Lower Your Family’s Tax Burden With A Prescribed Rate Loan

Lower Your Family’s Tax Burden With A Prescribed Rate Loan

The Canadian Income Tax Act contains attribution rules which prohibit a taxpayer from income splitting with their spouse and certain other family members. Where the attribution rules apply, income earned by the higher income family member is taxed in the hands of that individual, resulting in a higher tax bill for the family unit.

The concept of a prescribed rate loan is to satisfy certain requirements to avoid the application of the attributions rules. If properly implemented and administered, a prescribed rate loan allows a taxpayer to split income with their family members to take advantage of their lower income tax brackets, reducing overall taxes for the family.

This strategy allows a taxpayer to shift dividend income and capital gains realized on public company securities to a spouse, adult children, or even minor children or grandchildren. This strategy can be implemented between two individuals or through an intervivos family trust. Where there are multiple low income family members to which loans can be made, the use of a family trust can be very advantageous.

The strategy is ideal for high- rate taxpayers that have capital available to invest in a passive investment portfolio. In the absence of any further planning, the high-rate taxpayer would invest the cash and earn investment income that would be taxable to that taxpayer.

The prescribed rate loan strategy requires a loan from the higher income taxpayer to the lower income taxpayer or to a trust at an interest rate equal to the Canada Revenue Agency (CRA’s) prescribed interest rate at the time the loan is made.

The CRA’s prescribed interest rate is currently 1% (as of January 1, 2021. Updated quarterly), which makes this strategy particularly attractive right now. If the prescribed rate increases in a future quarter, the effective interest rate on the outstanding prescribed rate loan remains the same as when the loan commenced. The interest on the loan must be paid no later than 30 days after the taxation year (by January 30th) in order maintain the integrity of the planning and avoid the application of the attribution rules.

The timing and payment of this interest is critical. The interest charged on the loan is an income inclusion for the taxpayer making the loan and a deduction for the taxpayer receiving the loan. The proceeds of the loan are invested by the lower income taxpayer or by a trust and allocated to multiple lower income beneficiaries, effectively splitting the income and taking advantage of lower graduated tax rates.

Consider the following scenario for illustrative purposes:

Leslie and Dale are married and have three children. Leslie earns $330,000 of employment income each year. Dale’s income is less consistent, and generally earns $30,000 on average. Leslie and Dale’s two oldest children are enrolled in post secondary education and have no income. Leslie and Dale are assisting the children with their education, cost approximately $25,000, per child, each year.

Leslie has $750,000 of cash available to earn passive investment income. Assume an annual rate of return on investment of 8%, or $60,000 in 2021. For simplicity sake, lets assume the character of the income earned is public company dividends.


In this example, the family save approximately $19,000 per year by holding the investments in a trust and distributing the income among the family members.

In addition to the absolute tax savings associated with using a trust for prescribed rate loan planning, there may be estate planning benefits as well. The growth on the investment accrues within the trust while maintaining control of the assets, allowing for efficient future asset distributions to beneficiaries, where appropriate.

This also allows the application of the deemed disposition rules that could apply to trigger tax on any accrued gains on investments held by the taxpayer in the event of their death to be avoided.

Contact Us

If you are interested in this type of planning, we would be pleased to review your situation to determine its merit in your specific circumstances and to tailor and implement this strategy to benefit you and your family.

Give us a call for more information about this article at (613) 235-2000 or send an email to info@hwllp.ca


Our goal is to provide updates on topical accounting and tax issues. Information contained in this article is not meant to be a comprehensive summary of the issues raised. Rather, we wish to bring what we believe to be important issues to the attention of our valued clients and readers. We would be pleased to discuss any questions that you, the reader, might have in greater detail.

Testimonial from Rob Waterman - President at Waterman Sales Ltd.

We have been in Business since 1992 and had an accountant who was a family friend. When he retired, we needed to find a new accountant. Jacob at Hendry Warren was recommended to us through our Lawyer. We met with him and were impressed immediately; over the years we have gotten to know more of the staff and are equally impressed. They have done our company taxes, company valuations, share purchases, tax planning, covid relief, personal taxes, etc. All of which have gone very smoothly. Hendry Warren is aware of new legislation and has helped us grow as a company.

Rob Waterman (President at Waterman Sales Ltd.)
Testimonial from Lynn LaHam - CPA, CGA, Crossroads Children’s Centre

Hendry Warren is a very professional organization who are very sensitive to client needs and timelines. Marie Fraser and all of the staff that I have met and worked with exhibit the same degree of courtesy and professionalism. It is always a pleasure working with them.

Lynn LaHam ( CPA, CGA, Crossroads Children’s Centre)
Testimonial from Chris Jerome, Treasurer - Habitat for Humanity – National Capital Region

Hendry Warren LLP has been easy to work with, dependable, personable and professional and are always available when we need them. The annual audit process is efficient and timely and their staff is always knowledgeable and well prepared.

Chris Jerome, Treasurer (Habitat for Humanity – National Capital Region)
Testimonial from Don Silverman - CFO Sciemetric

From the partners to the new graduates, the quality of service and advice were second to none…we rely heavily on the advice we are given from both an audit and tax perspective…I know that our firm can count on Hendry Warren LLP to be accurate, timely and professional at all times.

Don Silverman (CFO Sciemetric)
Testimonial from Gordon Miller - President, UNIGLOBE Premiere Travel

In every instance where advice or assistance has been needed it has been provided with clarity and timeliness. And with a very satisfactory outcome. Our accounting staff have always appreciated the efficiency of Hendry-Warren team assigned to our audits and review engagements. We appreciate that Hendry-Warren LLP is able to support our needs as a paperless group of companies.

Gordon Miller (President, UNIGLOBE Premiere Travel)
Testimonial from Les Bell, - CPA, CA, President, Lincoln Heights Ford Sales Ltd.

Ian Hendry is a truly responsive and responsible partner in our business and has been for over 20 years. I would (and have) recommend his services to everyone.

Les Bell, (CPA, CA, President, Lincoln Heights Ford Sales Ltd.)
Testimonial from Colin Goodfellow - field_5cebff5066bfc

I have used Marie Fraser and her team at Hendry Warren for business, personal and special projects. Deep enough bench strength to cover anything, and small enough to pay attention.

Colin Goodfellow (field_5cebff5066bfc)
Testimonial from Rupert Bonham-Carter - field_5cebff5066bfc

Jacob has been invaluable over the past 18 months in assisting with the incorporation and start-up of my new business venture. I trust Jacob's advice on complicated income tax and HST matters to allow me to focus on what is most important - my business!

Rupert Bonham-Carter (field_5cebff5066bfc)
previous arrowprevious arrow
next arrownext arrow
PlayPause

Interested in Working with HWLLP?

How can we help you achieve your business and financial goals?

Share a few details and we'll schedule a call!

Request a Call