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CRA interest rate cut means opportunity

Very strange. I'm talking about the sport of extreme ironing. The sport was created in 1997 when Phil Shaw of England, who goes by the name Steam, came home to a pile of wrinkled shirts. According to an article carried by Associated Press last month, the idea of ironing was not nearly as exciting to Mr. Shaw as the thought of rock climbing. So he decided to do his ironing and rock climbing at the same time.

Soon, "extreme ironing" athletes all over the world were packing their irons and boards to compete against each other while hanging from cliffs, diving under water, kayaking, running marathons and skydiving. Events are judged on the quality of the pressing in addition to other measures. Hmmm. I'd say it brings a new meaning to the term "iron man competition." Strange indeed.

I've got something even stranger to tell you about. The prescribed rate charged by Canada Revenue Agency (CRA) is dropping to just 2 per cent on July 1. Okay, so it's not as exciting as high jumping with an iron and spray starch in your hands, but it'll leave you better off financially.

Prescribed rate

The prescribed rate is set quarterly and is determined by the average rate on 90-day treasury bills for the first month of the preceding quarter (rounded up to the nearest percentage point). The fact is, the prescribed rate has dropped to 2 per cent only once in history (the second quarter of 2002). So, you'll see a 2-per-cent rate about as often as you'll see someone bungee jumping with an ironing board under his arm.

You can bet the rate won't stay this low for long. You see, this falling rate presents a great opportunity for thousands of Canadians to save tax on certain loans. I want to discuss spousal loans today. Next column, I'll discuss employee home purchase loans.

Spousal loans

It can make sense for a higher-income spouse (or common-law partner) to lend money to a lower-income spouse. For example, if I lend my wife $100,000 and she earns $8,000 of income on that money, she won't pay any tax at all on that income if she has no other income in 2004. On the other hand, I'd pay as much as $3,713 in tax, being in the highest tax bracket in Ontario, if I had to report that $8,000 on my tax return.

There's one catch to making this idea work. I've got to charge the prescribed rate of interest (or commercial rates if they are less) on that loan to my wife, otherwise the $8,000 income will be attributed back to me. At just 2 per cent beginning July 1, she'll pay me $2,000 annually on that $100,000 loan. She must pay any interest to me by Jan. 30 each year for the prior year's interest charge. I'll pay tax on that interest received, and she'll receive a deduction for the amount, assuming she properly invests the $100,000. The bottom line? As long as she earns more than 2 per cent on the $100,000 portfolio, we save tax as a couple.

And get this: The rate in effect on the day I lend her the money is locked in for the full duration of the loan. So, if I make this loan between July 1 and Sept. 30, the 2-per-cent rate will apply indefinitely. What a bargain.

A promissory note signed by the lower-income spouse, and detailing the date and amount of the loan, the interest rate, and the terms of repayment ("due upon demand," for example) is all that you need. No need to send this note to the taxman unless you're asked to provide it.

Tim Cestnick, FCA, CFP, TEP is author of The Tax Freedom Zone and Winning the Tax Game 2003. He is managing director, National Tax Services, at AIC

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