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By Jeffrey Roy CPA,CA

When discussing personal taxes, most people worry about the amount of tax they pay individually. At Vulcan Investments, we ask clients to consider the amount of tax the entire family pays. With Canada’s graduated rate income tax regime, higher income family members pay more tax than lower income members. An income splitting strategy is a permitted method of lowering the family tax burden.

In fact, this strategy can be used between any adult family member (grand-parents, uncles, etc.) or common-law relative. Splitting income with children (less than 18 years old) is possible, but there are limits and rules on the type of income that can be split.

The plan often implemented by our clients is a cash loan to the lower income earning adult and the proceeds immediately used to invest in publicly traded marketable securities that produce dividend and/or interest income with possible capital appreciation.  

For implementation, the higher income family member (the person giving the loan) must have the lower income family member (the person receiving the loan) sign a demand loan agreement that documents:

  1. Borrower name;
    1. Lender name;
    1. Interest rate (rate cannot be lower than the prescribed rate set quarterly by the Canada Revenue Agency (“CRA”));
    1. Amount of the principal borrowed and
    1. Date of the loan.

As a business transaction, the lending spouse/adult must report the interest received as income on their personal tax return and the borrowing spouse/adult claim a deduction for the interest paid in their personal tax return for the same period.

The interest owed must be paid annually by January 30 of each year; if any payments are missed the strategy is offside and can be challenged by the CRA.

The benefit materializes when there is income in “excess” of the annual interest payment such that the lower income spouse/adult pays tax at their lower marginal tax rates. The benefit compounds by reinvesting the excess income instead of spending this amount.

We strongly recommend that the lower income adult never draw down on the capital (the funds borrowed). Drawing down on the borrowed funds could leave the borrower with insufficient funds to repay the loan at maturity.

There are many instruments that clients can invest in. In fact, the Vulcan Intrinsic Value Portfolio is the perfect investment when seeking; a) stability, b) dividend income and c) long-term capital appreciation. With our low fee structure, clients are positioned to quickly achieve “excess” faster than at other asset managers.

If you are considering this simple and easy to implement strategy, please feel free to contact Vulcan Investments for a personal consultation.  We can even share a suggested outline for the demand loan agreement.