

Lower the family tax bill

Intra-family loans as an income-splitting strategy.

With grocery bills and house prices continuing their upward trajectory, budgets are tighter than ever. Most Canadian families might welcome any opportunity to keep a bit more of their hard-earned money in their bank accounts. A good place to look for cost savings is on the family tax bill, and one strategy in particular can lead to significant savings: the use of intra-family loans to split income.

The basics on income splitting

Income splitting involves transferring income from a high-income earner to a family member in a lower tax bracket. Because the lower-income individual is taxed at a lower marginal tax rate, the family pays less tax overall. However, the Canada Revenue Agency (CRA) restricts most forms of income splitting through the Income Tax Act’s attribution rules. A person can’t simply give their spouse $100,000 to invest and have the spouse declare the investment income in their tax return at their lower marginal tax rate. In such a situation, the investment income would be attributed back to the original individual and taxed at their higher marginal rate.

There are, however, a few legitimate and effective ways to split taxable income with a spouse or other family members. One of the most effective strategies in a low interest rate environment is through a loan directly to a family member or, where minors are involved, to a family trust. Provided the loan is properly structured, the recipient can invest the proceeds from the loan, with the income taxed at a lower marginal rate. Of course, one of the keys to a successful income-splitting strategy is to make sure that investment returns are higher than the interest rate charged on the loan.[1]

Interest rates and deadlines

Intra-family investment loans most commonly involve a loan between spouses, either married or common-law. But this strategy can also be effective for funding the expenses of minor children, such as private school or extracurricular activities, through a prescribed-rate loan to a family trust with the minor children as beneficiaries. It’s a good idea to have a formal written loan agreement in place. For this strategy to work, the following criteria must be met:

  • Interest must be paid on the loan at a rate that’s at least equal to the CRA’s prescribed rate (updated quarterly). If the commercial loan rate is lower than the prescribed rate at the time the loan is made, this lower commercial rate can be used. You can find the CRA’s current prescribed rates here
  • In order to be compliant with the CRA’s attribution rules, annual interest payments must be made to the lender no later than January 30 of the following year. Failure to do so may result in the income earned on the borrowed funds being attributed back to the high-income earner. And as a result, the income splitting strategy will no longer work. 

Already have a prescribed-rate loan?

Locking in current low interest rates may seem very attractive. But what if you and your spouse already implemented this strategy in the past when the prescribed rate was higher? You can still take advantage of the current lower rate to increase your tax savings opportunities. First, your spouse will need to repay the existing loan – it’s not enough to just re-sign the loan agreement. To repay the existing loan, investments may have to be sold, which may result in capital gains. However, any gains would be taxed to your spouse and, therefore, the tax would be less than if you held the investment yourself. You can then arrange a new loan at the current lower rate and new investments can be purchased.

Making it work – an example

Spouses John and Jill are in different tax brackets – John at 48 per cent and Jill at 20 per cent. John loans Jill $200,000 at a prescribed rate of one per cent.[2] Jill invests the money and earns four per cent, or $8,000. She then pays John the $2,000 loan interest and deducts the same amount as loan interest expense. Jill pays $1,200 in tax on the remaining $6,000, and John pays $960 on his interest income. 

Here’s how it stacks up: 

  • John would have had to pay $3,840 in taxes had he invested the $200,000 himself. 
  • By loaning the money to Jill for the purpose of income splitting, the family tax bill is reduced by approximately 44 per cent to $2,160, representing savings of $1,680. 

Take action 

Income splitting can be a great tax-saving strategy for families that have a pool of non-registered capital that they’re willing to invest, and where a spouse or other family member is in a lower marginal tax bracket. To take advantage of income splitting, speak with your advisor, who can walk you through the necessary steps. 



[1] If either the lender or borrower is a U.S. person (a U.S. citizen, U.S. resident or U.S. green card holder), this strategy can have adverse U.S. tax consequences. Please speak to your advisor before undertaking this strategy.

[2] This is a fictional scenario for illustration purposes only. Effective July 1, 2020, the CRA prescribed rate is one per cent.

Financial Advisor Websites by Twenty Over Ten Powered by Twenty Over Ten