Income Splitting Post-Morneau’s Tax Proposals (Part I)

A prescribed rate loan strategy allows high-income earners to income split with their family members (spouses, children, grandchildren, etc.) who earn income taxed at a lower marginal tax rate or earn no income at all.   The strategy requires the high-income individual to make a loan directly (or indirectly through a trust) to one or more family members.  Commonly, a family trust is settled for the benefit of the family members and the loan is made to the trust.


In order to avoid the application of attribution rules (which cause the income earned on the loaned funds to be taxed in the high-income earner’s return) the loan must bear interest of at least the prescribed rate (hence the name “prescribed rate loan”).  The current prescribed rate is 1%, however, the rate is updated every quarter.  The rate is based on the average rate of 90-day treasury bills sold during the first month of the previous quarter.  In April 2018, the prescribed rate is set to increase to 2%.  This increase may reduce the tax savings that would have otherwise been available had the loan been made while the rate was still at 1%.  This will be the first increase in the rate since the fourth quarter of 2013. As recently as 2007, the prescribed rate was as high as 5%.   Implementing this strategy prior the rate increase is ideal.


How it Works


The borrower (individual family member or family trust) invests the funds received from the loan and any income earned in excess of the prescribed rate is taxed at a lower marginal rate.  The tax-saving opportunity lies in the spread between the prescribed rate and the rate of return on the invested funds.  Once the loan is made, it bears interest at the prescribed rate (set at the time of the loan) for the entire duration of the loan.  In other words, a loan made before April 1, 2018 will bear interest at 1% without regard to future prescribed rate increases.


The prescribed rate of interest must actually be paid for the year to the lender (the high-income earner) by January 30th of the following year (eg, interest owing for a loan in 2018 must be paid by January 30, 2019).  If that payment is missed, the attribution rules will apply and the benefits of the planning will be compromised.


There are no restrictions on the amount of the loan or the term of the loan.




Mr. Jones, who is in the highest tax bracket, loans Mrs. Jones, who is in the lowest bracket, $300,000 at the (current) prescribed rate of 1%.  Mrs. Jones invests and earns a yield of 5% ($15,000).  She takes $3,000 of the $15,000 and pays interest on the loan to Mr. Jones (which is taxable to Mr. Jones and tax deductible to Mrs. Jones).  The net savings is the $12,000 taxed in the name of Mrs. Jones at the lowest rate.  If Mr. Jones’ tax rate is 53.53% and Mrs. Jones’ is 20.05%, Mr. and Mrs. Jones save $4,017.60 in tax by having the $12,000 taxed in Mrs. Jones’ name.  Click here for  a diagram of the structure using a trust.