Enhanced Income Splitting Opportunity – Reduction in Prescribed Interest Rate

June 15, 2020

A prescribed rate loan (PRL) transaction represents a legitimate tax planning technique for more effective family tax planning.  Effective July 1, 2020, this tax planning method becomes a bit more enticing with the reduction in the Department of Finance’s prescribed interest rate from 2% to 1%.  Income splitting can be accomplished where a family member in a high tax bracket makes a prescribed rate loan to a family member in a lower tax bracket; the loan being subject to interest at the prescribed rate.  The recipient of the loan invests the borrowed money and earns investment income which forms part of his/her taxable income that would have otherwise been included as taxable income of the high tax bracket family member.  Interest is payable by the recipient of the loan calculated at the prescribed rate by January 30th of the following calendar year.  This interest received by the high tax bracket family member is included in his/her taxable income.

To illustrate this concept, assume a highest tax bracket Parent in Ontario makes a $100,000 prescribed rate loan to a minor child who has no other source of income. The loan is subject to an interest rate of 1% and assume the child earns 4% interest return on investment.  The following table illustrates the tax applicable pursuant to the prescribed rate loan strategy:

Interest income$1,000$4,000
Interest deductionNil$1,000
Net taxable income$1,000$3,000
Personal tax$530Nil

If the Parent in the above example did not make the $100,000 PRL to the Child, the Parent’s taxable income would have been $4,000 and the taxes payable thereon would have been $2,120 [$4,000 x 53%] as opposed to $530 under the PRL tax plan. The prescribed rate loan transaction will result in a tax savings of $1,590.

If you have any questions about a new or pre-existing prescribed rate loan, please reach out to your Bateman MacKay account manager or a member of our tax team.

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