How to save on your tax bill ahead of CRA’s prescribed rate hike


Jamie Golombek: The CRA’s prescribed rate is set to double to two per cent on July 1, but if you act quickly, you can lock in the current rate

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If you’re thinking of doing some family income splitting for 2022 and beyond, you’d better act quickly as the Canada Revenue Agency’s prescribed rate is set to double to two per cent on July 1, 2022, as a result of this week’s Treasury Bill auction yield. But, if you can get everything in place before that date, you can lock in the current one per cent prescribed rate for years to come, potentially yielding thousands of dollars in tax savings.

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Here’s what you need to know about income splitting, the prescribed rate and how to take advantage of an exception to the attribution rules to lower your family’s annual tax bill on investment income.

What is income splitting?

Income splitting transfers income from a high-income family member to a lower-income family member. Since our tax system has graduated tax brackets, the overall tax paid by the family may be reduced if the income is taxed in a lower-income earner’s hands.

The “attribution rules” in the Income Tax Act, however, prevent some types of income splitting by generally attributing income (and potentially capital gains) earned on money transferred or gifted to a family member back to the original transferor. There is an exception to this rule if the funds are loaned, rather than gifted, provided the interest rate on the loan is set (as a minimum) at the prescribed rate in effect at the time the loan was originated and the interest on the loan is paid annually by Jan. 30 of the following year.

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If the loan is made at the prescribed rate of one per cent before July 1, 2022, the net effect will generally 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, you need only use the prescribed rate in effect at the time the loan was originally extended. In other words, if you establish the loan before the July 1, 2022 increase, the one-per-cent rate would be locked in for the duration of the loan without being affected by any future rate increases.

How is the prescribed rate calculated?

The prescribed rates are set by the CRA quarterly and are tied directly to the yield on Government of Canada three-month Treasury Bills, albeit with a lag. The calculation is based on a formula in the Income Tax Regulations, which takes the simple average of three-month Treasury bills for the first month of the preceding quarter, rounded up to the next highest whole percentage point.

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To calculate the rate for the upcoming quarter (July to September 2022), we look at the first month of the current quarter (April 2022) and take the average of April’s three-month T-Bill yields, which were 1.02 per cent (April 12) and 1.38 per cent (April 26). Given that the Bank of Canada is expected to hike its overnight rate by another half-point in its June meeting, it’s not surprising that the latest auction yield jumped to 1.38 per cent on Tuesday, effectively pricing in a 50 basis point increase in June.

The three-month Treasury Bill average yield for April 2022 is therefore only 1.2 per cent, but when rounded up to the nearest whole percentage point, we get two per cent for the new prescribed rate for the third quarter. This upcoming increase marks the first time the prescribed rate has gone up since it dropped to the current historic low of one per cent back in July 2020.

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Spousal income splitting

Here’s how we might lock in the one per cent current rate for years to come, implementing a prescribed-rate loan strategy to split income between spouses, using an example of Harold, who is in the highest tax bracket, and Maude, who is in the lowest bracket.

Harold loans Maude $500,000 at the current prescribed rate of one per cent evidenced by a written promissory note. Maude invests the money in a portfolio of Canadian dividend-paying stocks with a current yield of four per cent. Each year, she takes $5,000 of the $20,000 in dividends she receives to pay the one per cent interest on the loan to Harold. She makes sure to do this by Jan. 30 each year starting the year after the loan was made, as required under the Income Tax Act.

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The net tax savings to the couple would be having the dividends taxed in Maude’s hands at the lowest rate instead of in Harold’s hands at the highest rate. This would be offset slightly by having the $5,000 of interest on the promissory note taxable to Harold at the highest rate for interest income. Maude would be able to claim a tax deduction at her low rate as the interest was paid to earn income, namely the dividends.

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Income splitting with kids

This strategy can be expanded to help fund children’s expenses, such as private school and extracurricular activities, by making a prescribed rate loan to a family trust. The trustee then invests the money and pays the net investment income, after the interest on the loan, to the kids either directly, or indirectly by paying their expenses. If the kids have zero or little other income, this investment income can be received perhaps entirely tax-free.

Continuing with the above example, let’s say Harold instead loans $1 million at one per cent to a family trust, of which his two minor kids are beneficiaries. The trust’s funds are invested in a portfolio of Canadian dividend-paying securities, yielding four per cent or $40,000. The trust can deduct the $10,000 of interest expense, netting $30,000 of dividend income. This income, if paid out to the beneficiaries or used for their benefit, is deductible to the trust and taxable to the children. But if the kids have no other income, each child could effectively receive up to $54,000 of eligible Canadian dividends either completely tax-free, or, depending on the province, with minimal provincial tax, due to the basic personal amounts and the federal and provincial dividend tax credits.

Jamie Golombek, CA, CPA, CFP, CLU, TEP is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto.


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