Accountants often call the income splitting rules attribution rules. The term attribution simply means to attribute income back to the original person and effectively stop any attempt to income split.
Who Do The Income Splitting Rules Apply To?
The rules that are designed to prevent income splitting apply when you attempt to shift income to any one of the following people:
- Your spouse or common law partner,
- Any person who is under age 18 and are your children, grandchildren, nieces and nephews.
- Any person you are not dealing with at arms length, and
The rules are applied differently for each type of person listed above.
Income Splitting Between Spouses
The income splitting rules were designed to prevent you from giving your money or using a joint account to split income. If you do transfer property (for example, stocks) to your spouse directly or indirectly, the Income Tax Act says:
- The transfer is at your original cost, and
- All income and future gains will continue to be taxed your hands.
In the end, there is no tax when you transfer ownership and you continue to pay the tax just as you always had.
As luck would have it, you can still income split with your spouse if:
- Your spouse purchases the property from you with their own funds and at fair market value.
- You lend the funds to your spouse to purchase the property from you. The loan must be documented with repayment terms. Interest at the prescribed rate must be paid within 30 days of the end of the year. Of course, you include the interest as income on your tax return but your spouse can deduct the interest paid on their tax return provided the loan was used to buy income-producing investments such as stocks.
Income Splitting With Children
The income splitting rules are a little different when it comes to children under the age of 18. As mentioned above, these rules apply if you give or lend income producing property such as stocks or other investments to a minor who is your child, grandchild, niece or nephew.
When you transfer property to a minor, the Income Tax Act says:
- The transfer is deemed to be at fair market value, and
- You will continue to be taxed on income such as interest, dividends, rents and royalties, until the child is 18.
When you give or transfer property to a child, you will have a capital gain or loss and all future gains and loses are taxed to the child. However, you still have to pay tax on the investment income until the child turns 18.
You can get around the investment income attribution if the child purchases the property from you at fair market value and pays with their own funds. In this case, all of the taxes going forward are taxed in the childs’ hands.
Tax on Split Income (Kiddie Tax)
The so-called kiddie tax was introduced to reduce some of the benefits of other types of arrangements such as family trusts by applying the top marginal tax rate to all income. In addition, this income is also not eligible for deductions or tax credits (other than the dividend tax credit).
There are a number of pitfalls that can result from these types of arrangements and professional advice should be sought.
Secondary Income Can Be Split
When the income splitting rules do apply, they will only affect the first generation received from the initial transfer. Income earned from reinvestment of the first generation income is not subject to the attribution rules.
For example, if $1,000 of interest was subject to the income splitting rules and taxed in your hands, then income earned from the re-investment of the $1,000 would not.
Other Rules Affecting Income Splitting
- If a spouse or minor child has an existing commercial rate loan, a new loan or interest free loan cannot be substituted.
- The Income tax Act does not permit funds to be lent to an unrelated third party who then lends the funds to the spouse or related minor.
- A loan guarantee cannot be used to avoid the income splitting rules. A higher income spouse cannot avoid the rules by providing a loan guarantee on a low rate or interest free loan to a spouse.
- There is a variety of other rules in the Canadian Income tax act designed to prevent income splitting through a trust or corporation.
Questions About Income Splitting?
If you have a question about this article, please feel free to leave a comment in the box below. Your comments and questions are welcome and help others.
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Assume a non-resident couple where the non-working spouse takes ownership of money that is earned while non-resident. Would attribtuion rules apply on the income after becoming residents in the future. Seems most Canadians ignore it and there hasn’t been any tax court cases that I can find.
The attribution rules under the Income Tax Act, subsection 74.2(1) do not apply if the transferor was not a resident of Canada. However, at the point the where the transferor becomes a resident of Canada, the attribution rules may apply. The facts are generally outlined in a 1999 technical interpretation bulletin. If you have access to CRA technical interpretation bulletins, the document number is 1999-0013435 (E).
Hello, Tax Guy:
For the income split, I have a question about how it works: assume that my annual income of $100k, my spause stays home without income. I lend her $50k for investment. When filling tax return form, should I claim my income as $50k + the interest from my lending money to my spause, or I still have to report $100k?
Thanks for your help.
Regards,
Joe
@ Joe:
If your spouse invests the money you have lent, then the tax will be on the investment income and not the loan. In your example above, you make $100k and lend $50k to your spouse, you still pay tax on $100,000.
If you lent your spouse $50,000 and took back a promissory note with a stated interest rate at the prescribed rate, then you must declare the interest you receive from your spouse from the note (x% of $50k). Your spouse invests the $50,000 and is taxed on the investment income from that $50k and will also be able to deduct the interest paid to you.