When it comes to income splitting in Canada, understanding the impact of attribution rules is crucial. The Income Tax Act of Canada has specific provisions to prevent income splitting opportunities, but prescribed rate loans offer a viable tax planning tool. By utilizing a promissory note and adhering to the prescribed interest rate, individuals can effectively reduce their overall family tax bill while complying with the law. In this blog post, we will explore the intricacies of prescribed rate loans and how to leverage promissory notes for income splitting, considering the impact of attribution rules.
Understanding Attribution Rules and Prescribed Rate Loans
Income attribution rules in Canada prevent individuals from gifting or loaning funds to a spouse, common-law partner, or children without charging interest. If interest is not charged or if the interest rate is less than the prescribed rate, any investment income or capital gains earned on those funds would be attributed back to the lender for tax purposes, effectively nullifying income splitting opportunities. However, by using a prescribed rate loan with a promissory note, individuals can navigate these rules and achieve effective tax planning.
Working Mechanism of Prescribed Rate Loans
Prescribed rate loans are initiated when an individual loans money to their lower-income spouse or common-law partner, adult child, or an investment trust. The loan is documented through a promissory note, with interest charged at the prescribed rate in effect at the time of the loan. The borrower then invests the funds, earning investment income or capital gains.
Compliance and Documentation
To ensure compliance with attribution rules, certain requirements must be met. The interest on the prescribed rate loan must be paid to the lender by January 30th of the following year. Failure to meet this deadline would render the loan ineligible for exemption from attribution rules in the specific year and subsequent years, leading to all investment income and potentially capital gains being attributed back to the lender.
What is the CRA's prescribed rate of interest?
The CRA's prescribed rate is 5% from July 1, 2023 to September 30, 2023. The prescribed rate is set each quarter by the CRA and published on their website.
The prescribed rate is based on the average 90-day Government of Canada T-bill rate for the first month of the previous quarter.
Writing a Promissory Note for a Prescribed Rate Loan
LegalDeeds offers a convenient solution for writing a promissory note tailored to meet the specific requirements outlined by CRA for prescribed rate loans. Simply provide the loan terms, and LegalDeeds will generate a legally compliant promissory note to facilitate your income splitting strategy. Best of all, LegalDeeds promissory notes are available for just $5, making them a cost-effective option for those engaged in DIY financial planning.