Income Splitting and Rules of Attribution
Why Split Income?
If only one spouse works in a household, then that individual is usually tempted to try and give some income to his or her spouse or children in order to pay less taxes. This is known as income splitting. The Family Tax Cut was one method of income splitting that has now disappeared. However, there are many other methods but before attempting any, you should consult with a tax professional.
Pension Splitting
Beginning in 2007, Canadian residents were allowed to split certain pension income with their resident spouse or common-law partner. Taxpayers may split up to half of their eligible pension income. Both spouses must agree to the transfer by filing Form T1032, Joint Election to Split Pension Income with their tax returns.
Income Splitting Through Loans
If a taxpayer has an asset that earns passive income (i.e. dividend income, or rental income), he or she may attempt to give that asset away to a spouse or child so the income is being earned by someone in a lower tax bracket. Unless it is done properly, the rules of attribution discussed below will come into play and the income will be attributed back to the individual who originally held it.
Through the use of loans, a taxpayer may be able to give an asset that earns passive income to a spouse or child, and have the income earned by that spouse or child. This is a very technical tax transaction and professional advice should be sought before this is attempted.
Essentially, subsection 74.5(2) of the Income Tax Act allows the taxpayer to loan his or her relation funds in order to purchase the asset. The taxpayer must charge a proper rate of interest, and that interest must actually be paid. The Canada Revenue Agency (CRA) provides prescribed interest rates.
Employing Spouse and/or Children
If you run your own business, another method to split income is to employ your own children or your spouse. Please keep in mind that they must be paid a reasonable wage for the services performed.
Rules of Attribution
As mentioned above, unless done properly, any income that is given from one related party to another may be attributed back to the original party who earned that income. Taxpayers should keep in mind that the Rules of Attribution apply to income producing assets, but they do not apply to business income.
If you are considering splitting income, or transferring income producing assets to a non-arm’s length party, please give us a call today! Don’t get caught by the Rules of Attribution!
CRA Resources
Do you qualify to split your pension income?
How do you split your pension income?
How do you report your split-pension income amount?
How do you claim the pension income amount?
Line 115 – Other pensions or superannuation
Line 116 – Elected split-pension amount
Line 210 – Deduction for elected split-pension amount
Line 314 – Pension income amount
Line 437 – Total income tax deducted
Case Law
Neuman v. The Minister of National Revenue, 1 SCR 770 – Income Splitting and the Rules of Attribution
Cantin v. The Queen, 2014 TCC 20 – Pension Income Splitting
Swartz v. The Queen, 2013 TCC 86 – Capital Gains Splitting
Speer v. The Queen, 1998 CanLii 267 – Dividend Income Splitting
Johnson v. The Minister of National Revenue, 2011 TCC 501 – The Rules of Attribution and Non-Arm’s Length Employment
**Disclaimer
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a lawyer.
