Skip to main content

The Globe and Mail

Taxes: What the prescribed rate is, why it matters and how you can save on tax

My wife Carolyn and I were chatting last weekend with our friends, Don and Janet. We were commenting on how fast the years go by. Our kids are now teens, and quickly moving through those years. "I remember reading them bedtime stories every night when they were little," Janet said. "Dr. Seuss was their favourite."

"Tim used to read to our kids too," Carolyn said. "But he chose practical books that he authored, like Winning the Estate Planning Game and 101 Tax Secrets for Canadians."

Oh, you can laugh if you want, and my kids may not be able to tell The Cat in the Hat from the Fox in Socks, but they sure understand what the prescribed rate is. Speaking of the prescribed rate, there are some planning opportunities that you should consider in the next few weeks (my kids will be very excited). Let me explain.

Story continues below advertisement

The rate

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.

Family loans

If you choose to lend money to your spouse, or to a child under age 18 through a trust (technically, you can't lend money directly to a child under the age of majority), any income earned on the money by those family members will be attributed back to you and taxed in your hands. You can avoid this attribution, however, if you charge the prescribed rate on the loan. Here's how that can work:

Suppose that Don lends Janet $100,000. The plan is for her to invest the money and pay the tax on any income, rather than Don paying tax at his higher rate. Don could charge the 1-per-cent prescribed rate on the loan. Janet would have to pay this interest every year by Jan. 30 for the prior year's interest charge.

Now, suppose that Janet earns 3 per cent on the money. Janet would be entitled to report the 3-per-cent income without attribution back to Don. Don would have to report as income the 1 per cent in interest he receives from Janet. Janet can deduct the interest paid to Don. The net effect for Janet is that she reports 2 per cent in her income – the amount of the returns over and above the prescribed rate she pays to Don.

Story continues below advertisement

In this case, Janet would report a net $2,000 that would have otherwise been taxed in Don's hands. The difference in their marginal tax rates is about 20 per cent, so the tax savings enjoyed is about $400 (20 per cent of $2,000). Keep in mind: The higher the amount Don lends to Janet, the more the tax savings.

Also, this idea makes the most sense if Janet is going to invest to earn income. If she's investing for capital growth, and doesn't realize any income for several years, the value of this idea is significantly reduced. So, perhaps the fixed income portion of Don's portfolio that is held outside a registered plan would be the right dollars to lend to Janet.

Here's the best part: The 1-per-cent rate can be locked in indefinitely if the loan is set up on or before Sept. 30. So, as the rate rises in the future, Janet can still take advantage of the 1-per-cent rate when paying Don interest annually.

Employee loans

Finally, if you receive a no- or low-interest loan from your employer, there will be a taxable interest benefit that results. The benefit is equal to the prescribed rate less any interest you actually pay during the year or by Jan. 30 of the following year. If the loan is used to finance a home, the prescribed rate in effect at the time of the loan is locked-in for five years. So, consider taking out a new loan (perhaps to replace an old loan) on or before Sept. 30 at the current 1-per-cent rate while you can, locking it in for five years.

Tim Cestnick is president of WaterStreet Family Offices, and author of several tax and personal finance books. tcestnick@waterstreet.ca

Story continues below advertisement

Report an error Licensing Options
About the Author
Author and founder of WaterStreet Family Offices

Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP, is an author and founder of WaterStreet Family Offices. More

Comments

The Globe invites you to share your views. Please stay on topic and be respectful to everyone. For more information on our commenting policies and how our community-based moderation works, please read our Community Guidelines and our Terms and Conditions.

We’ve made some technical updates to our commenting software. If you are experiencing any issues posting comments, simply log out and log back in.

Discussion loading… ✨

Combined Shape Created with Sketch.

Combined Shape Created with Sketch.

Thank you!

You are now subscribed to the newsletter at

You can unsubscribe from this newsletter or Globe promotions at any time by clicking the link at the bottom of the newsletter, or by emailing us at privacy@globeandmail.com.