If there was ever a time that you would want to consider using spousal loans, this is it. The current prescribed rate on a spousal loan is 1%, which is the lowest the prescribed rate has ever been. This is really as good as it gets, because the formula used to calculate the rate (average 90-day treasury bill rate, rounded up to the next full percent), would not allow it to go any lower than this.

This is truly an excellent opportunity to set up a long-term spousal loan at the amazingly low rate of 1%.
To get a better understanding of how this strategy can work, let’s consider an example. Let’s assume that John loans his wife Lucy, $100,000, and Lucy earns $5,000 on this investment over the year. She pays John $1,000 (1% of the $100,000 loan) in loan interest and pays tax on the remaining $4,000. Jack in turn, will pay tax on the $1,000 loan interest received from Lucy. Based on Ontario tax rates, this couple could save over $1,000 per year by having the $4,000 investment income taxed at the lowest tax bracket rather than the highest.

While the current historically low level of the prescribed rate charged on spousal loans is a new phenomenon, spousal loans are not a new strategy themselves and have been around for a while. In case you have already set up a spousal loan in the past when the prescribed rate was 3% or 4% and are wondering if you can adjust the rate to the new 1% rate going forward, unfortunately the answer is definitely not.

In order not to run afoul of Canada Revenue Agency, it would be in your best interests to sell the investments to pay off the existing loan. If you have capital gains on those investments, this would of course mean incurring the capital gains and having to pay tax on those gains. Then, you will need to start a brand new spousal loan from scratch and use the services of a lawyer to draw up a new promissory note based on the current prescribed rate.

As always, you should consult your financial advisor, accountant and lawyer before taking any action on implementing this strategy.

26 Comments for this entry

• Allan Madan January 31st, 2010 on 8:58 pm

  I agree with you. As a Chartered Accountant in Toronto, I can tell you that loaning funds for investment purposes to a spouse at the prescribed rate of interest is an excellent income splitting strategy.

  However, you must ensure that a proper loan agreement is in place to evidence the transaction.

  In addition, interest on the loan must be paid by no later than January 30 of the following year.

  The lending spouse should include the interest received as income, and the recipient spouse can deduct the interest paid on their tax return.

  About the Author

  Allan Madan is a Chartered Accountant in Toronto & Mississauga. As a Toronto Accountant, Allan provides advice to employees, business owners, corporations, and the self employed.

  To learn more about Madan Chartered Accountant in Toronto & Mississauga, please visit http://madanca.com

  You can also view Madan Chartered Accountant’s blog at http://madanca.com/blog
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