Prescribed Rate Drop

Advisor's Edge

2013-11-07


If you missed the deadline to get your prescribed rate income splitting loan in place before it doubled to 2% from 1% last month, you’ve lucked out as the prescribed rate is scheduled to drop back down to 1% on January 1, 2014.

The prescribed rate is set by the Canada Revenue Agency quarterly and is tied directly to the yield on Government of Canada 90-day Treasury Bills, albeit with a lag. The calculation is based on a formula in the Income Tax Act regulations which takes the simple average of three-month Treasury bills for the first month of the preceding quarter rounded up to the next highest whole percentage point.

To calculate the rate for the upcoming quarter (January to March 2014), we go back to the first month of the current quarter (October) and take the average of October’s T-Bill yields, which were 0.959% (October 9) and 0.9149% (October 23). That average is 0.937% but when rounded up to the nearest whole percentage point, we get 1% for the new prescribed rate for the upcoming quarter.

In a typical income splitting loan strategy, a high income spouse loans funds at the prescribed rate to their lower income spouse. The investment returns less the tax deductible interest on the spousal loan can then be taxed in the lower spouse’s hands.

The advantage of advancing a loan when the prescribed rate is low is that under the tax rules, to avoid the income being attributed back to the higher income spouse, you need only use the prescribed rate in effect at the time the loan was originally extended. In other words, if you hold off until January 1st, and establish the loan during the first quarter of 2014 when the prescribed rate is 1%, you can use that rate for the duration of the loan, which could be unlimited if there is no fixed term and it is simply a demand loan.

Prescribed rate loans can also be used to help fund minor children’s expenses, such as paying for private school and extracurricular activities, by making a prescribed rate loan to a family trust.

The rates can be found online at: http://www.fin.gc.ca/admin/len/rcr-trc-eng.asp