TSG (Tax Specialist Group) - Attribution That Works (Attribution)

The third quarter of prescribed rate has been set at 2%. This is the lowest prescribed rate in a long period of time. It may now be a good time to consider income splitting using loans since the rate is so low. We discussed this in our March 26, 2002 Tax Tip. However, it is worth discussing again due to very low prescribed rates.

When one spouse (Spouse #1) lends funds to another spouse (Spouse #2), any income earned by Spouse #2 would generally be attributed back to Spouse #1. If, however, the prescribed rate of interest is charged on any funds lent from Spouse #1 to Spouse #2, then attribution does not occur. As long as Spouse #2 can earn at least 2% on his/her funds, the lending of funds would make sense.

One of the key points in order for this plan to work is that the interest must be paid 30 days after each year. It is important to stress that it is not at the end of the first month but, instead, 30 days after year-end. The best way to evidence that the amount has been paid is by writing a cheque from Spouse #2 to Spouse #1. Spouse #1 will have to bring into income the interest paid to him/her. Again,however, if Spouse #1 makes more than 2%, then there is income splitting with the lower income spouse.

For those clients that have a loan receivable from a company, there is the added possibility to reducing the income of the company while income splitting at the same time. The company can repay the shareholder loan to the client, the client can then lend the funds at the prescribed rate to his/her spouse and the spouse can lend those funds back to the company at a reasonable rate of interest. Given that corporate borrowings have a higher risk and therefore interest rate, it is possible for the lower income spouse to earn significantly higher interest rate than the 2% prescribed rate that the spouse will have to pay to the initial client.

The prescribed rate will only be a 2% until the end of September. At this point, we are unsure of what the last quarter prescribed rate will be, so now is the time to take advantage of this.

TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.