How to potentially save thousands on your tax bill ahead of CRA's prescribed interest rate hike

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.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.

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.

To calculate the rate for the upcoming quarter , we look at the first month of the current quarter and take the average of April’s three-month T-Bill yields, which were 1.02 per cent and 1.38 per cent . Given that the Bank of Canadain 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 roundedto 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.

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.

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