One percent loans are back

On July 1, 2020, the Canada Revenue Agency reduced its prescribed interest rate to 1%. This opens up opportunities for income splitting among family members — in spite of the 2018 amendments that made income splitting a little more difficult.

At its most simple, a high-income husband (let’s call him Richard) lends funds to his low-income wife (let’s call her Portia).  Portia invests those funds and earns investment income.  Normally, Richard would pay tax on Portia’s investment income as if Richard had earned the income.  But if Portia pays 1% interest to Richard and earns a 5% return, Portia pays income tax at her lower rate on her net 4% return (her 5% return less the 1% paid to Richard as interest).  Richard pays income tax only on the 1% interest received from Portia.  This allows more of the family income to be taxed at Portia’s lower income tax rate and allows Portia to build up her own investment portfolio.

Even though the prescribed interest rate is subject to change on a quarterly basis, it is possible to lock in the current 1% rate for an extended period of time.

Any such loans have to be carefully documented and managed.  Dwyer Tax Law can assist with implementation of these and other income-splitting strategies.

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