Income splitting remains one of the most powerful — and legally sound — tax planning strategies available to Canadian families. Among the tools available, the prescribed rate loan stands out as a highly effective method for shifting investment income from a high-income earner to a lower-income family member, reducing the overall tax burden on the household. With the right setup and strict adherence to CRA rules, this strategy can generate significant annual tax savings.
A prescribed rate loan is a legal arrangement where a high-income individual — typically a spouse, common-law partner, or parent — lends money to a lower-income family member at the CRA's prescribed interest rate. The lower-income borrower invests the funds and earns investment income. Because the loan carries interest at the prescribed rate, the attribution rules under the Income Tax Act do not apply, meaning the investment income is taxed in the hands of the lower-income borrower at their lower marginal rate rather than being attributed back to the lender.
This distinction matters enormously. A high-income earner in Alberta facing a combined marginal rate above 50% on investment income will pay far more tax on the same dollar than a lower-income spouse in the 22% bracket. A properly structured prescribed rate loan bridges that gap.
Canadian tax law contains what are known as attribution rules, found primarily in sections 74.1 and 74.2 of the Income Tax Act. These rules exist to prevent income splitting by effectively reversing transfers of property between spouses or to minor children.
Under the attribution rules, if a high-income individual transfers property to a spouse or common-law partner — or lends money to a spouse without charging interest — any investment income (including dividends, interest, and capital gains) earned on those transferred funds is attributed back to the transferor and taxed at their higher marginal rate. The strategy of simply handing your spouse money to invest does not work; CRA has anticipated this and ensures the income lands back on the higher-income return.
For loans to minor children, the rules are slightly different. Dividends and interest income are attributed back, but capital gains are not. This means loans to minors can still be partially effective for capital-growth-focused investments, though the attribution rules remain a significant constraint.
The prescribed rate loan is the recognised legal mechanism to avoid attribution. By charging interest at or above the CRA's prescribed rate, the loan is treated as being made on commercial, arm's-length terms. Attribution does not apply, and the investment income stays with the lower-income borrower.
The CRA sets its prescribed rate quarterly, based on the yield of 90-day Government of Canada treasury bills. Over recent years, the rate has shifted considerably. It sat at a historic low of 1% through much of 2020 and 2021 before rising sharply alongside the Bank of Canada's rate cycle — climbing to 3%, then 4%, and reaching 5% by mid-2023, where it remained for several quarters.
For 2025, the prescribed rate has moved in response to easing monetary policy, but the critical planning point is this: the rate is locked in at the time the loan is made. Clients who set up prescribed rate loans when the rate was 1% and have maintained them properly — paying interest annually by the January 30 deadline — still benefit from that 1% rate today. Their loans remain fully effective regardless of subsequent rate increases.
For new loans established in 2025, the applicable rate applies from the date the promissory note is executed. It is worth confirming the current quarter's prescribed rate with an accounting professional before executing any new loan arrangement.
The structure of the loan must be documented with care. A valid prescribed rate loan requires:
The investment returns earned by the borrower belong to them. They report that income on their own return and pay tax at their lower marginal rate. The lender reports only the interest income from the promissory note.
The single most important ongoing obligation for a prescribed rate loan is the annual interest payment deadline. The borrower must physically pay the accrued interest to the lender by January 30 of the year following the year in which the interest accrued.
To be specific: interest that accrues throughout 2025 must be paid to the lender by January 30, 2026. A bank transfer, cheque, or other documented payment must be made. It is not sufficient for the interest to merely accrue on paper or be noted in an account ledger.
The consequence of missing this deadline is severe and permanent. If the borrower fails to pay the required interest by January 30, the attribution rules apply — not only for that year, but for all subsequent years as well. The strategy collapses entirely, with no ability to revive it by making a late payment. The promissory note would need to be unwound and a new one established under the then-current prescribed rate.
Setting a calendar reminder for January 15 each year to confirm the interest transfer is a simple precaution that preserves what can amount to tens of thousands of dollars in annual tax savings.
Consider a couple where one spouse earns $300,000 in employment and professional income and the other earns $45,000. In 2025, the high-income spouse lends $500,000 to the lower-income spouse at the 5% prescribed rate via a properly documented promissory note.
The lower-income spouse invests the $500,000 in a diversified portfolio generating an 8% annual return — $40,000 gross. They pay $25,000 in interest to the lending spouse, which they deduct as an investment expense. Their net taxable investment income is $15,000, taxed at approximately 22%, resulting in roughly $3,300 in tax.
Without this structure, that same $40,000 would be attributed back to the high-income spouse and taxed at their marginal rate of approximately 53%, producing a tax bill near $21,200 on the same income. The annual tax saving approaches $18,000 — from a single properly executed arrangement.
The lending spouse does report the $25,000 in interest income, but at their marginal rate that cost is already factored into the analysis. The net household saving remains substantial. Over a decade, the cumulative impact of this strategy compounds significantly.
At Swift Accounting Calgary, we work with clients throughout Alberta to implement and maintain prescribed rate loan arrangements, ensuring promissory notes are properly drafted, interest payments are tracked, and annual tax filings reflect the strategy correctly.
Prescribed rate loans are most effective for households with a significant income gap between spouses or partners, and where there is sufficient investable capital to make the administrative overhead worthwhile. The strategy also works for adult children with lower income, though the dynamics differ slightly from spousal arrangements.
Families with non-registered investment capital — funds sitting outside an RRSP, TFSA, or FHSA — are ideal candidates. Registered accounts already offer tax-sheltered growth, so the prescribed rate loan is typically aimed at non-registered portfolios where income is otherwise taxable each year.
It is equally important to review the strategy in the context of the full household tax picture. Factors such as pension income splitting, TFSA contribution room, and capital gains exposure all interact with prescribed rate loan planning. A comprehensive review ensures the strategy delivers its full potential without unintended consequences elsewhere in the return.
If your household has meaningful investment assets outside registered accounts, a conversation about prescribed rate loans is well worth having. The team at Swift Accounting in Calgary is available to assess whether this strategy fits your situation and to handle the full implementation.
Ready to explore prescribed rate loans and other income-splitting strategies for your family? Contact Swift Accounting today to schedule a tax planning consultation.
Yes. Prescribed rate loans can be made to adult children who are lower-income earners. Because adult children are not subject to the same spousal attribution rules under section 74.1, the mechanics are slightly different, but the fundamental benefit of shifting investment income to a lower marginal rate applies. The same documentation and January 30 interest payment requirements must be met for the arrangement to remain compliant.
Yes. The interest obligation under the promissory note is unconditional and is not tied to investment performance. If the portfolio underperforms or declines, the borrower must still pay the prescribed rate interest by January 30 each year. This is an important risk consideration: in years where investment returns fall below the prescribed rate, the borrower may realise a net loss on the arrangement. Families should ensure the borrower has liquidity to meet the interest obligation regardless of market conditions.
You can establish a new loan at the lower prevailing rate, but you cannot retroactively change the rate on an existing promissory note. Restructuring typically involves the borrower repaying the original loan in full, then entering into a new loan agreement at the new rate. Before restructuring, the tax implications of unwinding the original arrangement — including any capital gains triggered by selling investments to repay the loan — should be carefully reviewed with your accountant.
Yes. The lending spouse or parent must report the interest received as income on their own tax return. This is a real cost, but it is built into the strategy's design. The net benefit arises because the investment return earned by the borrower exceeds the prescribed rate interest, and that excess is taxed at the borrower's lower marginal rate. The higher-income lender effectively trades higher-taxed investment income for lower-taxed interest income on the same capital, while the surplus investment return shifts to the lower-income household member.
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