By: Brenda Bouw
You Ask, We Answer
Financial Post
March 30, 2002
Question:
How can my spouse and I best utilize the provisions of the Canada Customs and Revenue Agency prescribed rate of 3% by March 31st?
Answer:
Adrian Mastracci, a fee-only investment counsellor at KCM Wealth Management Inc. in Vancouver, says this provision is an important planning opportunity for many of his clients. It achieves income tax savings in a situation where one spouse loans money to the other spouse who has low income or a lower tax rate.
Mr. Mastracci suggests waiting until April 1st and here's why. You may consider lending your spouse some money if the spouse is in a lower tax bracket than your own. The key is to charge interest at least at the Canada Customs and Revenue Agency (CCRA) prescribed rate on all funds loaned to your spouse.
Adrian Mastracci, president of KCM Wealth Management says, “For business owners, there are other variations on this income splitting opportunity that involve loans to shareholders.”
The rate for the quarter ending March 31, 2002 has been set at 3%. The great news is that the prescribed rate drops to a rock bottom 2% for the second quarter ending June 30, 2002. Better yet, the loan rate can be locked in for a long period.
The recipient spouse invests the funds and reports the income earned on the investments. However, the recipient must pay the prescribed interest to the lender spouse not later than Jan. 30 of each year following the loan.
As an example, one spouse loans $100,000 to the other at 2% who invests it at 5%. The recipient spouse is then taxed on the 3% difference. In essence, an annual income of $3,000 is shifted to the lower income spouse. Documentation is required between the spouses as evidence of the loan.
Further, there must be actual interest payments made, and the lending spouse must report the 2% loan interest income.
This is one of the few forms of income splitting still available to spouses. Over time, the lower income spouse can accumulate a bigger nest egg. It can then be utilized as an income source for now and during the financial independence or retirement years.
The prescribed rate set by CCRA changes every calendar quarter. The upcoming 2% prescribed rate is the lowest that it's ever been and may well rise for the third quarter. Follow all the rules if you intend to take advantage of this planning opportunity at the 2% rate. All documentation must be in place between April 1, 2002 and not later than June 30, 2002.
Loans between spouses should be made for investment as opposed to consumption reasons. For business owners, there are other variations on this income splitting opportunity that involve loans to shareholders.
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