Interest on Spousal Loan

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Phil D
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Interest on Spousal Loan

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I know that the interest payment for spousal loans in place during 2011 has to be paid inside the first 30 days of 2012.

Does anyone know if that implies that the interest is reported in the 2012 tax return, or does it have to be reported as earned in 2011 even if not paid until January 2012 ?

Thanks for any advice.
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Re: Interest on Spousal Loan

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We've had spousal loans in place for a number of years and have always reported the interest paid and interest received in the taxation year when the payment is made. We always make the payment on the near the end of January. I'll report the January 30th, 2011 payment on the 2011 tax returns. CRA has always accepted this.
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Re: Interest on Spousal Loan

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Thanks, PI. CRA seems to imply that is acceptable because of their ' end of january' statement. However, they don't say it clearly and I worry because other interest, for example GICs, require declaring the interest in the year it was earned not the year it was paid.
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Re: Interest on Spousal Loan

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Phil D wrote:Thanks, PI. CRA seems to imply that is acceptable because of their ' end of january' statement. However, they don't say it clearly and I worry because other interest, for example GICs, require declaring the interest in the year it was earned not the year it was paid.
Suppose you purchased a one year GIC on January 5, 2010. 98% of the interest accrued to you during the 2010 calendar year, but the bank puts all the interest on a 2011 T5 slip.
Suppose you purchased a compound interest 5 year GIC on July 5, 2010. The bank will report the first year's interest on a 2011 T5 slip, because the first anniversary date is (again) in 2011. That's the rule for interest-income, not 'the year it was earned'.

The spousal loan rule is a mash-up I guess. You don't need to report any interest income until the year in which the loan has its first anniversary (consistent with CRA's rules for ordinary interest-bearing investments), but (in the first year) you don't report 12 months of interest income - only the interest from the date of the loan to December 31. In each following year you report 12 months of interest.
EDITED TO STRIKE ERROR - please see new post December 20, 2011 1:32 pm below

I agree that CRA does a poor job of explaining many things. They miss so many opportunities to clarify things. Their tax experts can't write and/or their writers don't seem to have any curiosity. If they had ever tried to follow the rules they are writing about, they'd see how incomplete their information is... (end of rant)
Last edited by DavidR on 20 Dec 2011 12:35, edited 1 time in total.
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Re: Interest on Spousal Loan

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DavidR wrote: The spousal loan rule is a mash-up I guess. You don't need to report any interest income until the year in which the loan has its first anniversary (consistent with CRA's rules for ordinary interest-bearing investments), but (in the first year) you don't report 12 months of interest income - only the interest from the date of the loan to December 31. In each following year you report 12 months of interest.
I think I've learned something here. When I calculate the payment that is due on January 30th, I've always calculated the interest earning/owed up-to January 30th. I didn't know that it should be calculated to Dec 31st. As well, does what you've written mean that no interest payment is required on Jan 30th, 2012 for new spousal loans written after Jan 30th, 2011? We wrote two new spousal loans this year to take lock in the current low prescribed rates.

Like most things CRA related, my guess is that when "grey" areas of interpretation are involved, as long as one chooses a methodology and remains consistent, CRA will generally accept that methodology.
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Re: Interest on Spousal Loan

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The ability to lock-in today's low interest rate is a significant advantage. Are spousal loans restricted to fixed or declining balances - or could they be written in the style of a line of credit? This would lock-in today's interest rate - and allow future borrowing of additional funds when available and/or when required/requested?
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Re: Interest on Spousal Loan

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OK, I think I posted too hastily up-thread. The devil is in the details, and the parsing of the rules. What does your loan agreement say regarding when interest should be paid? Once a year, on the anniversary date of the loan? Monthly?

Here is my paraphrase of paragraph 22 of IT511R
there will be no attribution... if interest is charged (at prescribed or arm’s length rate) and if all such interest is paid no later than 30 days after the end of each calendar year in which it becomes payable.

