An Overview of Attribution Rules Canada
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Income splitting among family members can be beneficial largely because of the graduated tax rates used in our income tax system.
All provinces similarly have graduated tax rates. As a result, if you are in a lower tax bracket than your family members, the splitting of income can subject the income to a lower rate of tax. In addition, their tax credits can further reduce tax payable on the split income. The government is aware of this potential tax savings, and generally frowns on income splitting. As a result, there are various income attribution rules that can apply if you transfer property to your spouse (or common-law partner) or minor children. These rules are summarized below, followed by the major exceptions to the rules.
Loans or Transfers to Spouse
Attribution can apply if you lend or transfer money or property to your spouse (or common-law partner), including a loan or transfer before you became spouses. Under this rule, income or loss from the property (or property substituted for that property) is attributed to you and included in your income (or loss) rather than your spouse’s income. Income from property includes items such as interest, dividends and rent.
A similar attribution rules Canada can apply to attribute taxable capital gains (or allowable capital losses) from your spouse’s dispositions of the property or substituted property. The substituted-property rule means attribution can continue even if your spouse sells or converts the lent or transferred property and uses the proceeds to acquire another property. For example, if you give your spouse cash and she uses the cash to purchase corporate bonds, the interest from the bonds will be attributed to you. Furthermore, if she sells the bonds and uses the proceeds to buy another income-producing property, the attribution rules can continue to apply to the income or gain from that other property.
The property income attribution stops if you divorce, or are living separate due to the breakdown of your marriage (or common-law relationship). The capital gains attribution ceases after divorce, but stops during your separation only if you make a joint election with your tax returns.
Loans or Transfers to Minor Children
Another attribution rules CRA applies if you lend or transfer property (or money) to your child who is under 18, any other minor child with whom you do not deal at arm’s length, or your minor niece or nephew. As with the rule for spouses, income or loss from the property or property substituted for that property is attributed to you. The income attribution does not apply throughout the year in which the minor child turns 18 or in later years. However, the attribution rules do not apply to capital gains of minor children, so capital gains splitting with your minor children is generally allowed.
For example, you can purchase common shares or equity mutual funds for your minor children, and subsequent taxable capital gains on the property will be included in their income and will not be subject to attribution. (But see the discussion below on the “kiddie tax”, which can apply to a minor child’s capital gains in limited circumstances.) You also have to make sure that, under the law of the province in which you live, your minor children are legally allowed to acquire and own the property in question.
Exceptions
Fortunately, there are various exceptions to the attribution rules Canada. The main ones are summarized below. The rules do not apply to income from business. Therefore, you can give or lend property to your spouse or minor children to earn business income and the income will not be attributed to you. As noted, the attribution rules CRAdo not normally apply to capital gains of minor children. Therefore, you can legitimately split capital gains with them. Note however that attribution can apply if you transfer certain farm or fishing property to your child under the rollover provisions of the Income Tax Act.
The rules do not apply if you lend money to your spouse or minor child at the prescribed rate of interest, as long as they actually pay you the interest each year or by January 30 of the following year. For example, if you lend money to your spouse at the prescribed annual interest and she uses the fund to purchase an investment that pays an annual return greater than the prescribed rate, the attribution rules will not apply provided she pays you the prescribed rate every year. She will include the excess net return in income.
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You will include the prescribed interest received by you. However, if your spouse misses or is late with even one interest payment, this exception from attribution ceases to apply. The attribution rules do not apply if you receive at least fair market value consideration for the property.
Similar to the lending exception above, if the consideration is debt, you must charge at least the prescribed rate of interest, and they must pay you the interest each year or by January 30 of the following year. Also, in the case of your spouse, if you transfer property under this exception you must elect out of the tax-free “rollover” on the transfer, which is otherwise available for transfers between spouses. This means that the transfer of the property will normally take place at fair market value, which could generate a capital gain for you if the value exceeds your cost of the property.
Unfortunately, because of the superficial loss rules (discussed further below in this Letter), any loss on the transfer will normally be denied. The rules do not apply to reinvested income. Thus, if you transfer property to your spouse or minor child and they reinvest the income earned on the property, the income earned on the reinvested income is not subject to attribution. The rules do not apply to transfers of property to children over 18. However, there is an anti-avoidance rule that can apply if you lend money to a relative (minor or adult) or another non-arm’s length person and one of the main reasons is to reduce your tax payable.
As above, there is an exception to this anti-avoidance rule if you charge at least the prescribed rate of interest on the loan. The rules obviously do not apply if the property generates no income or capital gains. Therefore, you can make personal expenditures for your spouse and children and not worry about any attribution rules.
As a planning point, consider paying most or all of your spouse’s personal expenses, common household expenses and any income tax your spouse owes, thus freeing up your spouse’s own income to invest in income-earning property. The attribution rules will not apply. Since income or capital gains from a tax-free savings account (TFSA) are not included in income, you can put cash into your spouse’s or adult child’s TFSA and there will be no attribution on any subsequent income. Similarly, as noted earlier, if you contribute to your spouse’s RRSP (provided it was set up as spousal plan), there is no attribution when the funds and income are withdrawn by your spouse, generally as long as the withdrawal does not take place in the year during which you contributed or the two subsequent years.
If you receive the Universal Child Care Benefit because you have children under 18, the benefit can be invested and all income or gains from the investment are exempt from attribution provided you can track it. So it can be a good idea to put these payments into a separate bank account, if you don’t need to spend them.
Tax on Split Income of Minor Child (“Kiddie Tax”)
Although not an attribution rule, the kiddie tax can apply to the “split income” of a minor child. The tax is levied on the split income of the child at the highest marginal rate of tax (i.e. 33% federal, plus provincial tax). Furthermore, the only tax credits available against the tax on the split income are the dividend tax credit and any available foreign tax credits. Thus, although the income is not attributed, the kiddie tax is just as onerous or more so. “Split income” includes shareholder benefits and dividends received from shares of corporations other than publicly-traded shares and mutual funds. In general terms, it also includes certain trust or partnership income derived from services or property provided to a business in which a parent is involved (the details are somewhat complex).
If you have any questions or want to speak further about your tax situation, contact Nicholas Kilpatrick at nkilpatrick@burgesskilpatrick.com
Nicholas Kilpatrick is a partner with the accounting firm of Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients. Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm. This article has been paraphrased from an article by Pierre-Yves Daoust, Marcil Lavallee.
