Income splitting involves transfering income from the hands of a family member in a higher tax bracket to the hands of a second family member in a lower tax bracket so that the same income is taxed at a lower rate - or not at all if the second family member's income is low enough.
For example, if a taxpayer's spouse is in a lower tax bracket than he or she is, the higher income spouse can lend money to the lower income spouse to invest so that the investment income can be taxed in the lower income spouse's hands. To achieve this result, it's essential that the spouses have a written agreement that specifies the terms of repayment and an interest rate at least equal to the CRA's prescribed rate at the time.
The lower income spouse must pay interest on the loan annually by January 30 of the following year (a loan created by unpaid interest is not a payment of interest, under subsection 74.5(2)). If the interest is not paid, the investment income from the loan will be taxed in the hands of the higher income spouse.
Take advantage of 1% interest rate
The CRA's prescribed interest rate for family loans has gone back down to the lowest possible rate of 1% for the first quarter of 2014, after increasing to 2% for the fourth quarter of 2013. As a result, taxpayers who did not lock in interest rates on family loans at 1% before October 1, 2013 now have another chance to do so.
For more information, contact your KPMG adviser.
Information is current to January 14, 2014. The information contained in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's National Tax Centre at 416.777.8500