After over four years of having the prescribed interest rate at the lowest possible rate of 1%, this rate is expected to increase to 2% on April 1, 2018. The next few weeks is your final opportunity to arrange for investment income earned over 1% to be taxed in the hands of a lower income family member by making a loan to them at the Canada Revenue Agency (CRA) prescribed rate of 1%.

Generally, if you simply transfer assets to your spouse or a minor child, the investment income earned on such assets (interest, dividends, and if the recipient is your spouse, capital gains) is attributed to you for income tax purposes. You accordingly pay tax on such income at your marginal tax rate. To avoid the attribution of such income to you, you can make a loan to your spouse or to a trust for a minor child at the CRA prescribed interest rate in effect at the time of making the loan. If your spouse or the trust invests the borrowed money at a higher rate of return, you effectively shift the excess of the income earned over 1% to a lower income family member, who will be taxed at their lower marginal tax rates. Overall the family can achieve significant annual tax savings.

Furthermore, the prescribed rate applicable to such loans remains the rate in effect at the time the loan was made, no matter how much the prescribed rate may increase in the future. It is therefore possible to lock in the 1% rate for all loans made between now and March 31, 2018, for an indefinite period.

Locking in at CRA's prescribed rate of 1% provides a great opportunity to maximize the spread in investment returns that may be shifted to a lower income family member. Based on 2018 tax rates, annual income tax savings of up to $36,000 could theoretically be achieved for each family member who has no other taxable income or loss, although this high of a tax benefit would require yields significantly above market or several million dollars in capital. At a practical level, achieving a 3% yield (so a 2% spread) on a $1,000,000 loan would create about $9,000 of tax savings.

For this loan strategy to work, there must be a properly documented loan agreement which we recommend be drafted by your lawyer, and the annual loan interest must be paid for each year not later than 30 days after the end of the calendar year.

Note that with the 2017 proposed Tax on Split Income Rules, the borrowed funds should only be used to invest in arm’s length entities (publicly traded securities or properties with no related tenants or management). Investment income earned from related businesses could end up taxed at the highest personal tax rate eliminating all tax savings.