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How to make tax-cutting a family affair
7/18/2018 4:35:47 AM
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Tax-saving tips and strategies from a leading Canadian tax-planning expert.

By Samantha Prasad  | Thursday, July 27, 2017


In the search for yield, investors have turned to such things as monthly income funds and income trusts, structured notes, capital class units, and so on. But again, cash in your hands means investment income that must be reported in your tax return. Income splitting has long been used as a strategy to minimize tax on investment income. However, the attribution rules and the kiddie tax have more than curtailed the use of this avenue. Happily, there are a number of other strategies than still allow you to slash the tax bill.

Making the most of independent capital

Make sure that the lower-income spouse invests his or her own capital, while the higher-income spouse’s capital is used for day-to-day living expenses. Examples of independent capital can include just about anything that doesn’t come from the higher-income spouse, e.g., a gift or inheritance from a parent, or earnings from a job.

You can maximize a spouse’s independent capital in a number of ways. For example, use the higher-income spouse’s earnings for personal expenditures – even paying the lower-income spouse’s taxes. Likewise, if a parent of one of the spouses is thinking of giving some money to the family, it’s better tax planning if the gift is made to the lower-bracket spouse.

Tax Tip: Make sure that the lower-income spouse’s earnings and other independent capital are segmented in his or her own bank account and not commingled with money that comes from the higher-income spouse, e.g., joint accounts and the like. That way, there should be no question about who pays the tax on the income. Make sure that these “pure” accounts continue to “track.” For example, a separate “pure” brokerage account in the sole name of the lower-income spouse should be opened for the investments.

The loan manoeuvre

The Income Tax Act also allows a spouse to pay tax on investment income (and capital gains) if the investment is funded by a loan from you, provided that the spouse pays you interest at the “prescribed rate,” that is, the government’s rate that is in effect at the time the loan is made – it’s currently 1%.

In order to qualify for this tax break, the interest on the loan for each year must be paid no later than January 30 after the year-end. Otherwise, the attribution rules will apply, and the profits will be taxable in your hands, not your spouse’s. Furthermore, if you miss even one deadline, the attribution rules will apply to the particular investment forevermore.

Note: Once you make the prescribed loan, the interest rate can be locked in, based on the prescribed rate in effect at the time, even if interest rates go up. This prescribed loan strategy is also available for loans to a trust for the benefit of your minor children.

Capital gains splitting

As the attribution rules potentially apply to children (and grandchildren), they generally state that income from an investment is taxed in the hands of the funding parent while the child is a minor. However, the attribution rules do not apply to kids’ capital gains. This means that if a parent funds an investment in an account for a child (either by way of gift or loan), the attribution rules do not apply to capital gains, even though they do apply to interest, dividends, and the like until the year in which the child (or grandchild) turns 18.

This important exception to the attribution rules will apply even if you do nothing more than put some money in the child’s name to make an investment.

However, there is one complication I should mention. Many financial institutions require investment accounts for minors to be set up in the name of a parent, because there are legal restrictions for accounts in the name of minors. These are called “in-trust” or “in-trust for” accounts.

A number of years ago, there had been some confusion as to whether these accounts would thwart capital gains splitting. But in a series of Technical Interpretations, the CRA has indicated that this should not generally be the case.

However, larger-scale investors should still seriously consider documenting these in-trust accounts. In fact, in many cases, it may make sense to set up a formal trust. Remember, a separate in-trust account should be set up for each child, and the investments in the account really belong to the child, not you. A formal trust may make sense if you’re uncomfortable with this. For example, if you change your mind as to which child should benefit from the investments, a powerful financial planning weapon known as a “discretionary family trust” can help you to hedge your bets. Note that this is not a do-it-yourself strategy; you’ll need qualified legal counsel for this type of planning.

Samantha Prasad, LL.B. , is a Partner with Toronto law firm Minden Gross LLP , a Meritas Law Firm Worldwide affiliate, and specializes in corporate, estate, and international tax planning. She writes frequently on tax issues, and is the co-editor of various Wolters Kluwer Ltd. tax publications . Portions of this article first appeared in The TaxLetter, © 2017 by MPL Communications Ltd. Us ed with permission.


© 2017 by Fund Library. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited.

The foregoing is for general information purposes only and is the opinion of the writer. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.

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