A new technical interpretation of the Income Tax Act published by the Canada Revenue Agency stipulates that interest owed on joint loans must be paid within 30 days of the end of the calendar year, regardless of the terms of payment in the statutory loan contract. Consultants should pay attention to clients, as the absence of interest payments for a matrimonial credit could end a couple`s income splitting opportunities for all years to come. The use of spos` loans in times of low interest rates is a popular way to circumvent Canada`s strict income-splitting rules. When a person falls into a higher tax class in a matrimonial or common law relationship, he or she may lend money to his or her spouse for investment purposes. According to the rating agency`s rules, all income generated by this money is then taxed at the borrower`s lower interest rate. However, it is essential that the borrower pays interest on time each year, as the rating agency imposes a ”look back” rule under which all interest on these loans must be paid on time, both for the current year and for all previous years. If the interest on the joint loans of previous years is not paid over time, the couple is no longer entitled to use this income-splitting technique. Similarly, the rating agency considers good faith credit only if interest is calculated at the interest rate charged by the rating agency, which is currently 4%. ”The Income Tax Act still stipulates that interest must be paid within 30 days of the end of the contract year; We`ve always known that,” said Jamie Golombek, vice president of taxation and real estate planning at AIM Funds Management Inc. in Toronto. ”But if you read the technical interpretation that came out, it would appear that the interest is due within 30 days of the calendar year in which the interest was collected.” In most cases, unless the loan was granted precisely on January 1, this means that, in order to comply with CRA rules, certain interest must be paid before the date set out in the legal loan contract. For example, a man could borrow money from his wife on July 1 of this year with interest that arrives each year on July 1, starting in 2009.
However, the rating agency`s interpretation, published in April, stresses the importance of paying ”interest for each year.” Therefore, in this example, the husband would have to pay the interest accrued in 2008 before the end of January 2009 and not on July 1, 2009, the date set in the loan agreement. The rating agency also applies to loans between parents and their children. Cy Fien, senior tax partner at Fillmore Riley LLP in Winnipeg, says the provision of the Income Tax Act is ”unequivocal” and he is concerned that the new interpretation will discourage many taxpayers. Fien says most loan contracts pay interest either monthly or on the anniversary. ”It`s a common business practice,” he says. ”But now the rating agency says that even if interest is paid on the anniversary, it won`t work – which people who aren`t tax-mavens would normally be in order.” Under Cra`s new interpretation, borrowing interest is payable tax-free at times other than under the trade agreement, he adds. ”No one would think they would have to do a calculation and pay them at the end of the year if the change in sola itself does not require payment of interest before the anniversary.” Because these types of credit are quite common, many of the people who process them are not tax specialists.