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| Sawmill manager Paul Scott,
right, aims to cut his family's tax bill by
lending son Ritchie, rear, $25,000. |
By: Gigi Suhanic
Financial Post
FP Money
June 27, 2002
Paul Scott, manager of a plywood plant and sawmill
in northern Alberta, has income splitting on his
mind.
The financial strategy sees the biggest bread
winner in a household lend money to another family
member. Typically, one spouse lends money to the
other who in turn invests it, but must pay the
lender a prescribed rate of interest as set by
the Canada Customs and Revenue Agency. Any income
earned from the loan is then taxed in the hands
of the person in the lower bracket.
Currently, the prescribed rate is the lowest
it's ever been, 2%, and is scheduled to rise to
3% on July 1.
Mr. Scott, 47, who lives with his wife and three
children -- a boy, nine, and twins, four -- in
Slave Lake and is taxed near the province's top
range, sees the prescribed rate as an opportunity
for the taking.
He says he has $25,000 currently at loose ends.
Rather than lend it to his wife, who is taxed
at a rate lower than his, though "not as
low as I'd like," he wants to lend the money
to his nine-year-old son.
Mr. Scott's two priorities in doing this would
be firstly to reduce his taxable income and secondly
to provide for his son's education or a future
big-ticket purchase such as a house or car.
"I don't want them [his children] living
with me forever," he laughs.
He proposes to lend his son the $25,000 for 10
years. This would be invested in an "in trust"
mutual fund account. Based on 7% growth, Mr. Scott
is expecting his son to pay him back the $25,000
at the
end of the term and calculates he will have $24,000
left over for university.
Adrian Mastracci, fee-only
investment counsel at
KCM Wealth Management, says, “As a first
and preferred course of action, Mr. Scott should
start a Registered Education Saving Plan for his
children.”
Under CCRA rules, Mr. Scott's son would be required
to pay his father interest at the prescribed rate
by Jan. 30 of each year for the loan's duration
-- $750 per year, if the rate is 3%. The interest
rate is locked in as long as the loan exists and
Mr. Scott must declare that $750 interest payment
as income.
Jonathan Richler, a tax lawyer contacted by FP
Money, confirms that such a plan is possible and
that any income the loan generates will be taxed
at his son's interest rate.
But other financial experts wondered if it is
really the best route for Mr. Scott to pursue.
One thing people should ask themselves, says
Don Nilson, a certified management accountant,
is "how big of a win is it? You might be
looking at saving the tax on $600."
"The only way it has a material impact is
if the capital is very large," Mr. Nilson
says.
In this kind of arrangement, says Ron Batty,
a chartered accountant and partner with Nordahl,
Craig, Cummings & Gares in Vancouver, it's
a good idea to review legal issues with professional
advisors. "You don't want to lend money without
fully considering the family aspects," he
says.
"You want to keep things simple. An in-trust
loan is not the way to go," says Adrian
Mastracci of KCM Wealth Management
in Vancouver.
Mr. Mastracci cautions that Mr. Scott may have
trouble recouping his $25,000 because once the
child reaches age of majority, the mutual fund
becomes his property.
Jamie Golombek, vice-president of taxation and
estate planning, reinforces this point. "At
age of majority that money is the child's and
should be turned over."
As a first and preferred course of action, Mr.
Mastracci suggests Mr. Scott should start a Registered
Education Saving Plan for his children.
"He can maintain total control," Mr.
Mastracci says. "He has a good level of flexibility."
Diane McCurdy sees the RESP option as "a
no-brainer."
Under the current RESP rules, Mr. Scott can contribute
up to $4,000 per child per year, with the government
kicking in a grant on the first $2,000 to a maximum
$400 contribution for each youngster.
To make the best use of the RESP, Ms. McCurdy
says Mr. Scott should not contribute more than
$2,000 per child per year since there is no federal
grant component past that point.
If the children decide not to continue their
education after high school, up to $50,000 can
be transferred from the RESP to Mr. Scott's or
his wife's RRSPs, with any remaining amounts subject
to tax.
Mr. Scott says he hasn't started any RESPs for
his children because he wouldn't have RRSP contribution
room to accommodate a transfer.
Mr. Mastracci says Mr. Scott should take a gamble.
He recommends Mr. Scott start a family RESP since
he has three children. That way if one or even
two of his children decide not to pursue post-secondary
education, the money can be used for the third
child.
"The worst-case scenario is none of them
go to university. Chances are one of them is going
to go to some university," Mr. Mastracci
says. "I'm doing the same thing for my children.
If I won't have room [in my RRSP], I'll take my
lumps to pay tax. I think I have a reasonable
chance one out of two will do something."
The other benefit of starting an RESP, says Ms.
McCurdy, is that under the new guidelines introduced
in 1997, Mr. Scott can pick up more grant money
from the years since that year he didn't contribute
for his children. "It's really attractive,"
says Ms. McCurdy.
In order the ensure some flexibility for Mr.
Scott and his children, Mr. Golombek suggests
he gift money to his son and start an in-trust
mutual fund for the nine-year-old. Any income
from the fund will taxed back to the parent until
the child reaches age of majority.
"A tax return should be done for the child
every year to realize the capital gains because
the child is allowed a $7,000 personal exemption,"
says Ms. McCurdy. "You could have $14,000
in capital gains each year because 50% is tax
free."
"The caveat of the mutual fund," says
Mr. Golombek, "is that it is meant to be
used for the child. But it's not confined to education."
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