If you transfer or gift funds to your spouse or common law partner, any interest, dividends or capital gains earned on those funds will continue to be taxed in your hands. If you are interested in finding out how attribution works between married couple, please see my What Are The Canadian Income Splitting Rules? article.
Although stock prices have recovered somewhat since March 2009 lows, prices still remain low compared to 2008. In addition, we have seen interest rates at all time lows and in particular, the Canada Revenue Agency’s (CRA) prescribed rate for family loans has been set at 1% as of the second quarter of 2009.
Avoid Attribution With A Spousal Loan
You can avoid the attribution of income back to you by lending your spouse money he or she can then use to invest in stock, bonds, mutual funds or any other income producing investment. You the take a note back with a stated rate of interest, the prescribed rate at 1%, and as long as your spouse pays you the interest on the loan, from their own funds, within 30 days of the end of each year, there will be no attribution.
For more information on how the loans works, see my article from last year called Income Splitting Using Loans To Your Spouse.
What is the Big Deal With 1% and Low Stock Prices?
Whenever you borrow money you look for the lowest rate, right? Who wants to pay more interest? The 1% allows you to lock in a low rate until the loan is paid … And there is no requirement to pay the principal back, only the interest.
You must pay tax on the 1% interest your spouse pays you. If the goal is to shift income from you to your spouse, the lower the rate of interest, the better.
Your spouse can deduct the 1% interest from his or her income. If your spouse’s portfolio generates more than 1% in interest and dividends, the loan interest is fully covered both from attribution and cash flow perspectives.
The process will also allow your spouse to acquire investments at what could still be considered bargain prices.
There are three things to remember when using the spousal loan strategy:
- Document the loan with a promissory note. Include that date, amount lent, and rate of the loan.
- Try to lend cash as opposed to stock or other investments. Lending investments cash trigger capital gains or result in denied capital losses (see below).
- Ensure your rate of return on the investments is higher than the precribed rate of interest.
Watch Out For Superficial Loss Rules
One final note: If you plan on lending stocks to your spouse, any capital gain is fully taxable but the superficial loss rules apply if there was a loss. For more on superficial losses see Superficial Losses: Gains & Loss on Identical Properties.