Income Tax Act Subsection 74.5(2)
Income Tax Regulations Subsection 4301(c)
Income splitting is an attempt by one taxpayer to send taxable income to another taxpayer in a lower bracket. Typically this is done by splitting income between family members.
Income splitting through loans is where a taxpayer loans funds to the lower-income son, daughter, mother, father, or spouse. The funds are then used to purchase investments with the income earned by those investments taxed at a lower rate than they would have been if purchased by the higher-income earning individual.
The interest rate must be greater of equal to the prescribed rate se by the Canada Revenue Agency. The prescribed rates change each calendar quarter, and can be found on the CRA prescribed interest rates page.
The higher-income individual who loaned the funds must account for the interest in his or her income every year that the loan is outstanding.
Income splitting through loans is extremely technical and professional advice should be sought prior to proceeding.
One final note is that the tax savings are not beneficial unless the higher income earner loans $100,000 or more to the lower income individual.