January 17, 2009 by Dan White.

The Smith Manoeuvre and the Singleton Shuffle bite the Dust.

I hate to feel smug, but what they hell, every once in a while it is ok. Especially after all the crap unloaded on me over my article in REM and then Bob Arron picking up the article in the star and then the ensuing attack on him and I. You would think we had insulted the Holy Grail.

I am proud to say that I think we successfully prevented all our clients from getting involved with this. I was so loud and determined to make sure everyone knew to say away from this tax scheme.

So last week the long awaited judgment came down from the Supreme Court. The final word is in.

The Lipson versus Canada was the final word case and the game of over. You can not convert your home mortgate to a tax deductible mortgage. Check out my previous blog article on the Smith Manoeuvre, what I wrote is now the guiding light on the matter.

The majority decision was written by two criminal lawyers, a family lawyer and a labour lawyer, and the only Justices who actually know something about tax were in the minority.

While there are complaints that the ruling in the Lipson case did not clear up the matter as to how to know when GAAR applies and when it does not. I think the matter is pretty clear.

GAAR itself is pretty clear to me…. the simple solution is if your primary purpose is to reduce tax… it is wrong… if saving taxes is secondary, and you have the documentation to prove it… then there is nothing to worry about you can deduct the interest for investment loans.  So long as the masters of muddy water try to invent phony schemes and paper for untrue diversionary reasons, then they will continue to get caught in grapples of GAAR.

That is not to disagree that the tax system is inept, unfair or unethical and that CRA previous publications on the matter were ambiguous. The end result is now that now thousands of Canadians to be hit with serious penalties and interest. CRA has known this stuff for years but do nothing because it is a good investment for them to let citizens blunder.

For every single person who played this game, they can expect to get audited. The CRA computers can easly identify every homeowner who has unreasonable interest deductions.

I sure won’t complain because my company is here to help victims who got trapped in the sexy nature of converting their taxable mortgages to tax deductible interest deductions. They now become prime prospects for a WNBC rescue mission.

We have our defence strategies worked out to mitigate damages. I will write on this later. CRA will claim gross negligence and will likely go for 100% penalties plus interest.

Following is further information on this topic. Also check out my previous blog article.

So I am going off to have a nice glass of wine. I think I will have a bottle of Chateau Gloat 2009,

Best Regards

Dan

Lipson v Canada(F.C.)(32041)(March 16, 2007)
“The taxpayer E and his wife entered into an agreement of purchase and sale for a family residence.  The wife borrowed $562,500 from a bank to finance the purchase of shares in a family corporation.  She paid the borrowed money directly to the taxpayer who transferred the shares to her.  The taxpayer and his wife obtained a mortgage from a bank for $562,500.  That same day, they used the mortgage loan funds to repay the share loan in its entirety.  On his 1994, 1995 and 1996 tax returns, the taxpayer deducted the interest on the mortgage loan and reported the taxable dividends on the shares as income when applicable.  The brother of the taxpayer, J, conducted similar transactions.  The Minister of National Revenue disallowed the deductions for those taxation years and reassessed the taxpayers accordingly.  The Tax Court of Canada dismissed the taxpayers’ appeals, holding that the series of transactions constituted a misuse of ss. 20(1)(c), 20(3), 73(1) and 74.1 of the Income Tax Act and the taxpayers’ appeals were dismissed.  The Federal Court of Appeal upheld that decision”.

