As a result, income-splitting amongst family members can save tax, particularly where there is a high income earner and one or more low income earners. For example, if my marginal tax rate is 53% and my spouse’s or child’s marginal tax rate is 20%, we are obviously better off on the whole if I can shift some income to them. Furthermore, we might be able to multiply some tax credits, such as the basic personal tax credit.
The government is not keen about income splitting, at least in most cases. The Income Tax Act contains income attribution rules, which, when they apply, shut down the beneficial tax effects of income splitting. Fortunately, there are some exceptions, which allow certain forms of income splitting.
The attribution rules
There are two main income attribution rules.
The first rule applies if you lend or transfer property, which includes cash, to your spouse or common-law partner. If they earn income from the property (such as dividends, interest or rent), or taxable capital gains from selling the property, the income will be attributed to you and included in your income. Exceptions are discussed below.
This rule can apply even if you lend or transfer property to them before becoming married or common-law. In such case, the rule can start once you are married or common-law, but not before that time.
The first attribution rule ceases to apply when you become divorced or are no longer common-law partners. If you are separate but still married, the rule relating to income from property does not apply, although the rule relating to capital gains ceases to apply only if you and your spouse or partner make a joint election in your tax return.
The second rule applies if you lend or transfer property to a child under the age of 18 with whom you do not deal at arm’s length (e.g. your child or grandchild), including a niece or nephew. This rule applies only to income from property such as interest, dividends and rent, and does not apply to capital gains. Therefore, splitting capital gains with your child is legitimate. For example, you could buy public common shares or equity mutual funds for your child, and subsequent capital gains would be taxed to them rather than you. (Of course, you don’t know for sure that the shares will go up in value!)
The second rule ceases to apply in the year during which the child turns 18 years, regardless of the birth date. For example, if your child turns 18 on December 31 of this year, there is no attribution throughout this year.
Both rules can continue to apply for income from “substituted property”. For example, if you give cash to your spouse and she buys shares, then sells the shares and buy bonds, income from the bonds can still be attributed to you. The “substituted property” rule can continue regardless of the number of sales and purchases of new property.