The prescribed rate of interest represents the interest rate used to calculate taxable benefits on low interest employee loans and loans between family members, amongst other tax matters. The historically low prescribed interest rate of 1% may see an increase on April 1, 2018. The prescribed rate is set each quarter based on the average 90-day Government of Canada Treasury Bill rate. Other than a 3 month increase during 2013, this rate has been unchanged from April 1, 2009 at 1%, which represents the lowest possible prescribed interest rate. Based on the average January T-bill yields of 1.185%, the prescribed rate of interest may increase to 2%. This increase in the prescribed interest rate would reduce the potential tax benefits of the prescribed rate loan strategy to income split amongst family members.
The prescribed rate loan income splitting strategy is for families where one spouse makes a much higher income than the other spouse (and/or children). The partner who has a higher income, and is taxed in a higher bracket, can loan money to the partner (and/or children) in the lower bracket to invest. The dividends from these investments will be taxed at the lower bracket rate, as long as the partner receiving the money pays interest on the loan at the prescribed rate. The tax rules surrounding loans to children are more complex; however, the income splitting objectives are similarly accomplished. To keep additional control over the loaned funds, one can also consider involving a family trust as a part of this strategy.
Those looking to take advantage of the current lower rate need to act by March 31, 2018. For loans established prior to April 1st, 2018 the 1% prescribed interest rate will still be apply. Subsequently, the rate may rise to 2%, effectively reducing the tax advantages of this strategy for at least the next quarter.
We invite you to reach out to your tax specialist at Bateman MacKay with any questions you may have about the income splitting strategy or if you are looking for advice on other tax matters.
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