A common strategy amongst Canadian taxpayers is shifting income from a high‑income taxpayer to a low-income taxpayer, such as a spouse or child. This can result in a lower overall tax bill for the family due to our graduated rate tax system. However, the Income Tax Act contains many attribution rules that prevent or negate the benefits of income splitting. One notable exception that provides an opportunity to split income with family is a prescribed rate loan arrangement.

The mechanics of a typical prescribed rate loan arrangement are as follows:

• A high‑income taxpayer loans funds to a low‑income family member or a family trust in exchange for a promissory note bearing interest at the prescribed rate.
• The prescribed rate is set by the Canada Revenue Agency on a quarterly basis and is currently 3% as of the fourth quarter of 2025. The rate in effect at the time the loan originates will remain in effect for the duration of the loan.
• The interest must be paid by the recipient of the loan to the lender within 30 days of each year‑end. The lender must report this interest income on their tax return.
• The recipient of the loan invests the funds to earn property income and can deduct the interest expense on the loan against this income.

Taxpayers can benefit from this tax strategy if the recipient of the loaned funds is in a lower tax bracket than the lender, and the funds are invested to earn an investment return in excess of the prescribed rate. Any investment returns in excess of the prescribed rate will now be taxable at a lower marginal tax rate, resulting in tax savings for the family.

This strategy is particularly effective when the prescribed rate is low, as the benefits increase based on the spread between the investment return and the prescribed rate. The prescribed rate was as low as 1% in 2022, which created a highly beneficial environment for these loans. However, due to the government’s efforts to combat inflation, the interest rate steadily increased and reached a high of 6% during 2024. Advisors generally did not recommend this strategy during this period. However, with the recent decline to 3%, this might be an effective strategy once again.

An investment return in excess of 3% seems like a modest target, but other tax changes enacted during the high‑rate period have complicated the equation. During 2024, significant changes to the Alternative Minimum Tax (“AMT”) came into effect. AMT is an alternative tax calculation for individuals and trusts that restricts certain deductions and credits. Taxpayers may be required to pay AMT if this amount exceeds the regular income tax calculation.

One of the most significant changes to the AMT calculation is the restriction on interest expenses related to property income. Only 50% of the actual interest expenses are deductible in the AMT calculation. Therefore, the interest expenses paid on a prescribed rate loan will be limited, which will potentially lead to a higher than anticipated tax bill.

As part of these changes, the AMT exemption for individuals was increased from $40,000 to $177,882 (as of 2025, indexed annually). Loans to individuals will continue to be beneficial in many situations due to this increased exemption, as these loans are most effective when made to low‑income taxpayers. However, trusts are not eligible for this exemption. Prescribed rate loans to trusts will require careful planning and analysis to determine if they are worthwhile due to the higher likelihood that AMT will apply.

The reduction in interest rates has provided the opportunity to benefit from a prescribed rate loan arrangement, but such strategy and analysis are complex and unique to each taxpayer. Please contact your advisors at Melo to assess whether this strategy could be effective for you.

Strategic insight, lower family taxes