Refinancing of Prescribed Rate Loan—Income Splitting
The overall tax savings related to this strategy are partially diminished by the amount of tax you pay at a high rate on interest included in your income paid on the prescribed rate loan (let’s call it Loan 1). In accordance with the relevant tax rules, the interest rate on Loan 1 is equal to the prescribed rate at the time the loan was made (X%). The prescribed rate is currently 1% (the current prescribed rate of 1% is the lowest the rate can possibly go, unless the yield on government of Canada treasury bills becomes zero or negative). If Loan 1 was refinanced to simply lower the interest rate on the loan to the current prescribed rate, the applicable exception from the attribution rules would cease to apply and income on the investments purchased with Loan 1 would be attributed back to you and taxed at your high tax rate. Unfortunately, the same result would arise if you were to loan [X] a new amount (Loan 2) at the current lower prescribed rate, and [X] used the proceeds to repay Loan 1.
There is, however, a way to reduce the interest rate on the outstanding loan to the current prescribed rate without the attribution rules applying. Note that this strategy may trigger some initial taxes depending on the investments held by [X].
Example:
Assume a low-income child (Child) has a prescribed rate loan at 2% for $100,000 (Loan 1) that is due to a high-income parent (Parent). The borrowed money was used to purchase shares for $100,000. The shares now have a value of $125,000. Child wants to refinance the loan at the current prescribed rate of 1%. To achieve the refinancing, Child sells 80% of the shares currently held and uses the proceeds to repay Loan 1. Child then borrows $100,000 from Parent at the prescribed rate of 1% (Loan 2). The proceeds of Loan 2 are used to purchase new securities for $100,000 (the same shares can be purchased, except that if a loss was triggered on a sale of certain shares, Child must wait 30 days before repurchasing those shares or the loss will not be available to offset gains that may have been triggered on other shares sold). In the above scenario, the CRA has confirmed that:
the attribution rules will not apply to the shares that are still owned by Child that were purchased with Loan 1, and
the attribution rules will not apply to the investments purchased with Loan 2.
For more information, please contact info@gytdcpa.com or 1 844-GYTD-CPA
GYTDCPA.com-Refinancing of Prescribed Rate Loan—Income Splitting
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