With the increase in the Bank of Canada rate back in July and the second in September, there’s a looming possibility of an impact on prescribed rates. If they rise, what will that mean for employee loans?

Fortunately, prescribed rates won’t rise this year, as is evident in the calculations below. Still, an increase is inevitable.

While the bank rate reflects policy decisions by the Bank of Canada, prescribed interest rates follow a formula. In brief, it’s the average yield of government of Canada three-month treasury bills auctioned in the first month of the preceding quarter, rounded up to the next whole percentage.

The prescribed rate has been at one per cent since April 2009, other than in the fourth quarter of 2013 when it rose to two per cent (the reference figure had bubbled over to 1.02 per cent that July). Based on the auction rate from July 2017, the prescribed rate will remain at one per cent through to the end of 2017.

Read: Will Canadian companies follow U.S. trend towards student loan assistance?

That reference auction rate is nonetheless on the rise. For the last two years leading into June, it has hovered at around 50 basis points. In July, it jumped to 0.75 per cent. Time will tell whether that’s a blip or the beginning of a trend towards breaking through one per cent.

Effect of a rate increase on employee loans

The prescribed rate has an impact on employee loans.

Employees who obtain a loan at preferential terms available because of their employment relationship may have a taxable benefit if the rate is lower than the prescribed figure. If a $10,000 loan was charging one per cent while the prescribed rate was four per cent over a given year, there would be a taxable benefit of $300 (three per cent of the $10,000 difference between the two rates).

In current times, such arrangements may simply reflect the one per cent prescribed rate. But if the prescribed rate rises to two per cent while the employee loan remains at one per cent, there will be a taxable benefit of one per cent of the principal. Alternatively, if the loan rate rises to two per cent in line with the prescribed figure, the employee’s out-of-pocket interest cost rises. The cost to the employee is the same either way.

Read: Mountain Equipment Co-op provides staff with interest-free bike loans

As a result, it’s useful to remind employees that a rise in the prescribed rate will automatically increase the cost of any loans and to work that in as a contingency in their cash budgeting.

Doug Carroll is practice lead for tax, estate and financial planning at Meridian. This article originally appeared on the website of Benefits Canada‘s companion publication, Advisor.ca.

Copyright © 2018 Transcontinental Media G.P. Originally published on benefitscanada.com

Add a comment

Have your say on this topic! Comments that are thought to be disrespectful or offensive may be removed by our Benefits Canada admins. Thanks!

* These fields are required.
Field required
Field required
Field required