Interest deductions on investments

January 24, 2008 by Dan White.

Hey guys,

This article by Jamie, demonstrates the point I made about the Smith Maneuver.   aka The Singleton Shuffle.

Passive Investors beware of thinking you can always deduct your investment Interest. See Ruling.

 Interest deductions take hit from CRA ruling
Jamie Golombek, Financial Post
Published: Saturday, March 31, 2007

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A recent decision by the Federal Court of Appeal on a tax maneuver called the Singleton Shuffle, has dealt a severe blow to investors’ ability to write off interest expenses when money is borrowed for the purpose of earning investment income.

The Singleton move was named after Vancouver lawyer John Singleton’s 2001 Supreme Court of Canada victory, which upheld the notion that if you have equity in either your business or home, you can borrow against that equity for the purpose of earning income and write-off interest charges.

Since that 1991 decision, Canadians who have non-registered 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.

The most recent case involved Earl and Jordanna Lipson, a couple who 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 question before the court was whether the interest expense on the money Jordanna borrowed to purchase shares from her husband was tax-deductible.

The Canada Revenue Agency attacked the Lipson case using the general anti-avoidance rule (GAAR), an overarching rule in the Tax Act that can attack a legitimate tax plan for being a misuse or abuse of the rules.

The CRA won its battle against the Lipsons last year in court, and won the appeal this month.

What’s interesting about this case 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 earning income. However, when viewed as a whole, the court found the entire “series” of transactions was abusive.

This is clearly troubling as it may preclude an individual from rearranging his or her affairs in the most tax-effective manner.

And where does this leave the Singleton Shuffle?

Al Meghji, a senior tax litigator with Oslers, who has successfully argued a GAAR case before the Supreme Court, cautions investors to tread carefully.

“Although it is difficult to say that it is ‘the end,’ it certainly makes it much easier for CRA to attack,” he says.

David Spiro, a tax partner at Blakes, advises investors not to throw in the towel.

“This particular plan clearly wasn’t able to withstand attack by Revenue Canada. Are there plans out there that could withstand attack? Sure.”

- Jamie Golombek, CA, CPA, CFP, CLU, TEP is the vice-president, taxation and estate planning, at AIM Trimark Investments in Toronto.

Jamie.Golombek@aimtrimark.com

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