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Tax Planning
Reduce Your Taxes With A Prescribed Rate Loan
Under
our tax system, the more you earn, the more you pay in income taxes on
each incremental dollar earned. With this in mind, it makes sense to
spread income among family members who are taxed at lower marginal rates
in order to lower your family’s overall tax burden. However, the income
attribution rules can prevent most income splitting strategies where
there has been a transfer to a spouse or minor child for the purpose of
earning investment income. The attribution rules transfer the taxation
of investment income (and capital gains in the case of a gift to a
spouse) back to the person who made the gift regardless of whose name is
on the investment. While there are significant restrictions, there are
still a number of legitimate income-splitting strategies available to
you.
Prescribed Rate Loan
A simple, yet effective
income-splitting strategy involves transferring income-generating assets
(ideally cash) to a lower-income spouse (or other family member) and
taking back a loan (equal to the fair market value of the assets
transferred) at the Canada Revenue Agency’s (CRA) prescribed interest
rate in effect at the time of the loan. Given the CRA’s recent
announcement to further decrease the prescribed rates for the second
quarter of 2009, implementation of this strategy as of April 1 presents a
very compelling opportunity. For loans made to a family member, the
rate necessary to avoid the income attribution rules is decreasing from
2% to only 1% effective for loans made between April 1 and June 30, 2009
– an all-time low for CRA’s prescribed rate. Most importantly, if
structured properly the prescribed rate in effect at the time of the
loan, will continue to apply until the loan is repaid, regardless of
future changes to the prescribed rates. For loans made after June 30,
2009, the CRA’s prescribed rate at the time of the loan will apply.
How it Works
Briefly
stated, an interest-bearing loan is made from the person in the higher
marginal tax bracket to a family member (such as a spouse) in a lower
tax bracket for the purpose of investing. To avoid the income
attribution rules there are a number of requirements that must be met.
For example, as outlined above, interest must be charged at a rate at
least equal to the CRA’s prescribed rate in effect at the time the loan
is made. Interest is charged annually at this rate and must be paid by
the following January 30th each year.In order for there to be a net
benefit, the annual realized rate of return on the borrowed funds must
exceed the annual interest rate charged on the loan, which is included
in the income of the transferor and should be deductible to the
transferee family member, if used for investment purposes. By locking in
this strategy at this low rate, long-term benefits of income-splitting
can be achieved to the extent future investment returns exceed this low
1% threshold. The impact of increased income to the transferee family
member (e.g. loss of spousal tax credit) should also be considered
before employing this strategy. Finally, it is important to consider the
possible recognition of capital gains or capital losses, which may be
denied, when assets other than cash are loaned or transferred to a
family member.
Given the complexity of the income attribution rules,
you should consult with your tax and legal advisors to review and
structure any income splitting strategies to ensure that the strategies
are implemented and documented correctly and achieve the desired results
without any unanticipated implications.
Disclaimer:
™/®
Trade-marks / registered trade-marks of Bank of Montreal, used under
license. If you are already a client of BMO Nesbitt Burns, please
contact your Investment Advisor for more information. BMO Nesbitt Burns
Inc. and BMO Nesbitt Burns Ltée provide this commentary to clients for
informational purposes only. The information contained herein is based
on sources that we believe to be reliable, but is not guaranteed by us,
may be incomplete or may change without notice. The comments included in
this document are general in nature, and professional advice regarding
an individual’s particular position should be obtained. BMO Nesbitt
Burns Inc. and BMO Nesbitt Burns Ltée are indirect subsidiaries of Bank
of Montreal and Member CIPF. "BMO (M-bar Roundel symbol)” is a
registered trademark of Bank of Montreal, used under licence. "Nesbitt
Burns” is a registered trademark of BMO Nesbitt Burns Corporation
Limited, used under licence. The comments included in the publication
are not intended to be a definitive analysis of tax law: The comments
contained herein are general in nature and professional advice regarding
an individual’s particular tax position should be attained in respect
of any person’s specific circumstances.