April 4, 2008 by Dan White.

 Article in National Post

by Vern Krishna,

Re: The Smith Manoeuver….

When this case if over, we will have the final answer From the Supreme Court of Canada, on this topic.

My Prediction is; The Judge will rule that such manoevers are outside the spirit of the law, and within the spirit of GAAR.

It will be pointed out that the process is nothing other than a shell game and the game of doing will end.

The next part of the game will be from CRA who will feast on all the reclaiming of deducted interest, penalties and interest.

For every dollar of tax saved from doing the shuffle, the participants will write a cheque to CRA for three times the amount ($3.00)

It will be very easy for CRA auditors to identify large interest amounts on all the past tax returns in the last 3 years.

Yes, Dan White has been attacked and villified by my assertions; If it looks like a duck, quacks like a duck, walks like a duck then it is a duck……

So my prediction has been written. Be it right or wrong. Now we shall let the courts decide. My conscience is clear, I have advised many people to stay away from doing this kind of stuff.

Dan White.

Vern has done a great job of writing his article. Be sure to read it closely.

Homeowners, tax lawyers alike will watch Lipson case

Court to consider whether couple violated tax rules

Vern Krishna, Financial Post  Published: Wednesday, April 02, 2008

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Canadian income-tax law has matured in the past 91 years. It has grown from 20 pages in 1917 to more than 2,000 pages in 2008. Notwithstanding its lengthy development, it is still all but impossible for taxpayers today to predict whether the legal form of transactions prevails over economic substance or vice versa. Interest deductions are the classic — and most recent — example, which the Supreme Court of Canada will soon consider in a case called Lipson.

Joe Clark won the 1979 federal election by promising that he would allow Canadians the same rights as Americans to deduct home-mortgage interest for tax purposes. Unfortunately for homeowners, the Clark government fell in nine months before passage of the bill enacting the legislation. Since then, taxpayers have resorted– with varying degrees of success — to arbitrage interest payments and make their personal mortgage interest-deductible for tax purposes.

Interest arbitrage occurs where a taxpayer exchanges non-deductible interest for deductible interest through a series of transactions that allow form to prevail over substance. In the simplest case, for example, an individual sells stock worth $500,000 to buy a house and then borrows $500,000 to repurchase identical stock. The interest on the borrowed money should be deductible because the taxpayer uses the funds directly to purchase investments.

Canadian tax law has long recognized this type of tax planning. The Westminster principle — named after the 1935 decision of the House of Lords in the Duke of Westminster case — is that a taxpayer can legally arrange his affairs to minimize the tax payable regardless of his motive. The principle is simply one aspect of the doctrine that taxpayers should be governed by the rule of law, preferably clear and certain laws.

Westminster has been part of Canadian tax law for six decades. In a landmark decision in 1984, the Supreme Court of Canada rejected the government’s argument in a case called Stubart that a transaction must have a valid business purpose. The court also rejected any requirement of economic substance — a doctrine long used in the United States.

Following Stubart, Parliament enacted the general anti-avoidance rule (GAAR) in 1988 to curb so-called “abusive” tax avoidance.

GAAR is a clumsy provision even by the standards of tax legislation. It defines an “avoidance transaction” as one that a taxpayer undertakes for tax benefits and that does not have a primary bona fide non-tax purpose. Thus, GAAR has an objective and a subjective component. One must evaluate the taxpayer’s motive for undertaking commercial transactions to determine whether they are primarily tax-driven or have an independent non-tax purpose.

However, there is an important exception to GAAR: It does not apply to tax-motivated transactions — even if they have no bona fide non-tax purpose — provided the transactions do not:

(1) Misuse specific provisions of the Income Tax Act; or

(2) Abuse the underlying policies of the Act read as a whole.

Thus, virtually every GAAR case must analyze whether the taxpayer misused or abused the Income Tax Act. Income tax law has many different policies and they are not a coherent whole. They are a patchwork of rules that can pull in different directions.

The appeal to the Supreme Court of Canada in Lipson illustrates the complexity of GAAR in tax planning. Earl and Jordanna Lipson — a married couple — engaged in a series of transactions intended to arbitrage what would have been non-deductible interest on their home mortgage into deductible interest for tax purposes. The purpose of the transactions was to convert non-deductible personal interest on a home into deductible interest solely for tax purposes. The transactions purported to finance the purchase of investment property. In substance, however, the arrangement financed a personal residence.

The form of each step of the series of transactions was legal. They applied specific deeming provisions of the act. The cumulative effect of the provisions deemed the interest deductible for tax purposes. The arrangements were lawful tax minimization under the Westminster principle.

However, GAAR looks at whether the taxpayer misuses any of the provisions of the Income Tax Act or abuses the statute read as a whole. The economic substance of the Lipson transactions was to circumvent the underlying policy of the Income Tax Act, which clearly prohibits the deduction of personal mortgage interest for tax purposes. Transactions that abuse the underlying policies of the Income Tax Act are avoidance transactions and subject to recharacterization for tax purposes. The substantive economic effect of the Lipson financing was to convert non-deductible personal interest into deductible business interest.

Parliament, however, did not write GAAR as a notwithstanding rule that is paramount over all other rules. Thus, the question in tax planning is: To what extent does GAAR trump the Westminster principle?

There is only one absolute in tax planning: Legal form prevails over substance, except in those circumstances where a court determines that substance prevails over form. Look to the Supreme Court for the definitive answer to resolve the dilemma for the next decade.

— - Prof. Vern Krishna, CM, QC, FCGA, is counsel at Borden Ladner Gervais LLP and executive director of the CGA Tax Research Centre at the University of Ottawa.

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