescribed rate will double to 2%.
Although some of us can remember prescribed rates of 14%, the doubling of the prescribed rate is significant for families that want to continue some form of income splitting.
Accordingly, if this form of income splitting is of interest, there is an urgency to putting the pieces in place before March 31st, 2018.
As with all income tax planning, I strongly recommend that any loans be documented with promissory notes in writing.