The Canada Revenue Agency does not encourage income splitting. In fact, they have specific policies against it, such as the Attribution Rules, meant to enforce the idea that whoever earns the income pays the tax on the income.
Simply stated, the Attribution Rules say that when you transfer or loan property to your spouse (or to a trust in which your spouse has a beneficial interest), any income or loss from that property is deemed to be yours for a taxation year – effectively preventing you from splitting your income with your spouse by giving them money.
(You can read the details about the Attribution Rules in the Canada Revenue Agency’s http://www.cra-arc.gc.ca/E/pub/tp/it511r/README.html IT511R – Interspousal and Certain Other Transfers and Loans of Property.)
However, one way you can split your income with your spouse is to loan them money to purchase property from you or to purchase an income producing investment such as stocks, bonds or mutual funds.
What You Have to Do to Use This Strategy Effectively
1) Make sure the loan is properly documented just like any other loan, and includes repayment terms.
2) Charge interest that’s at least equal to the Canada Revenue Agency’s prescribed rate. Currently this interest rate is one percent! This rate may be locked in until the loan is paid.
3) Make sure the lower-income spouse who receives the loan pays the interest that is due on the loan every year or within 30 days of the end of the year. A missed payment will cause the Attribution Rules to kick in and the income generated by the lent money to be attributed back to the higher-earning spouse who lent the money that year and in all future years.
How Spousal Loans Work Tax-Wise
For you to end up with a lower overall tax bill between the two of you, the money you lend your spouse has to make a return greater than the prescribed rate – and you have a really good chance of your investment doing this with a prescribed rate as low as it is.
And there is no requirement to pay back the principal, only the interest.
The lending spouse has to include the interest as income on his tax return but if the loan was used to purchase income-producing investments such as stocks, the spouse who received the loan will get to deduct the interest paid on theirs.