In what was intended to be a strategy for the recovery of alternative minimum tax, Mr. X lent $100,000 to his spouse, Ms. X (also aged 30), at the 1% prescribed rate of interest. She then lent that amount as an unsecured loan (without a guarantee) to his wholly-owned personal holding company at a 5% rate of interest. Would the 5% interest earned by her constitute a “reasonable return” and thus be excluded under s. (g)(ii) of “excluded amount,” and would that change if the holding company was equally owned by her and Mr. X?
CRA noted that where, as here, the principal of the loan came from funds owned by Mr. X and the loan was “made by Ms. X to Mr. X's holding company for the purpose of generating sufficient interest income to minimize the impact of the AMT on Ms. X, it is difficult to see how the factors enumerated in the definition of "reasonable return" in subsection 120.4(1) could be satisfied.” Regarding the impact of the holding company instead being equally owned, CRA stated that “the dividends received by Mr. X and Ms. X should also be considered in relation to Mr. X's and Ms. X's contributions to the related business, in order to determine whether the amount of interest income is otherwise a reasonable amount to Ms. X.”
However, if the interest at 5% was not a “reasonable return,” the split income amount would not be the total interest amount but, rather, only the excess over the reasonable return – so that, for example, if the reasonable return was 3%, the split income inclusion would be 2%.