While it is possible for one spouse to split certain types of pension income with the other spouse by simply making an annual election on one’s tax return to do so, this potential income-splitting benefit does not apply to other sorts of income. It is possible, though, to transfer income from a spouse at a high tax bracket to one at a lower bracket. This can be done through the mechanism of a spousal loan.
The so-called “attribution rules” in the Income Tax Act, with respect to spouses, provide that where property is transferred or loaned, directly or indirectly, from one spouse to another, then all income or capital gain arising from that property will be attributed back to the spouse who transferred or loaned the property. This attribution of income and gains continues year after year. So even though a transaction has in fact been made, and assets have actually been moved from one spouse to the other, the tax rules look through the transaction and tax income and gains as if that transaction had never taken place.
As is often the case, there is an “exception to the rule”, and it is one thing that is easy and straightforward to put into place. The high bracket spouse simply transfers a portion of his or her portfolio to the lower bracket spouse in return for a promissory note for the value of the transferred assets. The income and gains arising from the transferred assets then, in the future, are taxed in the hands of the low bracket spouse. The best part about putting this strategy into place is that it’s easy and there is no direct cost involved (note, though, that the initial transfer could result in the triggering of capital gains or losses)
All that’s required is proper documentation and the actual payment of interest on the promissory note each year. Interest must be declared as income by the recipient spouse, but can be deducted by the paying spouse as interest on an investment loan. The rate of interest charged on the loan cannot be less than the CRA “prescribed rate”, which is currently 1%. That rate has never before been this low, and it cannot go any lower. As well, even if the prescribed rate increases in the future (which it almost certainly will), once the rate for your spousal loan is established, it is fixed and cannot go higher.
Clearly, not everyone can benefit from a spousal loan. But for those couples who find themselves in a situation where one spouse is in a lower (preferably much lower) tax bracket than the other, considerable tax savings can be realized every year. The greater the tax bracket disparity, the greater the benefit. Over the longer term, this can add up to tens of thousands of dollars going into your pocket, rather than the government’s.
Unlike, say, establishing a trust or setting up a holding company as tax reduction strategies, putting a spousal loan into place does not involve legal or accounting fees, incorporation expenses, additional tax returns and so forth. All that is necessary is that you play the game strictly by the rules. Document the loan with a promissory note, make the 1% interest payment annually and make sure that the recipient spouse reports that income on his or her tax return each year.
Adopting this strategy allows you to maintain the same investment portfolio that you had before. It simply puts it in a much more favourable tax environment. Again, this strategy is not for everyone. But it does make sense to consider whether it might be right for you.
President, HG Partners Limited
Director, Private Client Group &
Senior Financial Advisor,
HollisWealth Advisory Services Inc.
This article was prepared solely by Howard Goodman who is a registered representative of HollisWealth Advisory Services Inc. (a member of the Mutual Fund Dealers Association of Canada and the MFDA Investor Protection Corporation). The views and opinions, including any recommendations, expressed in this article are those of Howard Goodman alone and they are not those of HollisWealth Advisory Services Inc.
HollisWealth is a trade name of HollisWealth Advisory Services Inc. ® Registered trademark of The Bank of Nova Scotia, used under license.
HG Partners Limited is an independent company. Scotiabank companies have no liability for activities outside of HollisWealth.