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Now is the Time to Seriously Consider Prescribed Rate Loans

When the Tax on Split Income (TOSI) rules were first announced in July 2017, some tax experts declared that it was the death of tax planning. While it’s true that the TOSI rules dramatically altered the landscape for income splitting with family members, prescribed rate loans remain a highly effective tax planning strategy.

How it Works
Prescribed rate loans involve a family member in a high-income tax bracket making a loan to a lower-income family member such as a spouse or a minor child through a family trust. The interest rate that gets charged is the prescribed rate of interest which is set by the Canada Revenue Agency (“CRA”) each quarter.

The interest rate used in prescribed rate loans is significant since it avoids a “deemed benefit” when there are non-arm’s length parties involved. In the Canadian tax system, income or gains can be attributed back to the original transferor when trying to income split with a spouse or minor child. However, there is an exception to this rule if the funds are loaned at the prescribed rate in effect at the time the loan is made and interest is paid annually no later than 30 days after the end of the calendar year.

There should be a written agreement to support the loan with the prescribed interest rate clearly stated at the time the loan is made.

After each year that the loan is outstanding, the lender will report the interest income on their personal tax return and the borrower will claim an interest deduction on their tax return.

Why Now?
Since July 1, 2020, the prescribed rate for non-arm’s length loans has been 1% which is historically low. On July 1, 2022, the prescribed rate is set to increase to 2%. Although this rate is still quite low, now is the time to seriously consider making a prescribed rate loan.

The Benefit
Each Canadian resident individual gets their own set of graduated tax rates up to $221,708 (in 2022) of taxable income each year.

If an individual has taxable income over $221,708 and other family members earn significantly less income, this presents an opportunity to realize absolute tax savings.

In order for the family unit to come out ahead, the rate of return on the funds invested from the loan must exceed the prescribed rate of interest (currently 1%) that is charged on the loan.

What if I already have a Prescribed Rate Loan?
You may already have an existing prescribed rate loan that has an interest rate higher than 1%. In order to take advantage of the current rate, you would need to refinance the loan. The family member that borrowed the funds would need to sell the investments and repay the original loan in full to the lender. At that point, the family member can enter into a completely new loan agreement using the 1% prescribed rate.

Before undertaking a refinancing strategy, you need to be aware of the income tax implications that will arise when the investments are sold.

Prescribed Rate Loan – Example 1

Spouse A currently receives $300,000 per year in salary. Spouse A is married to Spouse B who currently receives $50,000 per year in salary. Spouse A decides to loan $500,000 to Spouse B on June 1, 2022 to invest in marketable securities. Since the loan is made during the second calendar quarter of 2022, Spouse A is permitted to charge an interest rate of 1%. This interest rate can remain in effect for the entire duration of the loan, irrespective of whether the prescribed rate of interest is increased by the CRA.

Spouse B receives $35,000 of Canadian public company dividends on an annualized basis. Spouse B will pay approximately $2,800 in Federal and Provincial income taxes and have an effective tax rate of 7.96% on this investment income.

If Spouse A were to receive $35,000 of Canadian public company dividends on an annualized basis, Spouse A would pay approximately $13,800 in Federal and Provincial income taxes and have an effective tax rate of 39.34% on this investment income.

In order to avoid attribution, Spouse B would need to pay $5,000 (i.e., $500,000 x 1%) of interest on the loan from Spouse A no later than January 30, 2023. This amount would get included in the income of Spouse A for 2022 and be deducted as an investment expense for Spouse B for 2022.

On an annualized basis, Spouse B will pay approximately $1,100 in Federal and Provincial income taxes after deducting the $5,000 of investment expenses from the $35,000 of investment income received. Spouse A will pay approximately $2,700 in Federal and Provincial income taxes on the $5,000 of interest income received. Overall, the family has saved approximately $10,000 per year in Federal and Provincial income taxes by undertaking this prescribed rate loan.

Prescribed Rate Loan – Example 2

Parent A currently receives $300,000 per year in salary. Parent A has two minor children, Child B and Child C. Neither child receives any income. Parent A decides to create a Family Trust where Child B and Child C are beneficiaries. Parent A loans $500,000 to the Family Trust on June 1, 2022 to invest in marketable securities. Since the loan is made during the second calendar quarter of 2022, Parent A is permitted to charge an interest rate of 1%. This interest rate can remain in effect for the entire duration of the loan, irrespective of whether the prescribed rate of interest is increased by the CRA.

The Family Trust receives $35,000 of interest income from marketable securities on an annualized basis. The trustees decide to allocate $15,000 to each of Child B and Child C following the $5,000 payment of interest on the loan. Child B and Child C will each pay approximately $100 in Federal and Provincial income taxes and have an effective tax rate of 0.60% on this investment income.

If Parent A were to receive $35,000 of interest income from marketable securities on an annualized basis, Parent A would pay approximately $18,700 in Federal and Provincial income taxes and have an effective tax rate of 53.53% on this investment income.

In order to avoid attribution, the Family Trust would need to pay $5,000 (i.e., $500,000 x 1%) of interest on the loan from Parent A no later than January 30, 2023. This amount would get included in the income of Parent A for 2022 and be deducted as an investment expense for the Family Trust for 2022.

On an annualized basis, Parent A will pay approximately $2,700 in Federal and Provincial income taxes on the $5,000 of interest income received. Overall, the family has saved approximately $15,800 per year in Federal and Provincial income taxes by undertaking this prescribed rate loan.

If you are interested in finding out if a prescribed rate loan makes sense for your family, please feel free to contact us.

Written by Principal-Taxation, Daniel Wilson CPA, CA from Segal LLP.

2022 Federal Budget Commentary

On April 7, 2022, the Canadian government released the federal budget for 2022.