Canada Court Strikes Mortgage-Interest Deduction Plan (Update1)
By Joe Schneider
Jan. 8 (Bloomberg) — Canada’s high court struck down a method some wealthy families use to gain tax deductibility for mortgage interest, ruling that a husband’s application of his wife’s deduction to his own income is abusive and illegal.
The Supreme Court of Canada, in a 4-3 decision today, upheld a federal ruling that dismissed a tax plan devised by Toronto residents Earl and Jordanna Lipson. Mortgage interest in Canada isn’t tax-deductible, though interest paid on investment loans generally is.
The Lipsons agreed to buy a house in Toronto in 1994 for C$750,000 ($633,000). Jordanna Lipson borrowed C$562,000 from the Bank of Montreal to buy shares in the family company, Lipson Family Investments Ltd., from her husband. The Lipsons then obtained a C$562,000 mortgage from the Bank of Montreal and used it to pay off the share loan. Earl Lipson deducted the interest on the mortgage loan on his 1994, 1995 and 1996 tax returns.
“The tax benefit of the interest deduction resulting from the refinancing of the shares of the family corporation by Mrs. Lipson is not abusive viewed in isolation,” Justice Louis LeBel wrote on behalf of the majority. “The ensuing tax benefit of the attribution of Mrs. Lipson’s interest deduction to Mr. Lipson is.”
The ruling won’t affect Canadians who borrow against the value of their home to buy investments, making their mortgage interest in effect tax-deductible, Jamie Golombek, managing director of tax and estate planning at CIBC Private Wealth Management, said in a telephone interview.
‘Plain Vanilla’
“That strategy, based on this ruling, is still alive and well,” Golombek said. “The plain vanilla debt-swap strategy should be fine.”
Golombek, who moved to CIBC last year after 12 years as vice president of taxation and estate planning at AIM Trimark Investments, said the case has been closely followed by Canadian tax planners. People lined up outside the Supreme Court in April, when arguments were heard, to gain a seat inside the courtroom, Golombek wrote on his blog at the time.
LeBel said the federal tax department properly relied on a law prohibiting abusive tax avoidance — the general anti- avoidance rule, or GAAR — to deny Lipson’s deduction. Justice William Ian Binnie, in dissenting, said the anti-avoidance rule will make it difficult for people to plan their taxes properly.
“The GAAR is a weapon that, unless contained by jurisprudence, could have a widespread, serious and unpredictable effect on legitimate tax planning,” Binnie wrote.
The case is Between Earl Lipson and Her Majesty The Queen, No. 32041, Supreme Court of Canada (Ottawa).
To contact the reporters on this story: Joe Schneider in Toronto at jschneider5@bloomberg.net.
Last Updated: January 8, 2009 14:55 EST

