If you have family income splitting loans, remember to pay lenders the 2022 interest on these loans by January 30, 2023 to avoid having the attribution rules apply to investment income earned on the borrowed funds.
Background
Taxpayers may want to consider entering into income splitting loan arrangements with family members or a family trust, where the family member or family trust can invest the borrowed funds at a higher rate of return than the CRA’s prescribed interest rate at the time the loan is entered into. If properly implemented, taxpayers can effectively arrange for all investment income earned over the CRA’s prescribed interest rate to be taxed at the lower-income-earning family member’s tax rate while the loan is outstanding. However, before entering into a prescribed loan arrangement with a trust, taxpayers should confirm that the complex tax on split income (TOSI) rules do not apply.
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 the spouses 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 must pay interest on the loan annually by January 30 of the following year (note that a loan created by unpaid interest is not a payment of interest). If the interest is not paid by the following January 30, 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.
Prescribed rate set to rise January 1, 2023
Although the CRA’s prescribed rate was at its lowest possible level of 1% from July 1, 2020 to June 30, 2022, the rate has since increased each quarter beginning July 1, 2022 and is set to rise again to 4% (from 3%) starting on January 1, 2023 until at least March 31, 2023. As a result, taxpayers that are considering entering into prescribed loan arrangements now, should do so before January 1, 2023 to benefit from the CRA’s 3% prescribed interest rate.
For more information, contact your local KPMG adviser.
Information is current to December 19, 2022. The information contained in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's National Tax Centre at 416.777.8500
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