January 25, 2012 Leave a comment
Prescribed rate loans are a great tool for family income splitting. By virtue of our graduated tax rates, a family group will save tax if income is shifted from a high rate taxpayer to one or more family members that are in lower tax brackets. For example, a parent in Ontario that is in the top tax bracket and earns $10,000 of interest income will pay approximately $4,600 of tax on the income. If the income was instead earned by a child, without other income, he or she would pay no tax on the income. If the child had $20,000 of other income, then the $10,000 of interest income would attract approximately $2,300 of tax. The annual tax savings via the strategy will depend on the income shifted and the relative tax rates to the parent and child.
So far so good, except that if the parent gifts or loans the underlying investment funds to a child or spouse, then the income earned on the funds will attribute back to the parent. For this reason we must have a plan to avoid the application of the attribution rules. A prescribed rate loan is such a plan – attribution does not apply if the funds are loaned and interest is paid at a rate equal to or greater than the prescribed rate. The good news is that the current prescribed rate is 1%. Further good news is that the 1% will continue to apply in the future even if the prescribed rate increases in future periods.
Welch LLP assists clients in implementing prescribed rate loan arrangements. In many circumstances we use family trusts as part of the plan which leads to added flexibility. The link directs you to an article that provides more insight.