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By: Adrian Mastracci
North Shore News
Business Section, “Loose Change”
Sunday, September 12, 2004
Pssst! Pssst! Does a 2% loan rate sound enticing to you?
No such luck. You're not borrowing from the Bank of Canada.
An important planning opportunity exists where one spouse, including a common-law partner, is in a lower income tax bracket than the other. It involves loaning funds from one spouse to the other.
You may consider lending your spouse some money if your spouse is in a lower income tax bracket than your own or has low 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 nestegg.
The key is to charge interest at least at the Canada Revenue Agency prescribed rate on all funds loaned to your spouse. This has nothing to do with bank loan rates.
The great news is that the prescribed rate has dropped to 2% for the third quarter ending September 30, 2004. Better yet, the loan rate can be locked in for a long period of time, say five to ten years, maybe more.
The recipient spouse invests the funds and reports the income earned on the investments. However, the recipient must pay the interest to the lender spouse before January 30 of each year following the loan.
Let's illustrate the process. Say one spouse loans $100,000 to the other at the 2% prescribed rate who then invests it at 5%. The recipient spouse is then taxed on the 3% difference. In this instance, an annual income of $3,000 is shifted to the lower income spouse.
Making this a long-term arrangement has plenty of planning appeal. All of the investment income in excess of 2% can be taxed in the hands of the lower tax bracket spouse.
Loans to a spouse should be made for investment purposes. The recipient spouse pays the prescribed rate regardless of the loan purpose.
This loan provision is also available for children. However, you may need a family trust if minor children are involved, and you have to be careful of the kind of income that's generated.
For business owners, other variations on this income splitting opportunity involve family trusts and loans to shareholders. A couple of uses for prescribed loans from your employer or business are the purchase of a home or an automobile.
The shareholder loan rules are much more involved. Therefore, professional counsel may be appropriate.
Speak to your advisors about how you can benefit from this provision. Some financial rearrangements may be necessary.
Clearly, this income splitting provision can provide significant income tax savings, especially over a number of years. More importantly, the family nestegg improves.
However, time is of the essence. The prescribed interest rate will rise to 3% for the calendar quarter commencing October 1, 2004.
Follow the rules closely if you intend to take advantage of this planning opportunity at the 2% rate. All your strategies, arrangements and documentation must be in place not later than September 30, 2004.
These golden opportunities don't come along often enough. So, have a good look.
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