It’s time to make loans to save tax

Maybe you’ve heard the story of a business owner who had employees who always showed up for work on time. Turns out he had 30 employees, 29 free parking spots and one paid parking spot at work. Arriving on time meant saving money.

Showing up on time can also mean tax savings. You see, time is running out to take advantage of the lowest prescribed rate in Canadian history. This week marked the beginning of what is sure to be a period of rising interest rates in this country. And as interest rates rise, the prescribed rate also rises. So acting fast is a good idea. Let me explain.

The rate

The prescribed rate in our tax law is used for a few things. More specifically, it is the rate of interest that should be charged on certain loans between individuals, or between businesses and their employees or shareholders. When loans are set up correctly at the prescribed rate, tax savings can result.

The lower the prescribed rate, the greater the tax benefits can be. Today, the prescription is only 1%, but it is very likely that it will increase this year. The rate is set quarterly and is tied to the average 90-day Treasury bill rate for the previous quarter, rounded to the nearest whole percentage point. The average 90-day treasury bill rate for the fourth quarter of 2021 was less than 1%, so the prescribed rate was rounded to 1% for the first quarter of 2022. You get the idea.

There is no doubt that we will see a prescribed rate of 1% for the second quarter of 2022, but it is possible that we could see the rate increase to 2% on July 1. Consider the following ideas before July to take advantage of the current prescribed rate.

The joint loan

Consider taking out a loan for your low-income spouse. If you charge your spouse the prescribed rate of 1% on the loan, then any income earned by your spouse on the loaned funds will be taxed in your spouse’s hands and not in your hands. Normally the attribution rules will apply to get you to pay the tax instead, but charging the 1% takes you out of those rules.

You will have to pay tax on the 1% paid by your spouse, and he or she will have to pay you by January 30 of each year for the interest charges from the previous year. Your spouse will be entitled to a deduction for the interest paid to you. The big news? This 1% rate can be locked in as long as the loan is unpaid.

The child loan

Similar to a spousal loan, you can loan money for the benefit of a minor child – usually to a trust – to have those dollars invested and the income taxed in the hands of the child. Again, you’ll need to charge the prescribed rate on the loan, but the 1% rate can be locked indefinitely if you set it up before the rate increases.

By the way, if you take out a loan at a higher prescribed rate later on, and then the rates drop again, you can’t just re-do the loan at the lower rate unless the higher rate loan is paid off in first.

The employee loan

As an employee, you can now borrow money from your employer at favorable rates. You will be deemed to have received a taxable employment benefit for any interest-free or interest-reduced loans. The taxable amount is equal to the prescribed interest rate (1% today) minus the actual amount of interest you pay on the loan. According to this calculation, you will not have a taxable employment benefit if you only pay 1% on the loan.

In addition, a special rule applies if you borrow from your employer for the purpose of buying a house. Under this rule, the taxable benefit for the first five years is calculated using the lesser of the prescribed rate in effect at the time the loan was made or in the particular quarter in which the benefit is calculated. The rules are a bit complex, so talk to a tax professional if your employer has given you a home loan.

The shareholder loan

There are special rules for shareholder loans that could cause the loan to be included in your income if you are a shareholder and borrowed from your business. Some loans will avoid these rules. In this case, there could still be a taxable interest benefit, but if you pay the prescribed rate – just 1% today – you’ll avoid this taxable benefit. Borrowing today when the prescribed rate is low might make sense. Speak to a tax professional for more details.

Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP, is author, co-founder and CEO of Our Family Office Inc. He can be reached at

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