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This coming July 1 will be particularly special. Sure, Canada will be celebrating its 158th birthday that day, but even more exciting for some of us is that the Canada Revenue Agency’s prescribed interest rate will drop to three per cent on that date, providing a greater opportunity to split income with a spouse or common-law partner, (grand)children or other family members.

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Prescribed rates are set by the CRA quarterly and are tied directly to the yield on Government of Canada three-month treasury bills. The calculation is based on a formula in the Income Tax Regulations, which takes the simple average of three-month treasury bills for the first month of the preceding quarter rounded up to the next highest whole percentage point. As a result, the prescribed rate can never be zero, and one per cent is the lowest possible prescribed rate, which it was for a couple of years during COVID, specifically between July 1, 2020, and June 30, 2022.

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The prescribed rate has not been as low as three per cent since December 2022. Here’s how to use this lower prescribed rate to your advantage, either by making a loan directly to family members or, where minors are involved, using a family trust to do so.

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Income splitting is the transferring of income from a high-income family member to a lower-income family member. Since our tax system has graduated tax brackets, by having the income taxed in the lower-income earner’s hands, the overall tax paid by the family may be reduced. But you can’t simply give money to your spouse or kids to invest and hope to have the income taxed in their hands. This is because of the attribution rules in the Income Tax Act that prevent most types of income splitting by generally attributing income or gains earned on money transferred or gifted to a family member back to the original transferor.

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The Tax Act does, however, provide an exception to the attribution rule if funds are loaned, rather than gifted, to family members, provided you charge interest at the prescribed rate, and the interest is paid annually within 30 days after the end of the year.

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For loans put into place between July 1 and September 30, 2025, the three per cent rate would be locked in for the duration of the loan without being affected by any future increases since the Tax Act only requires you to charge the prescribed rate in effect at the time the loan was originally extended. The net effect of this strategy will be to have any investment return generated above the three per cent prescribed rate taxed in the hands of the lower income family member.

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Prescribed rate loans can also be used to help fund minor children’s expenses, such as paying for private school and extracurricular activities, by making a prescribed rate loan to a family trust with the minor children as beneficiaries. Each year, the trust’s annual income above the three per cent interest charge is “paid” to the kids who are typically in zero or very low marginal tax brackets. This distributed trust income is then used to pay the kids’ expenses.