Spousal Loans

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(Thursday, February 04, 2010)

Spousal Loans

Many taxpayers are not aware of the spousal attribution rules in the Income Tax Act. Basically, if you loan or gift property to your spouse, any income earned by that property is taxed in your hands, not your spouse’s hands. This includes any capital gain when the property is disposed of. Property includes cash, so if your spouse invests money received from you as a gift, the attribution rules apply.

There is an exception to the attribution rules that is particularly attractive right now, due to the very low interest rates in effect. If money is loaned to a spouse, and interest is charged at a rate equal to or above the prescribed rate, then the attribution rules do not apply. The current prescribed interest rate for low interest rate loans is 1%, which offers an opportunity to split income between spouses and realize tax savings.

The really attractive part of loaning money between spouses in this way is that the exception to the attribution rules is based on the prescribed interest rate at the time of the loan. This means that as long as the money is loaned at the rate in effect at the time of the loan, future changes to the prescribed interest rate do not matter. So, if a loan is made at 1% in 2009 (or the first quarter of 2010), the interest rate can remain at 1% for the life of the loan, which may be many years.

There are several points to keep in mind if you want to avoid the spousal attribution rules.

1) The loan should be documented – having a lawyer draw up a promissory note that specifies the terms of the loan would be prudent.

2) The loan interest has to be calculated on a calendar year basis, that is from January 1 to December 31.

3) Most important, loan interest must be paid, it cannot be accrued and added to the loan balance. Payment must be made within 30 days of the year end. This means payment must be made by January 30, not January 31.

The spouse loaning the money will have to declare the interest earned on the loan on their tax return, while the spouse receiving the money can deduct the interest paid.

Before you loan money to your spouse for investment purposes, talk to you tax accountant and make sure you are not subject to attribution for income taxes.