Spousal Loan Strategies

By: James Parkyn

As of April 1, 2009, Canada Revenue Agency (CRA)’s prescribed interest rate for spousal loans dropped to 1%, the lowest level it has been in over 20 years.

Significant taxes can be saved over time when a higher income spouse lends money or investments to a lower income spouse.  For example, suppose that Marcel lends his wife Julie $100,000 to invest. Over the course of the year, Julie earns a 6% return, or $6,000. As long as Julie pays Marcel $1,000 in interest (1% of $100,000), the $6,000 return will be taxed at a lower rate in her hands. While Marcel will have to pay tax on the $1,000 interest income, this same amount will be deductible to Julie as an investment expense.  If you already have a spousal loan in place at a higher interest rate, you may be wondering if you can reduce the rate to 1%. This has to be done very carefully in order not to run afoul of CRA’s attribution rules. You cannot simply agree to a lower interest rate on the loan, nor can you repay the loan with a new prescribed rate loan.

There are two possible ways of proceeding:

1. Liquidate the investment portfolio and use the proceeds to repay the loan.
2. Take a bank loan, using the existing investments as collateral, to repay the loan.

Once the loan has been repaid, you can then set up a new spousal loan at the current prescribed rate.