To calculate the rate for the third quarter (July to September) of 2020, we look at the first month of the second quarter (April 2020) and take the average of the April Treasury bill yields, which were 0.24% (7 April), 0.30% (April 14), 0.27% (April 21) and 0.27% (April 28). This average is 0.27%, but when rounded to the nearest whole percentage point, we get 1% for the new prescribed rate for the third quarter of 2020. This is the first time the prescribed rate decline since it has increased until now. rate of 2% in April 2018.
Lowering the prescribed rate may provide some clients with an important opportunity to split their income with a spouse or common-law partner, (grand) children or other family members. Income splitting is the transfer of income from a high income family member (who pays tax at a high rate) to a low income family member (who pays tax at a lower rate) . Because our tax system has graduated tax brackets, having the income taxed in the hands of the lower income helps reduce the overall tax paid by the family.
The “attribution rules” in the Income Tax Act prevent certain types of income splitting by generally attributing the income or gains earned on money transferred or offered to a family member to the original transferor. There is an exception to these rules if funds are loaned rather than offered, provided the loan rate is set (as a minimum) at the prescribed rate in effect at the time the loan was taken out and the interest on the loan is paid. annually no later than January 30 of the following year.
Thus, if the loan is made at the prescribed rate of 1%, the net effect will generally be that any investment return generated above 1% will be taxed in the hands of the low-income family member. Note that although the prescribed rate varies from quarter to quarter and may eventually increase, it is sufficient to use the prescribed rate in effect at the time the loan was originally extended. In other words, if the loan is extended by the end of September 2020 (and possibly longer, if the prescribed rate remains unchanged), the lower rate of 1% would be locked in for the life of the loan without being affected by any increases. future rates.
Refinance a 2% to 1% loan?
Finally, what if your client took out a prescribed rate loan with a family member when the rate was 2% (or more) and the family member invested the proceeds? To take advantage of the next lower prescribed rate, you should encourage the family member to consider selling the investments (which could trigger the capital gains tax, depending on the market value of the investments relative to their tax cost) and to repay the loan. They can then enter into a brand new loan deal using the new prescribed rate of 1%. The CRA said that simply paying off a higher prescribed rate loan with a lower rate loan could trigger the attribution rules on investment income.