With all that is going on in the world these days, it is difficult to keep up with what to do or not to do.
We are here to tell you that to act now, will be to your benefit when it comes to taking advantage of a tax planning opportunity that can save you money.
With costs and prices of almost everything soaring these days, why would Canada Revenue Agency (“CRA”) be any different? Effective July 1, 2022, CRA’s prescribed interest rate will increase from 1% to 2%. Happy birthday, eh?
Many readers may be thinking, what does this mean? Does a 1% increase really matter?
The prescribed rate of interest is a key component when implementing an income splitting strategy such as shifting income from an individual who is in a high tax bracket to a family member who is in a lower tax bracket. For any prescribed rate loan arrangements that are entered into before July 1, 2022, the current 1% rate will be locked-in, thereby securing an optimal family income splitting arrangement.
In order for this strategy to be beneficial, the borrower would need to be in a lower tax bracket than the lender and the invested funds would need to have a higher rate of return than the interest on the loan and any administrative fees. For example, let’s
assume Ms. X is in the highest personal tax bracket, has $1 million of cash to invest, and could earn taxable income of $60,000
annually from the investments. Rather than investing the funds in her name, she loans the $1 million to her spouse, Mr. Y, who is in the lowest personal tax bracket. At the time the loan is made, the prescribed rate of interest is 1%. Mr. Y uses the borrowed cash to invest to earn taxable income of $60,000 annually from the investments. Each year, Mr. Y would pay $10,000 of interest to his wife. The $10,000 of interest would be taxable income to Ms. X and subject to her high marginal rate of tax. Mr. Y on the other hand, would deduct the $10,000 of interest paid from his income. In addition, his taxable income would subject to tax at his low marginal rates. As a result, the family has a lower overall tax bill. With the prescribed rate of interest raising to 2%, the tax savings of such an arrangement is not as optimal.
Other Prescribed Rate Loan (“PRL”) Arrangements
While a PRL can be made directly to a family member, making a loan to a discretionary trust for the benefit of your family will also provide a number of additional advantages, including:
- flexibility in optimizing your family’s income in any given year;
- allowing the lender to maintain control over the investments, thereby providing a mechanism to access the funds if necessary; and
- providing for income splitting with current/future children or grandchildren.
For those who already have a PRL plan in place, you have until June 30, 2022 to expand the income splitting potential at the 1% rate by making additional loans.
We Are Here to Help
To maximize these tax benefits, interest payment terms and other loan arrangements and requirements must be properly
structured and satisfied. A key aspect of PRL planning is the ability to access sufficient personal funds in order to make the structure worthwhile. Taxpayers should seek professional advice in considering their options for personally accessing the required funds.
You have until June 30, 2022 to determine whether these income-splitting strategies are suitable for your situation and to implement an appropriate structure using this historically low prescribed rate of 1%! Please consult your Welch LLP advisor before it’s too late.