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By Guest Blogger Sinan Terzioglu
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In Canada, the income attribution rules are designed to prevent high-income earners from transferring assets to family members solely to reduce taxes on investment income. An effective way to navigate these rules is through a spousal loan – a tax-planning strategy where a higher-income spouse lends money to a lower-income spouse for investment purposes. This helps shift the investment income to the lower-income spouse, potentially reducing the overall family tax burden.
To implement the strategy, the higher-income spouse provides a formal loan under a written agreement. The loan must carry interest at the Canada Revenue Agency (CRA) prescribed rate, which is updated quarterly. For Q3 of 2025 (starting July 1, 2025), the rate will drop to 3% from 4%, making this a good time to consider the strategy.
The prescribed rate applicable at the time of the loan remains fixed for its duration, unaffected by future CRA rate changes. To comply with attribution rules, the lower-income spouse must invest the funds in a non-registered account in their own name only and ensure the annual interest payment is made to the lending spouse by January 30th of the following year.
When considering a spousal loan strategy, it’s essential to run the numbers to determine if the tax advantages outweigh the costs. Recently, I was asked whether this approach would be beneficial for a high-income earner in Ontario, whose marginal tax rate is 53.53%, when he receives a $1 million inheritance instead of investing the funds directly. His wife is in a considerably lower bracket, with a marginal rate of 20.05%.
The spousal loan strategy would set a 3% interest rate on the loan, effective July 1, and allocate the borrowed funds to a diversified, balanced portfolio anticipated to generate a 6% annual return. Here are the details to assess whether this approach is worth considering:
1. Calculate the Pre-Tax Investment Income: The lower-income spouse invests $1 million and earns an annual return of 6%.
Pre-tax Investment Income: $1,000,000 x 6% = $60,000
2. Determine the Annual Interest Payment: Under the terms of the spousal loan, the lower-income spouse must pay 3% interest on the borrowed funds by January 30 of the following year.
Annual Interest Payment: $1,000,000 x 3% = $30,000
3. Net Investment Income for the Lower-Income Spouse: After paying interest, the net income earned totals:
Net Investment Income: $60,000 – $30,000 = $30,000
This $30,000 is then taxed at the lower-income spouse’s marginal rate of 20.05%
Tax on Investment Income: $30,000 x 20.05% = $6,015
After-Tax Income for Lower-Income Spouse: $30,000 – $6,015 = $23,985
4. Tax Implications for the High-Income Spouse ($30,000 interest received from loan).
Tax on Interest Received: $30,000 x 53.53% = $16,059
After-Tax Income for Higher-Income Spouse: $30,000 – $16,059 = $13,941
5. Total Combined Net Income for the Couple.
Total After-Tax Income: $23,985 (lower-income spouse) + $13,941 (high-income spouse) = $37,926
Now, consider the alternative scenario where the higher-income spouse invests the $1,000,000 directly and yields an investment return of 6%. In that case, the total gross income remains at $60,000 per year, but the entire amount is taxed at 53.53%:
Taxes = $60,000 x 53.53% = $32,118
After-Tax Income: $60,000 – $32,118 = $27,882
By using the spousal loan strategy, the couple can potentially save approximately $10,044 in tax in the first year ($37,926 – $27,882).
Spousal loans can provide enticing tax savings, but they come with several risks that require close attention. Compliance with CRA rules is essential because missing annual interest payments or failing to document the arrangement properly can lead to income attribution back to the higher-income spouse and potential penalties. Investment returns are uncertain, and market volatility may diminish the anticipated benefits. Moreover, future changes in tax legislation may alter the advantages of such loans, while personal financial difficulties might impact the borrowing spouse’s ability to make the interest payments every year.
If the lower-income spouse passes away, the invested funds in their non-registered account would be subject to probate. A spousal trust can be a useful estate planning tool to help mitigate probate risks when implementing a spousal loan strategy. By placing the invested funds into a spousal trust rather than a non-registered account solely in the lower-income spouse’s name, this approach could avoid probate and ensure a smoother transition of assets.
Before implementing a spousal loan strategy, conduct a thorough risk-benefit analysis. Running detailed calculations and considering various scenarios can help determine if the potential tax savings truly outweigh the risks. Although annual tax savings may seem modest, they can compound over time, allowing couples to enhance cash flow, maximize after-tax returns, and build wealth more efficiently.
Sinan Terzioglu, CFA, CIM, is a financial advisor with Turner Investments, Private Client Group, Raymond James Ltd. He served as vice-president of RBC Capital markets in New York City and VP with Credit Suisse in Toronto.
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