This budget was widely anticipated to have increased tax rates and additional new taxes as well as rules that would stop some tax planning that had been going on.

The good news is that there were no changes to income tax rates.  More specifically, there was no change to capital gains rates.  A lot of planning had been going on before the budget in anticipation of an increased capital gains tax rate.  Fortunately, that did not happen.

There was a change to the taxation of the sale of principal residences.  If a taxpayer buys and sells a property within 12 months, the capital gain would not be sheltered by the principal residence exemption subject to some allowances that allow for unexpected personal situations. The sale of the property, will be treated as business income and will be fully taxable (not at the 50% inclusion rate).

The most substantial change is the new rules on how non-CCPC’s will be taxed.

Please download our budget commentary and a more detailed listing of the budget highlights.

Segal Summary and Budget Highlights

If you have any questions, please do not hesitate to contact your Segal tax advisor.

Best regards,
Segal Tax Team

Canadian Overview – First Quarter 2022

This issue includes contributions from Segal LLP, Mowbrey Gil LLP, and DMCL. These pieces were produced as a part of the quarterly Canadian Overview, a newsletter produced by the Canadian member firms of Moore North America.

Senior Tax Specialist

Segal LLP is a rapidly growing mid-size accounting, tax and business advisory firm headquartered in midtown Toronto. Segal is committed to growth by investing in our team, providing continuous learning and a positive, supportive work environment all with a focus on providing clients best in class client service.

As a member of our Tax Team, you will advise our clients on corporate and personal tax planning, deferral strategies, financing structures, employee compensation, owner-managed remuneration or a range of other complex tax issues. You will have the opportunity to resolve client issues directly with the client, the CRA and other government or regulatory agencies.

Responsibilities

  • Work with partners and the tax team on client engagements and deliverables, and practice development initiatives.
  • Support Partners, Principals and Managers in all aspects of personal and corporate tax initiatives
  • Prepare notices of objection for corporate and personal clients and negotiate the same with the Appeals Division.
  • Prepare/review complex tax returns (T1, T2, and T3 returns) and tax elections as required.
  • Mentor, train, and delegate work to junior team members in the Tax team.
  • Research tax issues
  • Prepare calculations to support tax analysis

Qualifications

  • CPA designation; ideally enrolment in, the CICA In-Depth or M. Tax.
  • Bachelor’s Degree (or equivalent experience) from an accredited institution in Accounting, Business Administration, or related field.
  • Ability to prepare effective research and planning memos independently and as part of a team.
  • Tax experience working with owner-managed clients. This would include experience in preparing T1, T2, T3 and T5013 tax returns. Experience with T4, T5 and NR slip preparation.
  • Experience with Non-Resident filing requirements in Canada would be an asset.
  • Excellent understanding of basic tax concepts and files.
  • Strong interpersonal and relationship building skills.
  • Team player with a positive ‘can do’ approach.
  • Creative problem-solving ability.
  • Excellent verbal and written communication skills
  • Working proficiency in Microsoft Suite including Word, Excel, PowerPoint, is essential.
  • Be organized and able to meet multiple project deadlines while being detail oriented.
  • Strong commitment to professional client service excellence

This position represents a significant opportunity for those looking to advance their career by playing a major role in a growing organization, and who have the curiosity and interest in exposure to a broad range of clients, industries, and assignments.

To submit your resume for this position, please contact us by email here.

Tax Supervisor

Segal LLP is a rapidly growing mid-size accounting, tax and business advisory firm headquartered in midtown Toronto. Segal is committed to growth by investing in our team, providing continuous learning and a positive, supportive entrepreneurial work environment all with a focus on providing clients best in class client service.

As a member of our Tax Team, you will advise our clients by contributing to strategic tax planning and client management initiatives. As Tax Supervisor, you’ll work as part of a team to collaborate, design, and solve complex business issues from strategy to execution.

Responsibilities

  • Participate in income tax planning engagements
  • Participate tax planning memos including reorganizations, estate planning, cross border structures
  • Prepare detailed tax analysis on tax issues
  • Review complete corporate, personal, trust and partnership returns
  • Work with both the tax group partners and accounting/auditing group partners
  • Work efficiently and effectively within client engagement parameters and prioritize and balance multiple files
  • Supervise a team, delegate tasks, and promote teamwork
  • Mentor, train, and delegate work to junior team members in the Tax team
  • Participate in the training of staff to support their growth, knowledge, and professional development

Qualifications

  • CPA designation
  • Completion of at least Year 1 of the CPA Canada In-Depth Tax Program or Master of Taxation
  • Strong technical background in Canadian income tax; experience with corporate tax return preparation and review, tax research, and drafting letters would be considered an asset
  • Experience with Non-Resident filing requirements in Canada would be an asset
  • Ability to prepare effective research and planning memos independently and as part of a team
  • Can work under pressure, be decisive, exercise good judgment and common sense
  • Working proficiency in Microsoft Suite including Word, Excel, PowerPoint, is essential
  • Experience with Caseware and TaxPrep (or similar tax preparation software) is expected
  • Ability to recognize and analyze problems, propose sound alternatives and conclusions
  • Strong interpersonal and relationship building skills and a demonstrated ability to develop and nurture strong relationships with clients
  • Excellent verbal and written communication skills
  • Team player with a positive ‘can do’ approach
  • Creative problem-solving ability
  • Organized and able to meet multiple project deadlines while being detail oriented
  • Strong commitment to professional client service excellence

This position represents a significant opportunity for those looking to advance their career by playing a major role in a growing organization, and who have the curiosity and interest in exposure to a broad range of clients, industries, and assignments.

To submit your resume for this position, please contact us by email here.