If you want to deduct interest, move to the United States; Say Goodbye To The Singleton Shuffle
Ask the man on the street what the biggest difference in personal tax laws between Canada and the United States is and the response you will likely get is you can deduct your home mortgage interest in the U.S.
This difference has led to many U.S. homeowners maximizing the amount of mortgages on their homes in order to maximize their tax deductions.
Until recently, the most common way in Canada to make your home mortgage tax deductible was to use the so-called Singleton Shuffle: You sell your non-registered investments and use the proceeds to pay off your mortgage. Then you obtain an "investment loan" secured by the newly replenished equity in your home and use the funds to reinvest in the market for the purpose of earning investment income. The interest on the loan is thus fully tax deductible.
Unfortunately, this manoeuvre is currently under attack by the Canada Revenue Agency as a violation of the General Anti-Avoidance Rule (GAAR). The Supreme Court of Canada is in the process of deciding whether or not it will hear an appeal on behalf of the Lipsons, a Toronto couple, who lost their Singleton Shuffle case against the CRA.
In the meantime, last week the CRA did bless another method of interest deductibility known in tax parlance as "cash damming."
Let's say you're self-employed and you've got one bank account in which you deposit your sales revenues and also conduct your daily personal banking. You decide to use the money in this account to make your monthly mortgage payments. At the same time, you establish a business line of credit at the bank and use this line to pay all your business expenses.
The CRA was asked whether interest on such a line of credit would be tax-deductible against your sales revenues.
The CRA referred the taxpayer to the Income Tax Act, which states that interest is only deductible if the money is borrowed for the purpose of earning investment or business income.
The CRA also pointed out that, based on various previous court decisions, "it is the direct use to which the borrowed money is applied that governs whether the interest is deductible for tax purposes."
In this hypothetical case, since you've directly used the funds in your line of credit to pay tax-deductible business expenses, the CRA concluded that any interest paid on the line of credit would also be tax deductible.
As for the future of the Singleton Shuffle, if the highest court agrees to hear the Lipson case and ultimately reverses the prior two courts' decisions and concludes that the GAAR does not apply, taxpayers who might otherwise attempt such a manoeuvre do so at their own risk.