The income attribution rules prevent many forms of income splitting among family members. But for the rules, a high-income spouse could easily shift investment income to a low-income spouse or low-income minor child and save tax (since lower tax rates apply to lower levels of income).
For transfers between spouses (or common law partners), the basic rule provides that where you lend or transfer property to your spouse, any subsequent income from the property will be attributed to you and included in your income (rather than in your spouse's income). Similarly, any taxable capital gains from the property will be attributed to you. (Conversely, if there is a loss from the property or capital loss, that loss will also be attributed back to you.)
For minor children, the basic rule provides that where you lend or transfer property to a non-arm’s length child (including a niece or nephew) under the age of 18, any subsequent income from the property will be attributed to you. Attribution stops as of the year the child turns 18. The attribution rule does not apply to capital gains, so you can legitimately split capital gains with your minor children or grandchildren.
The attribution rules can apply even if the property lent or transferred is replaced with another property (under the “substituted property” rules). For example, if you give your spouse some stocks and she sells them and uses the proceeds to purchase bonds, the interest on the bonds will continue to be attributed to you. The substituted-property rules can go on indefinitely, so that attribution will continue even if your spouse continues to sell the property or properties and use the proceeds to buy replacement properties.
Exceptions
Fortunately, there are various exceptions, where attribution does not apply. These are some of the significant exceptions:
- Attribution does not apply to gifts or transfers of property to adult children. So you can easily income split with your children who are 18 or older. (There is an anti-avoidance rule that can apply to loans to non-arm’s length adults, if it can be shown that one of the main reasons for the loan is to lower your tax. But it does not apply to transfers other than loans.)
- Attribution does not apply to business income. Therefore, you can give cash or other property to your spouse or minor child and they can use it to earn business income that will not be attributed to you.
- Attribution does not apply if you lend money at the prescribed rate of interest (under the Income Tax Act) that applies at the time of the loan. Currently, the rate is 1%. Thus, for example, you could lend money to your spouse at 1% interest, and if she invested it and earned a 6% return, there would be no attribution. But you would include the 1% interest in your income, and she would deduct that 1% interest expense. Effectively, 5% of the 6% return would be taxed to her and 1% to you. Interestingly, the loan can be of any duration. For example, the exception could apply for 20 years if it was a 20-year loan. Note, however, that this exception applies only if your spouse (or child) actually pays you the interest during each year of the loan or by January 30 of the following year. If your spouse or child is late with even one interest payment, this exception no longer applies to that loan
- The attribution rules do not apply if you sell the property to your spouse or child for an amount that is equal to or greater than the fair market value for the property. Similar to the loan exception described above, if the consideration given to you is indebtedness, you must charge at least the prescribed rate of interest in effect at the time of the sale. Your spouse or child must pay you the interest during each year or by January 30 of the following year. In the case of a sale to your spouse, this exception applies only if you elect out of the tax-free spousal “rollover” that otherwise applies automatically to transfers between spouses. This means that the transfer of the property will normally take place at fair market value, which could generate a capital gain for you if the value exceeds your cost of the property.
- Attribution does not apply to re-invested (secondary) income. So if your spouse or child re-invests income from the money or property that you lent or transferred, the income earned on that reinvestment will not be subject to attribution.
- The attribution rules in respect of your spouse do not apply after a divorce. The income from property attribution also ceases on separation, although the capital gains attribution ceases upon separation only if you and your separated spouse make a joint election.
- The attribution rules do not apply if you pay your spouse’s personal expenses, including your spouse’s income tax. But by doing so, your spouse may be able to use her own funds to purchase investments, and the income from those investments will not be attributed to you.
- If your spouse has a tax-free savings account (TFSA), you can give your spouse cash to put into that TFSA and there will be no attribution on any subsequent income earned in the TFSA (simply because the income is not subject to tax while in the plan or upon withdrawal).
- If you contribute to your spouse’s registered retirement savings plan (RRSP), there is no attribution if the funds and income are withdrawn by your spouse, generally as long as no withdrawal takes place in the year during which you made the contribution or the two subsequent years.