TAX: GAAR (General anti-avoidance rule)
Lipson v Canada(F.C.)(32041)(March 16, 2007)
“The taxpayer E and his wife entered into an agreement of purchase and sale for a family residence.  The wife borrowed $562,500 from a bank to finance the purchase of shares in a family corporation.  She paid the borrowed money directly to the taxpayer who transferred the shares to her.  The taxpayer and his wife obtained a mortgage from a bank for $562,500.  That same day, they used the mortgage loan funds to repay the share loan in its entirety.  On his 1994, 1995 and 1996 tax returns, the taxpayer deducted the interest on the mortgage loan and reported the taxable dividends on the shares as income when applicable.  The brother of the taxpayer, J, conducted similar transactions.  The Minister of National Revenue disallowed the deductions for those taxation years and reassessed the taxpayers accordingly.  The Tax Court of Canada dismissed the taxpayers’ appeals, holding that the series of transactions constituted a misuse of ss. 20(1)(c), 20(3), 73(1) and 74.1 of the Income Tax Act and the taxpayers’ appeals were dismissed.  The Federal Court of Appeal upheld that decision”.
S.C.C. held (4:3 - with 2 separate sets of dissenting reasons) the appeal is dismissed.
Justice LeBel (in majority) wrote as follows (pp. 9-10, 12-13, 21-22):
“It has long been a principle of tax law that taxpayers may order their affairs so as to minimize the amount of tax payable (Commissioners of Inland Revenue v. Duke of Westminster, [1936] A.C. 1 (H.L.)).  This remains the case.  However, the Duke of Westminster principle has never been absolute, and Parliament enacted s. 245 of the ITA, known as the GAAR, to limit the scope of allowable avoidance transactions while maintaining certainty for taxpayers (Canada Trustco , at para. 15).  In brief, the GAAR denies a tax benefit where three criteria are met: the benefit arises from a transaction (ss. 245(1) and 245(2)); the transaction is an avoidance transaction as defined in s. 245(3); and the transaction results in an abuse and misuse within the meaning of s. 245(4).  The taxpayer bears the burden of proving that the first two of these criteria are not met, while the burden is on the Minister to prove, on the balance of probabilities, that the avoidance transaction results in abuse and misuse within the meaning of s. 245(4).
…In determining the purpose of the relevant provision(s) of the Act, a court must take a unified textual, contextual and purposive approach to statutory interpretation (Canada Trustco, at para. 47).  This approach is, of course, not unique to the GAAR.  As this Court confirmed in Kaulius, the approach to statutory interpretation is the same for provisions of the ITA as for those of any other statute: it is necessary “to determine the intention of the legislator by considering the text, context and purpose of the provisions at issue” (Kaulius, at para. 42; see also Placer Dome Canada Ltd. v. Ontario (Minister of Finance), 2006 SCC 20, [2006] 1 S.C.R. 715, at paras. 21-23).
…At this step, it is important to identify which provisions are associated with each tax benefit. Here, it is clear that the tax benefit of deductibility of interest relates to ss. 20(1)(c) and 20(3). On the other hand, the tax benefit arising out of Mr. Lipson’s use of the attribution rules, namely the possibility of deducting the interest to reduce his income, is linked with ss. 73(1) and 74.1(1). By virtue of these provisions, Mr. Lipson retains, for tax purposes, the stream of income from the shares sold to his wife but is able to deduct the interest payments on the mortgage from his income.
…In summary, the tax benefit of the interest deduction resulting from the refinancing of the shares of the family corporation by Mrs. Lipson is not abusive viewed in isolation, but the ensuing tax benefit of the attribution of Mrs. Lipson’s interest deduction to Mr. Lipson is. It follows that this latter tax benefit can be denied under s. 245(2), which is triggered because the transactions in the series include the attribution of the interest deduction under s. 74.1(1) and this attribution frustrates the object, spirit and purpose of that provision. I must now briefly consider the tax consequences of the denial of the tax benefit and the application of the GAAR”.

Posted in Audits, Tax Topics, Tax Tips For Real Estate, The Law in Canada | Print | 8 Comments »

April 5, 2008 by Dan White.

Tax Deductions in Real Estate Properties. By Dan White

When it comes to deducting real estate expenses, there is a lot of confusion in the minds of many. In reality it is all pretty simple and makes sense so long as you don’t listen to those who would have you believe otherwise.

The spirit of the law is that you can write off all expenses related to the business of real estate. The only real question is; Is it sooner or is it later?

The sooner or later depends on which side of the line in the sand the scenario appears to be. On one side you have capital expenses and on the other side of the line there are current expenses.

Where do current real estate expenses cross the line and become capital in nature? The line in the sand is not that obscure if you look to the spirit of the law.

On one side of the line you have current expenses which are fully deductible in the current year. On the other side of the line in the sand you have the capital expenses which are deductable over time by way of depreciation.

Maintenance and Repair is a current expense; so long as it does not improve the property to better than it was when it was new or if it is an addition to what was part and parcel of the original new condition edifice.

In my opinion, too many current expenses are not taken as a current expense because of timid tax preparers. Nowhere is it written in tax law that if you are in doubt about an expense, don’t take the deduction. If in doubt about it, you should get the facts. The facts usually make sense, it is the false stories that usually don’t make sense.

I have included below, the table from CRA’s web site that in my opinion it is pretty clear as to what is deductible and what is not.

A bit of a side note here; the down payment on a real estate property is capital in nature, so it is not tax deductable in your current year. Your down payment is your capital investment and is going to be tied up in the property until you sell it. So remember that the higher the down payment the greater the profit produced, by way of reduced mortgage interest. The greater the profit produced, the greater the tax implications to the businesses annual bottom line. Always keep in mind the purpose of investing is to grow long term wealth.

