Income Splitting Is Getting More Expensive…..Again.

The Canada Revenue Agency’s prescribed rate of interest will increase from 2% to 3% on October 1, 2022.


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 trust is settled for the benefit of the family members and the loan is made to the trust, which in turn invests the funds.


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 2%, however, the rate is updated every quarter.  The rate is based on a formula that ties into the average rate of 90-day treasury bills sold during the first month of the previous quarter


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 and there are no repayment terms required on the loan. In other words, a loan made before October 1, 2022 will bear interest at 2% without regard to future prescribed rate increases.  Any loan made on or after October 1, 2022 (and before the first quarter of 2023) would be subject to the 3% prescribed rate, resluting in less tax savings overall.


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 2022 must be paid by January 30, 2023).  If that payment is missed, the attribution rules will apply and the benefits of the planning will be compromised.




Mr. Jones, who is in the highest tax bracket, loans the Jones Family Trust (with minor children as beneficiaries who otherwise have no income), $300,000 at the (current) prescribed rate of 2%.  The Jones Family Trust invests the $300,000 and earns a yield of 5% ($15,000).  The trust pays $6,000 of the $15,000 income to Mr. Jones as interest (which is taxable to Mr. Jones and tax deductible to the Jones Family Trust).  The net amount of $9,000 is allocated to the low income beneficiaries of the trust (kids in this example but could also include a spouse) who pay no additional tax on that income.  The net effect is that 3,200 of tax has been paid  by Mr. Jones on $15,000 of investment income.  Had Mr. Jones earned the $15,000 of income directly he would have been subject to $8,000 of tax.   This represents a tax savings of $4,800. This tax savings (and potentially more savings) is achieved every year  throughout the during of the loan assuming the trust continues to invest the $300,000 of funds.