The ability to restructure your affairs to make your home mortgage tax deductible -- which has been challenged by the Canada Revenue Agency -- is heading to the country's highest court.
Yesterday, the Supreme Court of Canada granted leave to the Lipsons, a Toronto couple who used a variation of the "Singleton Shuffle" to make what would have otherwise been mortgage interest tax deductible.
The Singleton shuffle was named after Vancouver lawyer John Singleton's 2001 Supreme Court victory, which upheld the notion that you can rearrange your financial affairs, specifically your debt, in a tax-efficient manner so as to make your interest tax deductible if the funds are borrowed for the purpose of earning income.
Since that 2001 decision, Canadians who have nonregistered investments have been encouraged by financial advisors and tax planners to liquidate these investments and use the proceeds to pay off their mortgage.
The investor could then obtain a loan secured by the newly-replenished equity in their home, and use the loan for the purpose of earning investment income, thus making the interest on the loan fully tax-deductible.
That plan, essentially endorsed by Singleton's Supreme Court win, was implemented without concern by numerous Canadians -- that is, until it was attacked last year by the CRA in the Lipson case using the general anti-avoidance rule (GAAR).
The GAAR is an overarching rule in the Tax Act that can attack a legitimate tax plan for being a "misuse or abuse" of the rules. GAAR was never argued by the CRA in the original Singleton case and thus the Court did not have a chance to comment as to whether it should be applied to such a strategy.
In 1994, Earl and Jordanna Lipson wanted to buy a home. Jordanna borrowed $562,500 from the bank and used the money to purchase $562,500 worth of shares in the family's corporation from her husband. Earl then used the $562,500 to buy the home. The home was subsequently mortgaged and the proceeds from that mortgage were used to replace the original investment loan.
The main question before the court was whether the interest expense on the money borrowed to purchase the shares was tax-deductible.
To date, the Lipsons have lost both in the Tax Court of Canada and the Federal Court of Appeal. What's particularly interesting is that the Federal Court of Appeal actually agreed with each step of the Lipsons' transactions, including finding that the interest was indeed tax-deductible since the proceeds were used for the purpose of earning income. However, when viewed as a whole, the court found the entire "series" of transactions was abusive.
Seeking leave to the Supreme Court was the Lipsons' final avenue of appeal; however, such right of appeal was not automatic -- the Supreme Court only grants leave in matters of national importance.
Now, the Supreme Court will have the final say when the case is heard, likely some time in 2008. The Lipsons will have to convince the highest court that what they were doing was legitimate tax planning and not a "misuse or abuse" of the Act and thus subject to the GAAR. Stay tuned...