In Canada personal income is taxed based on graduated tax rates. This means tax rate increases as taxable income goes up.
To minimize their taxable income many individuals utilize a strategy known as income splitting. With income splitting a high-income earner transfers certain income to a family member with lower or no income. This arrangement eventually results in a lower tax liability for the family as a whole.
There are numerous income splitting strategies available to taxpayers, including pension splitting, spousal RRSP, and transferring and gifting property to a family member with low or no income.
Here we discuss the attribution rules relating to transferring and gifting of property to a family member with low or no income and the specific transfers allowed under the income tax act.
Attribution rules
Attribution rules apply when a high-income earner transfers or gifts property to a low-income family member at an interest rate lower than CRA’s prescribed rate. Thereafter, if the recipient family member uses the transferred or gifted property to pursue investment opportunities, any related investment income and/or capital gain will be “attributed” back to the high-income earner. The specific rules as to whether investment income and/or capital gain will be attributed back to the high-income earner depends on to whom the property was transferred or gifted. These are the applicable rules:
- Transfer or gift to a spouse or common-law partner: investment income and capital gain resulting from the property will be attributed back to the spouse transferring or gifting the property.
- Transfer or gift to a minor (i.e., a son, daughter, niece or nephew, or other minor child not at arm’s length): investment income will be attributed back to the person transferring or gifting the property while the minor would pay tax on capital gain.
Lend at CRA’s prescribed rate
Our discussion above might lead to the belief that there is no tax benefit in transferring or gifting property to a family member with lower income. To the contrary, this belief is not entirely accurate.
To realize optimal tax saving the key is to charge the related person (i.e., spouse/common law partner or minor child) an interest rate equal to CRA’s prescribed interest rate. Making a loan at this rate does not cause the investment income and capital gain to be attributed back to the high-income earner. Instead, investment income and capital gain is taxed in the hands of the lower income family member, who in turn pays tax at a lower rate. Ultimately, this strategy lowers the family’s overall tax liability.
To minimize tax liability, consider making the loan to the family member when CRA’s prescribed rate is low.
Related link: CRA's prescribed rates
For professional accounting & tax advice contact Alpha Accountzy, Accounting & Tax Solutions.
