- Income Splitting Opportunities: Prescribed Rate Lowered to 1%
- Simplified GST/HST Accounting For More Network Sellers
Income Splitting Opportunities: Prescribed Rate Lowered
By: Lauchlin MacEachern and Robert Hagerman
One positive to take out of the current economic downturn will be the lowering of the prescribed rate to 1% between April 1 and June 30, 2009. This presents opportunities for higher income earners to income split with their spouse, children, or grandchildren.
For income splitting purposes, the prescribed rate is used to determine whether the attribution rules of the Income Tax Act (the "ITA") apply to loans made to one's spouse, children or grandchildren, as well as any trust for such individuals.
The attribution rules operate to deem any investment income earned on a loan made to a spouse, child, or grandchild, or a trust for such individuals, to be taxable in the hands of the lender.1 However, where such a loan was made at the prescribed rate (which applied at the time the loan was made) and the interest is paid within 30 days of the end of each calendar year, the attribution rules do not apply.2
A simple example of how income splitting using the prescribed rate can work is where a husband lends $1 million to his wife at the prescribed rate of 1%. The wife then invests the $1 million and earns a 5% return. At the end of one year, the wife will have earned $50,000, $10,000 of which she will have to pay as interest to her husband. The wife will keep the remaining $40,000 and pay tax on this amount at a lower rate than her husband. In addition, the wife will be able to claim a deduction for the $10,000 of interest paid to her husband. Also, any future income the wife earns on the $40,000 of investment income (known as "secondary" income) will not be attributable to the husband.
New loans made between April 1 and June 30, 2009 at the prescribed rate of 1% per annum and which require interest be paid within 30 days of the end of each calendar year are generally a simple and safe means of minimizing tax by income splitting.
Re-Financing Existing Loans at the Prescribed Rate
Individuals with existing loans set up for income splitting purposes and who are looking to re-finance at a lower prescribed rate face the risk of losing the protection of subsection 74.5(2) (and 56(4.2)), and triggering the attribution rules.3 The Canada Revenue Agency have stated that "we would need to review the terms of the previous loan and the particular source of funds that in fact repay that loan" before being able to determine if such a re-financing would trigger the attribution rules.4 To ensure a refinancing is considered a new loan, as many features of the old loan should be changed as possible: principal amount, maturity date, parties (ex. loaning to a trust for spouse and children rather than to spouse directly), etc. It might also help to repay the old loan and then wait for a period of time before refinancing. Whether a refinancing will be considered to meet the requirements of 74.5(2) will be a question of fact in each case. Individuals should carefully consider this risk before re-financing a loan at a lower prescribed rate.
Income Splitting Opportunities: Prescribed Rate Lowered
By Michael Bussmann
Direct sellers are in the business of marketing and selling products through organizations of individuals in direct contact with consumers in their community.
Some direct sellers sell their products to contractors, who resell these products to consumers at a mark-up (a "resale model"), while others pay commissions to a network of sales representatives, who sell the products on behalf of the direct seller (the "commission model").
Since the early 1990s, there have been rules simplifying the Goods and Services Tax/Harmonized Sales Tax ("GST/HST") accounting for direct selling organizations under the resale model. The Federal Government has announced new rules to similarly simplify the accounting of direct selling organizations operating under the commission model in its Budget on January 27, 2009.
Background to the GST/HST
The GST/HST is a value added tax imposed on most supplies of property and services made in Canada. The GST is imposed at a rate of 5% throughout Canada, except in certain Atlantic Provinces where the HST is imposed in its place at a rate of 13%.
As a creditable or multi-stage tax, the GST/HST is charged and collected between most commercial parties. However, in most instances the tax is fully recoverable to the payor by virtue of its registration for GST/HST purposes. As a consequence, the economic cost of the GST/HST is intended to be borne by the end consumer.
To limit compliance obligations, so-called "small suppliers" with under $30,000 in sales per year are not required to be GST/HST registered, nor to charge and collect GST/HST. However, small suppliers also are unable to recover GST/HST on inputs into their businesses.
Existing Rules for the Resale Model
There is an alternate collection method for direct sellers under the resale model that requires the direct seller to collect GST/HST from the contractor calculated on the suggested retail price of the product to the consumer, rather than on the sale price to the contractor, as would be the case under the ordinarily rules. The direct seller remits this GST/HST to the government.
There have been several benefits to paying the GST/HST on the final sale price to the consumer. Contractors have not been obligated to remit GST/HST on their sales to consumers. In addition, supplies of sales aids, such as documentation, samples, demonstration kits, instructional items and catalogues, as well as host gifts by a direct seller to its contractors, have not been subject to GST/HST. As a consequence, contractors generally have not been required to be registered, nor motivated to be registered, for GST/HST purposes, which has lessened their compliance obligations.
Until the Budget, direct sellers operating under the commission model have not had available to them a similar alternate collection model.
New Rules for Network Sellers under a Commission Model
The new rules provide a modified alternate collection method for network sellers. These new rules will apply to network sellers operating under a commission model for any fiscal year of the network seller beginning in 2010 or later.
The sale of products by the network seller to the consumer will continue to be subject to the GST/HST under the normal rules. As a consequence, GST/HST is collected on the sale price to the end consumer.
The alternate collection method provides for commissions and bonuses paid by a network seller to its sales representatives to be free of GST/HST. Moreover, these commissions and bonuses are ignored for purposes of determining whether sales representatives are required to register for GST/HST purposes. This will permit many sales representatives to come under the small supplier threshold of $30,000 in taxable supplies per year, such that many sales representatives may elect to deregister for GST/HST collection purposes as a consequence. In addition, supplies of sales aids made by network sellers to sales representatives will no longer be subject to GST/HST, nor will supplies of host gifts to sales representatives, nor by sales representatives to hosts.
In order to qualify for the alternate collection method, the network seller must jointly elect with all of its sales representatives, and any new sales representatives, to use the proposed method. A network seller generally will be entitled to elect to use this alternate collection method if:
- the network seller is GST/HST registered,
- all or substantially all of the network seller's sales are expected to be made through sales representatives, or through a combination of sales representatives and contractors where the network seller operates under a mixed commission and resale model;
- all or substantially all of its sales representatives are expected to receive commissions and bonuses from the network seller of less than $30,000 such that they could qualify as small suppliers and deregister for GST/HST purposes; and
- all or substantially all of the sales of the network seller are to final consumers.
To qualify, the network seller must apply to the Canada Revenue Agency for permission to proceed on this basis.
If the Canada Revenue Agency determines that a network seller has not complied with one or more of the conditions of the election in a fiscal year, the network seller will be required to make an adjustment to the network seller's GST/HST net tax.
Adjustments will also be required if a network seller fails to notify its sales representatives that the election has ceased to have effect.
1. Sections 74.1 to 74.4 of the ITA. Also see subsection 56(4.1) for loans made to a non-arm's length party where a main purpose of the loan was to reduce the tax payable on investment income arising from the loan.
2. Subsections 74.5(2) and 56(4.2).
3. Technical Interpretation 2002-0143985 "Refinancing prescribed rate loan" (October 18, 2002).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.