If you have any family income splitting loans, it’s important that you make sure that the 2020 interest on these loans is paid to lenders by January 30th, 2021, in order to avoid having the attribution rules apply to investment income earned on the borrowed funds.
The CRA’s low prescribed interest rate offers taxpayers an opportunity to enter into income splitting loan arrangements with family members (or a family trust).
Take, for example, if a taxpayer’s spouse is in a lower tax bracket, the higher income spouse can lend money to the lower-income spouse to invest so that the investment income can be taxed in the lower-income spouse’s hands. To achieve this result, it is essential that they have a written agreement that specifies the repayment terms and an interest rate at least equal to the CRA’s prescribed rate at the time of the loan.
The lower-income spouse will then need to pay interest on the loan annually by January 30th of the following year. If the interest is not paid by the following January 30th, the investment income from the borrowed funds will be taxed in the hands of the higher income spouse for that year and all future years.
Note that the CRA’s prescribed interest rate has been 1% since July 1st, 2020, and it will remain at this rate until at least March 31st, 2021. Family loans entered into during this period should be subject to the 1% prescribed rate.