And here is an example from KPMG's 2010 Tax Planning for You and your Family
1. On January 1, 2009 you lend your spouse $10,000. Spouse then purchases an investment and earns $400 of interest.
2. If you do not charge interest to your spouse, then the $400 of interest will be attributed back to you.
3. If your spouse is required to pay interest on the anniversary date of the loan and actually pays you the interest by January 30, 2010, then the $400 interest will not be attributed back to you.

Has KPMG constructed a poor example?
(i) Looks to me like their $10,000 loan requires an interest payment on January 1, 2010 (anniversary date).
(ii) So the interest becomes payable in 2010.
(iii) So the spouse has up until 30 days after the end of the 2010 (ie. January 30, 2011) to pay the interest...?

Let's construct another example
Loan is advanced on June 20, 2010. Loan agreement calls for interest to be paid annually on the anniversary - June 20, 2011.

I would say the annual interest income became payable in 2011 and should be reported as income by the 'lending spouse' in 2011. As long as the 'borrowing spouse' pays the interest by January 30, 2012 the loan will meet the requirements for no attribution.

The tax deduction by the borrowing spouse for interest expense/carrying charge is generally taken in the year the interest is paid.

So I would advise someone in this situation to write the cheque for the interest in 2011 - then the income inclusion for one spouse and deduction for the other fall into the same year. (Less confusing for all parties, including CRA. And then, as PI says, be consistent in your methodology.)

YMMV
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Re: Interest on Spousal Loan

Post by Phil D »

Thanks, folks.

Conclusions for me are that the wording of the loan agreement dictates when interest is payable but I could not see CRA allowing that to be more than 12 months after the loan is put in place. My loan agreement says that interest is payable in January the year after the loan is put in place and every year thereafter. My practice has been to calculate interest on all loans to the end of the year they were put in place, and each year thereafter, and pay that no later than January, and actually I have usually paid it before the end of December.

I think that the answer to my original question is that, for me, the interest should be reported in the interest year rather than the January payment year. Especially since this has been my practice so far.

pmj - The CRA prescribed rate is for a loan, not a loan facility. It is hard to imagine that CRA would allow you to put a revolving line in place. It is already pretty generous that they allow a 1% short term rate to be used for loans into perpetuity.
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Re: Interest on Spousal Loan

Post by barrymorgan88 »

I am pretty sure the interest is implied for the 2011 tax return because that is when the loan is taken out.
Phil D wrote:I know that the interest payment for spousal loans in place during 2011 has to be paid inside the first 30 days of 2012.

Does anyone know if that implies that the interest is reported in the 2012 tax return, or does it have to be reported as earned in 2011 even if not paid until January 2012 ?

Thanks for any advice.
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Re: Interest on Spousal Loan

Post by Jagas »

Interest is included in your tax return in the period paid/received. In order to avoid attribution on a spousal loan the interest must be paid by January 30 of the year following. Assuming it is paid in January 2012, it is reported in 2012 rather than 2011 even though the interest relates to 2011. If you pay the interest early, ie in December 2011, it is reported in 2011. This keeps you onside for the attribution rules, which is the most important aspect, but you give up a one year tax deferral on the interest income. If you ever once forget to pay the interest by January 30 of the year following, the whole strategy falls apart and you get beaten with a big attribution stick.

Line of credit will not work. Make sure each loan is well documented.

Edit to note: My understanding only, not quite gospel
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Re: Interest on Spousal Loan

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Tip of the hat to Tim Cestnick's article, Taxes: What the prescribed rate is, why it matters and how you can save on tax - The Globe and Mail
Tim Cestnick wrote:The prescribed rate is important and is set each quarter based on the average 90-day Government of Canada T-bill rate for the first month of the prior quarter. The rate charged on overdue taxes, or paid on excess taxes remitted, is derived from the prescribed rate. In addition, the rate is used to calculate taxable benefits on interest-free or low-interest employee or shareholder loans, and applies to loans between family members who want to split income.

