Tax Alert – Prescribed Rate Loan Planning

A prescribed rate loan is a planning tool that can be beneficial when one spouse is in a very high tax bracket and the other spouse is in a low tax bracket.  It can also be advantageous in situations where a properly structured family trust has been created as part of the family tax planning.

This planning is implemented by having the high-income spouse loan funds to the low-income spouse, or the family trust, at the prescribed interest rate under a formal loan arrangement.  The recipient of the loan uses the funds to invest and earns income from the investments.  The interest on the loan is deductible to the payer and taxable to the recipient.  A benefit arises where the low-income spouse, or family trust, earns a return on the investments that exceeds the interest on the loan.  However only the investment income from certain types of investment income can be distributed from the family trust to the beneficiaries in a tax efficient manner.

The prescribed interest rate is published by the Canada Revenue Agency and is currently 1%.  Effective July 1, 2022, the prescribed interest rate will be increasing to 2%. Since the interest rate on the loan must be at least equal to the prescribed interest rate, on the day the loan is made, the timing is right if you are considering making a prescribed rate loan to your spouse or to a family trust.

A prescribed rate loan is created with a formal written loan agreement between the high-income spouse and the low-income spouse or between the high-income spouse and the family trust. The interest on the loan must be paid within 30 days of the calendar year.

Please contact us as soon as possible if you would like to learn more about the prescribed rate loan planning.  If you want to make a loan at the current 1% prescribed rate, the loan must be documented, and the funds must be moved, prior to July 1, 2022.

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Statistics as of 2018