Spousal Loan Strategy – 1% But For How Long!!??

In Canada, the taxation of married or common law partners is still based on an individual basis.  There are some tax credits that are couple or family based (a good listing of available tax tips for couples is found here http://www.fcac-acfc.gc.ca/eng/consumers/lifeevents/couple/manage/taxes_couples-eng.asp), but fundamentally each member of a couple is taxed individually.  For couples that have one spouse with significantly higher taxable income than the other, and where the higher income spouse earns or may in the future earn taxable investment income, a Spousal Loan Strategy may be a good fit.

In a Spousal Loan Strategy, the higher income spouse loans monies to the lower-income spouse at the prescribed rate of tax in Canada (currently 1%).  The lower income spouse takes the loan proceeds and makes an investment (typically marketable securities, but can also be rental properties or other investments that make taxable investment income).  The higher income spouse must report the interest earned on the spousal loan as interest income.  However, the lower income spouse can deduct this loan interest for tax purposes, where they have used to the loan proceeds to earn taxable investment income.  Where properly implemented, any profit earned on the spousal loan can be taxed in the hands of the lower income spouse, without any negative impact from a set of tax rules designed to prevent income splitting (income attribution rules).

For example, let’s assume an investment can pay a 5% investment return to a couple.  If the higher income spouse invests his/her accumulated cash in that investment, the 5% is taxed in that spouse’s hands at a higher marginal tax rate.  Instead, if that spouse uses a Spousal Loan Strategy property, the higher income spouse only reports 1% on their tax return, and the lower income spouse reports 4% (5% return less 1% paid to higher income spouse).  If there is a significant difference in the marginal tax rates applicable for a couple, this strategy can have quite a bit of benefit annually.

What makes the Spousal Loan Strategy even more preferred is that the current prescribed rate that must be charged for interest can be maintained indefinitely!   So even if interest rates rise in the future, a properly implemented and maintained Spousal Loan Strategy can continue to charge only 1%!!

Since April 1, 2009, Canadian taxpayers have been able to take advantage of a 1% prescribed rate for a Spousal Loan Strategy.  However, the prescribed rates are priced quarterly based on the average yield of the Government of Canada 90-day Treasury Bills, rounded to the next highest percentage point.  It is anticipated that as of October 1, 2013, the prescribed rate will be increased to 2%.

Canadians have until September 30, 2013 to put in place all lending agreements, and to have a tax professional review the implementation, in order to lock-in the 1% Spousal Loan Strategy.

If you think the Spousal Loan Strategy may be a fit for you, contact me at 604-789-3888 or marco@mgfadvisory.ca.