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[Chronique de Sandy Lachapelle] The convenience of loans at the prescribed rate at 1%

Spring is my least favorite season. Unlike many, it does not evoke renewal for me, but rather water damage and the return of seasonal allergies! Some people think of the sugar season; Personally, I associate it more with that of taxes to be paid… It may therefore very well be that my next columns will deal with subjects associated with tax planning!

On March 2, the Bank of Canada announced an increase in its key rate to 0.5%. We know that further hikes are expected this year, in order to combat inflation that has set in over the past two years and will be exacerbated by the Russia-Ukraine conflict. These gradual increases, depending on their frequency, could make 2022 an opportunity to make loans at a prescribed rate of 1%.

A strategy to reduce family taxes

We have already discussed together the concept of income splitting. This consists of transferring part of the income, and therefore of the tax burden, to a spouse or family members who are taxed according to a lower income bracket. The attribution rules in the federal Income Tax Act limit some strategies, as they provide, among other things, that income and gains will be taxed to the transferor. For example, if you take part of your non-registered investments to open an account in your spouse’s name, the attribution rules ensure that, following this gift to the spouse, you will still have to be personally taxed. on the income of this portfolio.

The law provides an exception where funds are lent, rather than given, at the prevailing prescribed rate, which is currently 1%. Thus, income exceeding the prescribed rate is then taxed in the borrower’s income tax return and the attribution rules do not apply. If your income is high and your tax rate high, you could lend some of your money to your spouse if their tax rate is lower. This type of loan can also be used with a family trust to pay certain expenses of your minor children, who are the beneficiaries.

Don’t wait for rate hikes

The prescribed rate used for this type of loan is set quarterly by the Canada Revenue Agency. It roughly corresponds to the rate of three-month Government of Canada Treasury bills that were sold in the first month of the previous quarter. As this rate is rounded, it cannot be lower than 1%. Although you don’t have to remember the calculation method to determine it, we can together hypothesize that with the increases in key rates expected this year from the Bank of Canada, we will one day arrive at a rate increase prescribed at 2%. If not in 2022, it will be in 2023.

Since the rate used for the loan remains the one that was in effect at the time of the loan, taxpayers with very high taxable income would therefore be well advised to consider this strategy with their financial and tax advisors before the prescribed rate is set. 2% by the tax authorities.

Two imperatives to know about this strategy

If you have used the loan at a prescribed rate in the past, it is important to remember that the borrower must absolutely pay you the interest each year no later than 30 days after the end of the year. This rule is mandatory to ensure income splitting. It is not a question of adding interest to the balance of the loan, but of making a payment with proof (check or transfer) in support. Failure to comply with this rule would result in the attribution rules applying for the year of the missed payment and all subsequent years.

Finally, if you used the prescribed rate loan before the third quarter of 2020, the rate to use is still 2%. Avoid the temptation to repay the loan at the rate of 2% and redo the exercise at the current lower rate, since disposing of your investments would entail financial consequences (taxable capital gain, commissions to be paid after redemptions of
titles, etc). In addition, the mere fact of changing the prescribed rate to a lower rate would expose you to the application of the attribution rules by the tax authorities.

For all these reasons, the coming quarters could represent an interesting opportunity to implement this strategy for households with high taxable incomes or whose income gap is very large. Don’t forget that, to achieve this, you need personalized financial, tax and legal advice.

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