If you have a prescribed rate loan as an income-splitting arrangement, with either a family member or with a family trust, the deadline to repay the 2023 interest on the loan is January 30, 2024. It is vital that the interest is paid in cash as failure to do so would cause the loss of the exemption from the attribution rules for not only that year, but all subsequent years. Given the increase in the prescribed rate to 6% as of 2024 Q1, individuals that were able to ‘lock-in’ a low prescribed rate need to preserve the tax beneficial arrangement by ensuring the interest is paid before the deadline.
What is a Prescribed Rate Loan Family Trust?
A prescribed rate loan family trust is a structure that can be used to implement an income-splitting strategy to help reduce your family’s combined tax liability. If structured properly, this strategy will allow a high-income parent to split income with their low-income family members through a prescribed rate loan lent to a family trust. The beneficiaries of the family trust could include your spouse, children, and grandchildren. The investment income earned in the family trust from the prescribed rate loan can be shared among the lower-income family members to achieve overall tax savings for the family. The income allocated to children can be used to pay for private school tuition, camp fees and other expenses.
Attribution Rules
The Income Tax Act contains certain income “attribution” rules to prevent family income splitting in various scenarios. If applicable, these rules will attribute taxable income back to the family member that provided cash for the investment, eliminating the benefits of income splitting. The attribution rules can generally be avoided if the funds advanced to the family member or a family trust are through a loan with an interest rate not less than the prescribed rate set by the CRA.
How Prescribed Rate Loan Family Trusts Work
A prescribed rate loan is established when funds are advanced by a family member (the lender) to a family trust (the borrower) using a formal written loan agreement at an interest rate that is at least equal to the CRA’s prescribed rate in effect at the time the loan is established. The CRA sets the prescribed interest rate every quarter and the current prescribed rate for Q1 of 2024 is 6%. Once the loan is established, the prescribed rate is maintained for the life of the loan regardless of any subsequent increases to the prescribed rate. The family trust must pay interest to the lender at the CRA’s prescribed rate on or before January 30th of the following year. If payment is made late for any year, the prescribed rate loan family trust will lose its exemption from the attribution rules for not only that year, but all subsequent years.
The investment income earned by the trust from the advanced funds can be allocated to the beneficiaries of the family trust and taxed at their respective marginal tax rate. The lender will include the interest received as income on his or her tax return. The interest paid by the trust is deductible by the family trust as investment expenses.
GG Comments
Although the CRA prescribed rate is currently at its highest at 6% compared to recent years, the prescribed rate loan can still be a viable strategy depending on the rate of return you can get on the funds advanced. If you implemented the prescribed rate loan strategy previously and were able to ‘lock-in’ a lower rate, it is important that the interest on the loan is paid (in cash) by the January 30, 2024 deadline to preserve the benefits of the strategy.
If you are looking to take advantage of the prescribed rate loan strategy, Grewal Guyatt has extensive experience in assisting clients with the implementation and administration of prescribed rate loan family trusts. For more information, please contact our tax team.
