Income attribution rules

Andrew Tricomi - May 02, 2024
Canada's tax system incentivizes individuals to transfer their investment assets to family members with lower incomes in order to reduce their tax burden. The benefits of doing so have grown over the last ten years,.

Income attribution rules


The income attribution rules are intended to prevent income splitting between spouses and with minor children. These rules generally apply when a taxpayer transfers or loans property to another family member. If the transfer is made to a spouse or a trust established for the benefit of a spouse, any income, capital gains, or losses from the transferred or loaned property will be taxed in the hands of the transferor. Similarly, if the transfer or loan is made to a minor child, including a nephew or niece of the transferor, any income or loss from the property will be attributed to the transferor. However, capital gains and losses are not subject to attribution in the case of minor children. It is worth noting that attribution generally ceases to apply to children once they turn 18 years old.

When a transfer or loan is made to a trust for the benefit of a spouse or minor child, only such income or capital gains that is paid or payable to the respective family member will be taxable to the transferor. Otherwise, the income and capital gains retained in a trust will be taxed to the trust at top marginal tax rates.

Some exceptions to the rules

important exceptions to the income attribution rules including:

contributions to a spousal RRSP

gifts to a family member to contribute to a TFSA or first home savings account (FHSA)

contributions to an RESP

capital gains realized on transfers of property or loans to minor children (as noted above)

It's important to note that there are specific requirements that must be met in order to make contributions to spousal RRSPs, TFSAs, and FHSAs. These requirements include contribution limits, age restrictions, and other criteria.

Another method that people often use to avoid attribution rules is by making a prescribed rate loan to a spouse or minor child. However, recent changes have made these loans less appealing. For instance, the prescribed rate on new loans has increased from 1% to 6% over the past two years, which reduces the benefits of this strategy. Additionally, when a trust is used to manage property (often for minor children), the new trust reporting rules create more costs and complexity. Proposed changes to the alternative minimum tax (AMT) could also result in an AMT tax liability for trusts that borrow funds.

The use of life insurance

It's worth exploring other planning opportunities as traditional income-splitting arrangements have some limitations. Life insurance is one option worth considering for several reasons. Although contributions are not tax-deductible, the growth in the cash value of a permanent insurance policy is not subject to annual taxation, provided it remains in the plan. Additionally, there are various ways to access the cash value of the insurance policy while the life insured is alive. The policy's death benefit can be received by the beneficiary on a tax-free basis, which can provide creditor protection to the policy and ensure the death benefit flows outside of the deceased's estate.

Parents can establish and fund a life insurance policy on the life of a child and then transfer that policy to their spouse or child on a rollover basis. For example, a high-income parent could acquire a permanent insurance policy on the life of a child and make additional deposits that grow over time. When the child turns 18 or older, the policy can be transferred to that child without tax. The child can then access the funds in the policy without the transferring parent being subject to attribution on any policy gains. The parent can also retain some control of the policy by being designated as an irrevocable beneficiary. If the policy values are not required immediately by the child, they will continue to grow tax-deferred and can be accessed by the child in the future. This policy can form the foundation of long-term insurance protection for that child's family.

To summarize, when transferring property between spouses or from a parent to a child, it's essential to consider the income attribution rules. Several important exceptions to the income attribution rules can be considered by family clients. Life insurance is another crucial option that can supplement and enhance other income splitting strategies.