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Financial Information
Loan to Lower Income Spouse or Child

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Personal Income Tax  ->  Income Splitting -> Lend money to your spouse or child

Lend Money to Your Spouse or Child

Income Tax Act s. 74.5(2), Income Tax Regulations s. 4301(c)

If one spouse is in a higher tax bracket, it may be beneficial to lend money to the lower-income spouse.  Money can also be loaned to a child.  The funds can be used to purchase investments, and tax on the investment income will be paid by the lower-income spouse at a lower marginal rate.  A promissory note should be written for the loan, with the interest rate and principal amount specified.  Interest must be paid on the loan by January 30th of each year.  In order for attribution rules to not be applied, the interest rate charged must be greater than or equal to the lesser of:

     - the prescribed rate set by Canada Revenue Agency (CRA) at the time the loan is made, or

     -  the rate that would, having regard to all the circumstances, have been agreed on, at the time the loan was made, between parties dealing with each other at armís length.

The prescribed rates are subject to revision each calendar quarter, and can be found on the CRA prescribed interest rates page.  The rate to use is the one for calculating taxable benefits from low-interest and interest-free loans to employees and shareholders.  This rate was reduced from 2% to 1% effective April 1, 2009.  The rate doubled to 2% for the period of October 1 to December 31, 2013.  Any loans created from October 1 to December 31, 2013 will use the 2% rate throughout the loan.  The rate was reduced to 1% effective January 1, 2014, and continues to be 1% until at least September 30, 2017.

The interest received by the lender must be included in income, but is deductible as carrying charges by the borrower, as long as a loan agreement has been drawn up so that there is a legal obligation for the borrower to pay the interest.

Example for Ontario residents:

bulletMr. A earns employment income of $80,000 per year.
bulletMrs. A earns $34,000 per year.
bulletMr. A has accumulated savings of $100,000, he and Mrs. A have no debt, he has used his maximum RRSP contribution room, and he would like to purchase investments outside of RRSPs.
bulletMr. A lends the $100,000 to Mrs. A on January 1, 2012.
bulletA promissory note is written up, specifying that the loan is made at the current prescribed interest rate of 1%.
bulletMrs. A invests the $100,000 in Canadian stocks yielding 10% (3% dividend, 7% capital gain).
bulletCanadian dividend income of $3,000 in 2013 is reported by Mrs. A on her 2012 tax return, which equates to $4,140 of taxable income because Canadian dividends are grossed-up by 38% to include in income.  The dividends are eligible for the enhanced dividend tax credit.
bulletMrs. A pays $1,000 (1%) interest expense to Mr. A on December 31, 2012.  This interest expense is deducted  on line 221of Mrs. A's 2012 tax return.
bulletMrs. A's taxable income is $37,140 (34,000 + 4,140 - 1,000).
bulletMr. A includes the $1,000 interest income on line 121 of his 2012 tax return.
bulletMr. A's taxable income is $81,000 (80,000 + 1,000).
bullet$360 in tax is saved by Mrs. A investing the $100,000 instead of Mr. A, assuming the Canadian stocks are not sold.
bulletIf the Canadian stocks are sold at the end of 2012 and 7% capital gain realized, $954 in tax is saved due to Mrs. A having the capital gain ($3,500 taxable) and dividends instead of Mr. A.

Disadvantages:

bulletThe interest on the loan for the prior year must actually be paid by Mrs. A to Mr. A by January 30th of each year, or the income from the investments will be included in Mr. A's income.
bulletIf Mrs. A has capital losses from her investments, the interest still must be paid (although Mr. A could gift Mrs. A the funds to pay the interest).
bulletVery little tax is saved even when $100,000 is invested.  The savings would be even less with a 2% prescribed rate instead of 1%.

See our article on attribution rules re gifts, transfers or loans to a spouse or related minor child.

Tax Tips:
        - Maximize RRSPs (especially spousal for the lower income spouse)
        - Carefully check your own circumstances, and get professional advice
        - The lending to spouse strategy saves very little tax if $100,000 or less is invested.

Revised: September 21, 2017

 

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