Clients who have implemented a prescribed rate loan should be reminded to pay the appropriate interest relating to the 2025 year on or before January 30, 2026.
What is a prescribed rate loan?
A prescribed rate loan is one of the few income-splitting opportunities provided to Canadians that does not violate the various “attribution rules” found in Canada’s Income Tax Act. These “attribution rules” are designed to prevent high-tax bracket individuals from shifting investment income to a lower-tax bracket individual’s hands.
A prescribed rate loan strategy allows Canadians to legitimately place income and gains earned from the invested loan proceeds in the hands of their spouse, common-law partner, or an inter-vivos trust with beneficiaries that are taxed at lower marginal tax rates. When structured properly, the family unit will pay less income tax on a combined basis on such income and gains.
When is the interest due?
For the prescribed rate loan planning to be valid, one requirement is that the loaned funds charge an interest rate that is at least equal to the Canada Revenue Agency’s (CRA) prescribed rate at the time that the loan is made. The CRA prescribed rate is published each quarter and is based on the Government of Canada three-month T-bill rate.
| Historical Interest Rates For Prescribed Rate Loans | |||
| 2025 | 2024 | 2023 | |
| Q1 | 4% | 6% | 4% |
| Q2 | 4% | 6% | 5% |
| Q3 | 3% | 5% | 5% |
| Q4 | 3% | 5% | 5% |
Interest on a prescribed rate loan must be “paid not later than 30 days after the end of the particular year”. As “particular year” in most instances refers to a calendar year, the year-end is December 31.
To ensure that any outstanding prescribed rate loans remain valid, the borrower must ensure that the required interest is paid to the lender on or before January 30 of the following year.
The payment of interest is required even if the prescribed rate loan was issued during the year or additional funds were loaned or repaid. Where the loan balance has changed in the year (e.g. a payment was made to principal), the interest payable should be prorated based on the number of days in the year that each different balance was outstanding.
For example:
- A $100,000 prescribed rate loan at 3% interest was established on December 1, 2025. The accrued interest for the period December 1-31 must be calculated and paid no later than January 30, 2026.
- A $2 million prescribed rate loan at 3% interest was set up on July 1, 2025, half the loan principal ($1 million) was repaid on December 15, 2025. Interest for 2025 will be calculated as 3% on $2 million (July 1- December 14) plus 3% on $1 million (December 15-31). Interest must be paid no later than January 30, 2026.
How should interest be paid?
It is best practice for the borrower to pay the required interest from their own separate account. Using joint chequing or joint investment accounts to make the interest payments should be avoided. Where a prescribed rate loan is in place between spouses or common-law partners, the borrower often pays the interest from their investment account to the lender’s investment account.
Interest payments should also be documented to provide support should the CRA request evidence of these interest payments. As with other supporting tax information, it is generally recommended to retain this documentation for a period of at least six years.
What happens if the interest is not paid?
If the interest is not paid on time, then the “attribution rules” will apply and the tax benefits of the prescribed rate loan strategy will be lost, and the loan will be considered “tainted”.
While a new prescribed rate loan can be established to regain the tax benefits, there are several negative outcomes that can arise if a new prescribed rate loan is required because of the interest payment not being made on time.
- Professional Fees
Establishing a prescribed rate loan generally comes with professional fees. For example, a lawyer is commonly engaged to draft a loan agreement to document the new prescribed rate loan. Additionally, professional fees from accountants and/or tax advisors may also be required. - Lost Access to Lower Interest Rates
Though the prescribed rate has been falling in recent quarters, these rates began to rise sharply in mid-2022, reaching a peak of 6.00%. Given the interest rate is “locked in” at the time a prescribed rate loan is established, missing an interest payment will taint a prescribed rate loan that has been established at a lower interest rate (many have been established as low as 1.00%). As such, missing an interest payment may result in the new prescribed rate loan being established at a higher prescribed rate of interest. This is not ideal as the lower the prescribed rate attached to the loan, the greater the tax benefits for the family unit. - Liquidation of Portfolio
Where the prescribed rate loan was used by the borrower to purchase marketable securities, it is generally best practice to liquidate the portfolio to settle the now “tainted” prescribed rate loan before establishing the new prescribed rate loan structure and investing the new loan proceeds. This can lead to various unintended consequences such as the “superficial loss rules” if the original investments are disposed of at a loss and are subsequently repurchased within certain timeframes.
Note: professional tax advice should be obtained if a prescribed rate loan falls offside due to a missed interest payment.
To facilitate payment of interest on your prescribed rate loans or to understand how this strategy may be a beneficial tax mitigation strategy for you and your family, contact your Wellington-Altus advisor.
