Beware of interest deductibility when it comes to spousal loans, a taxation expert warned advisors today at a national financial planning conference. New changes from the Canada Revenue Agency (CRA) could thwart clients’ income splitting plans.

“Be careful. It just came out 48 hours ago,” Jamie Golombek, vice president of taxation and estate planning at Aim Funds Management Inc., told an audience at the Canadian Institute of Financial Planners conference in Orlando, Fla. “The Canada Revenue Agency issued an interesting technical interpretation, which could pose a real problem for some people.”

Essentially, the CRA has released a new interpretation of the Tax Act related to spousal loans, a common income splitting strategy. If one spouse earns more than the other, it is common to split the income between the two using a loan with a prescribed interest rate.

For example, Golombek explained, let’s say a person gave their spouse a loan on December 17, 2007 at 4% with interest payable annually and therefore due on Dec. 17 of 2008. Would the interest then be deductible in 2008?

The answer is no, according to the CRA’s new interpretation of the Income Tax Act, Golombek said.

“They are looking at a very technical approach,” he told the visibly shocked crowd of planners. Golombek went on to explain the CRA’s new position, which is that the Act states a spouse has to pay the interest within 30 days of the calendar year and the “interest payable in respect of the particular year.” In the example above, the “particular year” of the loan was 2007 and therefore there were 14 days of interest for 2007 and the interest wasn’t paid within the requisite 30 days of the calendar year.

“The CRA says you are offside” in this case, said Golombek. “And therefore the whole income splitting falls apart for the first year and all future years.”

Golombek said he has spoken with two lawyers in the two days since the technical interpretation was released. One told him the new reading was plain wrong, while the other felt it was correct from a technical perspective.

“Beware,” the popular tax expert warned the crowd. “Because this is hot of the press.”