Jarrett McKay - Mar 07, 2017
The recent investment environment has been more than challenging with low interest rates reflected in the returns of fixed income markets and volatility affecting the equity markets. However, these conditions make this an opportune time to consider a
The recent investment environment has been more than challenging with low interest rates reflected in the returns of fixed income markets and volatility affecting the equity markets. However, these conditions make this an opportune time to consider a spousal loan, also known as a prescribed rate loan, as an income-splitting strategy to minimize taxes.
Why a Spousal Loan?
Under Canadian tax law, rules have been set up to generally block attempts to shift income between spouses, attributing income back to the original owner for tax purposes. Spousal loans are one way to potentially avoid these income attribution rules.
A spousal loan may be attractive in situations in which one spouse is in the top tax bracket and the other spouse is in a substantially lower tax bracket. Instead of investing funds personally and paying tax on the income at the highest tax rate, the higher-earning spouse can lend these funds to the lower-earning spouse at the prescribed rate.
The current rate in effect at the time of writing remains at one percent (as of September 2015) — the lowest possible rate. The prescribed rate is determined every quarter and is based on the rates of certain Government of Canada Treasury Bills.
The prescribed rate prevailing at the time that the loan is made is the rate of interest that remains in effect for the entire life of the loan.
Assuming that returns on investments made using the loan will be greater than the prescribed rate, income has been effectively split and the overall tax burden of the couple has been reduced.
Given the recent market turbulence, this may be an attractive time for the loan to be used to purchase equities with depressed prices, as the difference between the rate of return achieved on the invested funds and the prescribed rate payable on the loan may increase as the economic climate improves.
How Does It Work?
There are several requirements to properly set up a spousal loan. Documentation of the loan must be kept, indicating the date that the loan was entered into, the rate of the loan, and the principal due on demand.
The borrowing spouse must pay the interest on the loan by January 30th following the end of every year that the loan is outstanding to ensure that tax attribution rules will not apply. A record of this transaction should be kept. Interest earned by the loaning spouse must be recorded on his/her tax return and interest paid by the borrowing spouse may be deducted from that spouse’s investment income.
As always, seek the assistance of an accountant if you are considering implementing this tax strategy.
CANACCORD GENUITY WEALTH MANAGEMENT IS A DIVISION OF CANACCORD GENUITY CORP., MEMBER-CANADIAN INVESTOR PROTECTION FUND AND THE INVESTMENT INDUSTRY REGULATORY ORGANIZATION OF CANADA
This newsletter is solely the work of the author for the private information of clients. Although the author is a registered Investment Advisor at Canaccord Genuity Corp., this is not an official publication of Canaccord Genuity Corp. and the author is not a Canaccord Genuity Corp. analyst. The views (including any recommendation) expressed in this newsletter are those of the author alone, and are not necessarily those of Canaccord Genuity Corp. The information contained in this newsletter is drawn from sources believed to be reliable, but the accuracy and completeness of the information is not guaranteed, nor in providing it do the author or Canaccord Genuity Corp. assume any liability. This information is given as of the date appearing on this newsletter, and neither the author nor Canaccord Genuity Corp. assume any obligation to update the information or advise on further developments relating to information provided herein. This newsletter is intended for distribution in those jurisdictions where both the author and Canaccord Genuity Corp. are registered to do business in securities. Any distribution or dissemination of this newsletter in any other jurisdiction is prohibited. The holdings of the author, Canaccord Genuity Corp., its affiliated companies and holdings of their respective directors, officers and employees and companies with which they are associated may, from time to time, include the securities mentioned in this newsletter.
The preceding information is for general information only and does not constitute tax advice. All investors should consult with a qualified tax accountant. Tax & Estate advice offered through Canaccord Genuity Wealth & Estate Planning Services. FOR DISTRIBUTION IN CANADA ONLY