The rate has been at an all-time low of just 1 per cent since April 1, 2009, and is now due to rise to 2 per cent, effective this Oct. 1. If you act before then, you could create tax savings.
I checked the horse's mouth, Prescribed interest rates | CRA and this change doesn't seem to have been officially announced.
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Re: Interest on Spousal Loan

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This is the key phrase - and although I can find it at CRA, I can't find a full definitive statement :oops:
The basic rate is based on the rate charged on 90 day Treasury bills, adjusted quarterly, and rounded up to the nearest whole percentage.
?Somewhere? the date on which this calc is made is stated...

There was a short period at the end of June when the rate was above 1% - which may have been the trigger...
http://www.bankofcanada.ca/rates/intere ... ll-yields/

Note that the above-1% rate in September didn't last to the end of the month - so it didn't trigger an increase.
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Re: Interest on Spousal Loan

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As Tim Cestnick reports:
The prescribed rate is important and is set each quarter based on the average 90-day Government of Canada T-bill rate for the first month of the prior quarter.
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Re: Interest on Spousal Loan

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Just a reminder, per Interest rates for the fourth calendar quarter | CRA, the rate has been at an all-time low of just 1 per cent since April 1, 2009, and is now due to double to 2 per cent, effective this Oct. 1.
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Re: Interest on Spousal Loan

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According to Tim Cestnick's article today the rate drops back to 1% again for Q1 2014.
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Re: Interest on Spousal Loan

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A reminder for those with spousal loan agreements in place that the annual interest payment is due by the end of January 30th.

For those that are considering a spousal loan as an Income splitting technique, you might want to move soon. The Canada Revenue Agency (CRA)'s Interest rates for the first calendar quarter - Canada.ca indicate the prescribed rate is 1% and given the Bank of Canada rate increases that have been happening, I'd hazard a guess that going forward we might well have seen the bottom on this rate for a while.
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Re: Interest on Spousal Loan

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CRA hasn't officially made the announcement, but in A key tax-splitting interest rate is about to double | Financial Post it is calculated the rate will jump to 2% beginning in Q2 2018.
Jamie Golombek wrote:Investors who wish set up a prescribed-rate loan to split investment income with a spouse, common-law partner or even their kids need to act quickly as the prescribed interest rate is set to double to two per cent on April 1, 2018 as a result of Tuesday’s Treasury Bill auction yield.

The prescribed rates are set by the Canada Revenue Agency (CRA) quarterly and are tied directly to the yield on Government of Canada 90-day 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 (if not already a whole number).

To calculate the rate for the upcoming quarter (April through June 2018), we look at the first month of the current quarter (January) and take the average of January’s T-Bill yields, which were 1.17 per cent (Jan. 9, 2018) and 1.20 per cent (Jan. 23, 2018). That average is 1.185 per cent but when rounded up to the nearest whole percentage point, we get 2 per cent for the new prescribed rate for the second quarter of 2018.
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Re: Interest on Spousal Loan

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For those that use this tax saving opportunity there is good news coming There’s a great opportunity for income splitting coming up | Financial Post
Jamie Golombek wrote:The Canada Revenue Agency sets the prescribed rates quarterly and they are directly tied 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. As a result, one per cent is the lowest possible prescribed rate.

To calculate the rate for the upcoming third quarter (July through September), we look at the first month of the second quarter (April 2020) and take the average of that month’s T-Bill yields, which were 0.24 per cent (April 7), 0.30 per cent (April 14), 0.27 per cent (April 21) and 0.27 per cent (April 28). The average is 0.27 per cent, but rounded up to the nearest whole percentage point, the new prescribed rate for the third quarter of 2020 becomes one per cent. This marks the first time that the prescribed rate has dropped since it increased to the present rate of two per cent back in April 2018.
The CRA page is Interest rates for the third calendar quarter - Canada.ca

For those with an existing spousal loan arrangement who might want to take advantage of the rate drop
Jamie Golombek wrote:Finally, what if you entered into a prescribed rate loan with your family member when the rate was two per cent (or higher) and the family member invested the proceeds?

To take advantage of the upcoming lower prescribed rate, the 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 to you. You can then enter into a completely new loan agreement using the new one-per-cent prescribed rate. 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.
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