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Income-Splitting Opportunities with Corporate Class Funds

By Evelyn Jacks

It is every person’s legal right and duty to arrange their affairs to pay the least amount of tax legally possible. In planning investment strategies, therefore, taxpayers can and should structure their resulting income and profits in a tax-efficient manner.

Just as tax return preparation is most effective when all of a family’s returns are prepared at the same time, financial advisors can promote tax efficiency within the family by structuring income-splitting opportunities between high income earners and their minor children, spouses and other adults.

Income splitting removes assets and income from tax exposure at the highest marginal rates to the lowest, resulting in significantly more after-tax dollars for the family. As a result, individuals keep more of the first dollar invested, avoid high marginal taxes levied on the highest-income earner, and also create more wealth by limiting clawbacks of social benefits like the Old Age Security and refundable and non-refundable tax credits.

Special rules called the Attribution Rules must be observed in income splitting. However, effective strategies can built around these rules.

Avoiding the Attribution Rules with Corporate Class Funds
It is generally not possible to transfer income to a spouse, common-law partner or minor child without triggering the Attribution Rules, which require that the resulting income be reported by the transferor, unless certain exceptions are met. For example, attribution can be avoided by making spousal RRSP contributions, or when properly documented inter-spousal loans are in place for other income from property – interest or dividends for example – or capital gains or losses. For minors, Attribution Rules apply to interest or dividend income earned by transferred funds, but not capital gains or losses.
By using corporate class funds as an investment solution, more tax-efficient income for the whole family can be result. This is because of the structure of corporate class funds, which provides:

  • The ability to defer capital gains taxes on disposal of the funds themselves (as transfers between funds within the corporate class do not trigger a taxable event).
  • Minimal annual taxable distributions, resulting from activities of the fund manager, as they are paid as dividends and capital gains income sources.
  • The ability to convert highly taxed interest income into capital gains. (Income-oriented corporate class funds retain interest income within the fund rather than paying regular distributions. Investors seeking income can set up an automatic withdrawal plan, and the withdrawals are taxed as capital gains.)

Transfers to a Spouse
Under the Attribution Rules, capital transferred to a spouse will result in the taxation of the associated income and capital gains in the transferor’s hands. This includes situations where a spouse guarantees the repayment of a loan, for investment purposes, made to the other spouse. This can be avoided when the higher earner draws up a bona fide investment loan between the spouses for the transfer of the money. Here are the requirements:

  • Draw up a formal demand note outlining terms of the repayment.
  • Pay interest at the Canada Revenue Agency’s prescribed rate each year at least by January 30 following the end of the tax year.
  • Ensure that the higher-income earner reports interest paid by the lower earner as income.

  • Resulting income and capital gains would then be properly reported by lower-income earner and taxed at lower marginal rates.

If the lower-income spouse uses the transferred funds to invest in corporate class funds, then the strategy becomes even more successful. That’s because, as noted above, corporate class funds tend to generate tax-efficient capital gains income (only 50% of the gain is added to taxable income), they have minimal annual distributions and they allow capital gains to be deferred when dispositions occur between fund classes.

Transfers and loans to minors
Where property is transferred or loaned either directly or indirectly to a person who is under 18 and who does not deal with the transferor at arm’s length or who is the niece or nephew of the transferor, the income or loss resulting from such property – interest, dividends, rents or royalties – is reported by the transferor until the transferee becomes 18 years of age. However, capital gains or losses that result from the transferred property are deemed to be the income of the minor.

When corporate class funds are selected as an investment by an adult for a minor, income attribution is avoided when the funds generate capital gains dividends as income or capital gains on later disposition. The child’s portfolio therefore also benefits from significant tax-efficient growth opportunities while the adult successfully transfers capital to the child.

Example: Mary and Jack have a child, Susan, to whom they have transferred $25,000. This money is invested in corporate class funds. Susan will report resulting capital gains and capital gains dividends, rendering them non-taxable if total income is under the basic personal amount.

Consider the following in planning income for minors:

  • Assuming no other income, up to $16,296 in taxable capital gains can be generated as income in the hands of the child before tax is payable in 2005.
  • Corporate class funds may also be an appropriate investment vehicle for income and assets properly attributed to and held in the child’s own name, including:
    • Gifts and birthday money from other adult relatives.
    • Earnings from full or part-time jobs.
    • Benefits from life insurance policies in which the child was named as the beneficiary.
    • Disability or survivors’ benefits from parents qualifying under the Canada Pension Plan paid directly to the child.
    • Reinvestment of income – such as interest and dividends
    • first attributed back to the adult from transferred funds. This second-generation income can now be reinvested on an attribution-free basis by the child.
    • Such capital previously transferred by the adult and subject to Attribution Rules, which becomes the child’s own-source capital upon attaining age 18.

Exceptions to the Attribution Rules
Tax-efficient investing strategies also include these exceptions to the Attribution Rules:

  • Transfers for fair market consideration. The Attribution Rules will not apply to any income, gain or loss from transferred property if at the time of transfer, the equivalent of fair market value was actually paid by transferee from his or her own sources.
  • Transfers to adult children. Income resulting from assets transferred to an adult child (over 18) will, in general, not be subject to attribution. However, when income splitting is the main reason for an investment loan to an adult child, the income will be attributed back to the transferor, unless the loan is a bona fide loan with interest payable as described above, by January 30 of the year following the end of the calendar year.
  • Attribution and Marriage Breakdown. If spouses are living apart due to relationship breakdown, they can jointly elect to have attribution rules not apply to the period in which they were living apart. Spouses can also choose not to have this section apply, with the result that any property sold in the time the spouses were living apart will be taxed in the hands of the transferor. If corporate class funds are sold under this scenario, the parties will keep more of the investment because of the advantageous tax treatment of resulting capital gains.

Those taxpayers who make tax-efficient investing a priority have the unique opportunity to reinvest or use more of the first dollar that is earned, regardless of the life-cycle of the investor. Corporate class funds provide an investment alternative for the whole family that may be appropriate for income-splitting activities with minors and spouses or common-law partners. The tax advantages of the structure of this product can result in better overall returns during the course of the investment, or upon disposition. Advisors and their clients may therefore be able to meet wealth accumulation goals more quickly and accurately over time.


Evelyn Jacks is the author of 30 best-selling books on the subject of personal income taxation, and the President of Knowledge Bureau, Inc., Canada’s leading professional education publisher in the tax and financial services industry, specializing in delivering courseware and information services to knowledge-based practices. For more information call toll free 1-866-953-4769 or visit

This article is written to be of a general nature and neither the author, her company, employees, subcontractors or others associated with The Knowledge Bureau can take responsibility for any results, positive or negative, taken by any persons. While the author received a fee to write this article, she is not in the business of providing advice on investment products and is not registered and licensed to do so, nor does the author have any compensatory relationship, or beneficial ownership regarding the sale of investment products discussed herein.



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