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It’s Prime Time For Income Splitting

Lock in the CRA’s low prescribed interest rate for non-arm's length loans to benefit from income splitting with family members

Low interest rates make it an ideal time to arrange non-arm’s length loans for in-family income splitting. In fact, you may never get a better opportunity.

When was the last time you could borrow money for a scant 1%? Well, that’s the interest rate prescribed by the Canada Revenue Agency (CRA) for non-arm’s length loans since April 1, 2009 (remains 1% as of Fall 2014).

Non-arm’s length loans are usually made to a spouse, child or grandchild as a tool for splitting income between a high-tax-rate earner and a low-tax-rate earner.

A prescribed rate of 1% means that in the current calendar quarter, you could lend your spouse money and charge him or her only 1% on the loan.

If your spouse is also the low-income earner in the family, he or she might be able to reinvest the funds for a higher return than the 1% being paid on the loan – and pay less tax than you would on the income earned.


Investment by high-income spouse $100,000
Assumed earned interest at 4% $4,000
Tax on $4000 @ 45% $1,800
Total after family tax income on $100,000 investment $2,200


That’s what income splitting is all about: movement of invested money and the income it generates from a high-income earner to a family member in a lower or zero tax bracket. Such a move makes a substantial difference in family taxes if income on, say, a $100,000 investment is taxed at a low (combined federal/provincial) tax rate of 23% instead of the top marginal tax rate at around 45%.

The tables show just how big a difference this strategy can make assuming the long-term bond rate of 4%.

The critical issue on non-arm’s length loans is that CRA’s prescribed rate of interest must be paid no more than 30 days after the end of each year for which the loan is outstanding. If interest is not paid before this deadline, the investment income is attributable back to the high-income spouse.


High income spouse Income Income Low income spouse
Lends $100,000
to low-income spouse
    Low income spouse
invests $100,000
    $4,000 Assume investment earns
interest @ 4%
  $1,000   Low income spouse pays
interest of 1% on loan of $100,000
Total income on investment of
income for high income spouse
$1,000 $3,000 Net income after deducting
interest expense for low-income spouse
Tax on $2,000 at 45% $450 $690 Tax on $3,000 at 23%
After-tax income on investment $550 $2,310 After-tax income on investment


Total family income from investment after tax $550 + $2,310 = $2,860

This income attribution rule is what makes non-arm’s length loans necessary in the first place.

You can’t just give your low-tax bracket spouse $100,000 and let him or her claim the income generated. That income is attributed back to you and you pay tax on it at your high marginal rate.

The same applies with a child or grandchild under age 18. Almost the only exceptions are transfers by bequest (via a will) or from donors who are non-residents of Canada.

To avoid attribution, you must go through the loan procedure and use the prescribed rate.

The good news is that the rate can be locked in. If the loan is made now, while the CRA prescribed rate is 1%, this rate can be left unchanged for as long as the loan exists.

In other word, you have an opportunity to lock in an extremely low rate for a long time. It makes no difference if CRA’s prescribed rate rises in subsequent quarters. The rate in force when the loan was made continues to apply indefinitely.

The prescribed rate is set quarterly by CRA and follows fluctuations in other interest rates. Since the second quarter in 2009 the prescribed rate has remained constant.  That could be as good as it gets. If a Bank of Canada prediction of interest rate increases holds true, CRA’s prescribed interest rate may begin to rise in the near future.

As a general income-splitting rule, it is better for the low-tax bracket spouse to apply as much of his or her after-tax earnings as possible to generating investment income. Preserving that investment power is a priority that often means that most, if not all, non-deductible family expenses should be absorbed by the high-income spouse.

This strategy might also include the high-income earner paying taxes for the low-income earner, making contributions to a spousal RRSP, and allowing the low-income spouse to claim all family tax credits such as medical costs and charitable donations.

By its very nature, the success of income splitting depends greatly on early and coordinated tax planning. Both spouses should start their tax planning at the beginning of each tax year and, ideally, use the services of the same tax advisor.