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So, if the loan is made at the prescribed rate of one per cent, the net effect will generally be to have any investment return generated above one per cent taxed in the hands of the lower-income family member. Note that even though the prescribed rate varies by quarter and may ultimately rise, one need only use the prescribed rate in effect at the time the loan was originally extended. In other words, if the loan is extended between now and the end of March 2021, the lower one per cent rate would be locked in for the duration of the loan without being affected by any future rate increases.
But, let’s say you entered into a prescribed-rate loan with a family member when the rate was two per cent (or higher) and you want to refinance the loan at one per cent. The CRA has stated that simply repaying a higher prescribed rate loan with a lower rate loan could trigger the attribution rules on the investment income.
Instead, the lower-income family member should sell the investments (which could trigger capital gains tax, depending on the market value of the investments compared to their tax cost), and repay the loan. They can then enter into a completely new loan agreement using the new one per cent prescribed rate. But do they need to sell all the investments or just enough to pay off the loan? The CRA addressed this question at the Roundtable session.
Let’s say Lisa, a high-income earner, loaned her husband, Harvey, who is in a lower tax bracket, $100,000 (“Loan 1”) back when the prescribed rate was two per cent. The borrowed money was used to purchase securities for $100,000. Those securities now have a value of $200,000. The couple wants to refinance the loan at one per cent. Harvey would sell half the securities and use the proceeds to repay Loan 1. Harvey would then borrow $100,000 from Lisa at the current lower prescribed rate of one per cent (“Loan 2”). The proceeds of Loan 2 would then be used to purchase new securities for $100,000.
At the roundtable, the CRA confirmed that the attribution rules will not apply to the securities that are still owned and were purchased with Loan 1 and, furthermore, that the attribution rules will not apply to the investments purchased with Loan 2. This allows Lisa and Harvey to take advantage of the new, lower prescribed rate for years to come by only triggering half the accrued gains on the portfolio.
Jamie Golombek, CPA, CA, CFP, CLU, TEP is the Managing Director, Tax & Estate Planning with CIBC Private Wealth Management in Toronto.