When purchasing a property, make sure you make as small a down payment as you can. A smaller down payment frees up more cash to do maintenance and repairs. Those maintenance and repairs will reduce your current year profits and generate a significant tax reduction in your current year.

Getting back to the Maintenance and repair expenses; the following is taken directly from The CRA web site.

Current or capital expenses?

Renovations and expenses that extend the useful life of your property or improve it beyond its original condition are usually capital expenses. However, an increase in a property’s market value because of an expense is not a major factor in deciding whether the expense is capital or current. To decide whether an amount is a current expense or a capital expense, consider your answers to the questions on the following chart.

A very important consideration about real estate properties is that sometime people lose money on them and how losses are dealt with is a very important strategy. In the year of the disposal of a rental property, you do not have a capital loss on the sale of a rental property; you have a terminal loss or a rental loss. That is hugely different in terms of your tax scenario. A terminal or rental loss is obviously the better situation for the individual investor.

That is particularly interesting because if you have a capital gain, you only have to take half of the gain against your income.

The above is inconsistent with CRA reasoning, but hey! If they have it on their web site http://www.cra-arc.gc.ca/tax/business/topics/rental/about/report/line9948-e.html I certainly won’t argue with them on this point.

As the days go on, it becomes increasingly clear on just how important tax strategies are.

So go forth and multiply your real estate investments and populate the earth with your assets.

Best Investing Wishes

Dan White

Tax Specialist

Posted in Tax Tips For Real Estate | Print | No Comments »

March 19, 2008 by Dan White.

Seek advice before making mortgage manoeuvre

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Mar 15, 2008 04:30 AM

Bob Aaron
The pitch sounds very seductive. “Go ahead. Make your mortgage tax deductible. Yes. It can be done. Yes it’s legal.”

The pitch is used to promote an investment technique called the Smith Manoeuvre.

According to Smith Manoeuvre Financial Corporation (smfc.com), “the Smith Manoeuvre is a financial strategy that simultaneously converts mortgage interest to tax deductions, shortens the amortization of your mortgage and builds a free and clear pension portfolio for your retirement – funded through your monthly mortgage payments and without requiring any additional monthly cash investment!”

The investment strategy is explained in a book called The Smith Manoeuvre: Is Your Mortgage Tax Deductible? by Canadian financial guru Fraser Smith (Outspan Publishing, $24.95).

But it may not be quite as rosy as it sounds.

Writing in the March issue of REM (Real Estate Magazine, remonline.com), a monthly publication for industry stakeholders, tax specialist Dan White sounds an alarm about using the strategy.

In providing a glimpse of the “dark side of the Smith Manoeuvre,” he cautions anyone contemplating using the technique to “think again and think carefully.”

Here’s how the program works: The homeowner obtains what the Smith people call a re-advanceable mortgage –which is basically a mortgage combined with a line of credit, where the balance can fluctuate from time to time.

As the homeowner pays down the principal with monthly payments, he or she then immediately has that amount re-advanced in order to invest in stocks, bonds or other real estate. In theory, that portion of the loan used for investments – and that portion only – is tax deductible.

In other words, the interest paid on the “re-advanced” portion of the loan can be used to reduce investment income.

According to White, the “significant flaw” in the scheme is when the primary purpose of using it is to make a home mortgage tax deductible, it leaves the homeowner vulnerable to attack by Canada Revenue Agency.

Under CRA rules, interest paid on money used from a mortgage to produce capital gains is not tax deductible.

As a result, if a Smith Manoeuvre loan is used to buy stocks mainly for the purpose of capital appreciation, the interest is not deductible.

Interest can only be deducted as a legitimate business expense if it is used to invest in an active business to generate business income. “Even so,” warns White, “if you are going to do this kind of stuff, you need to think it through, get good advice and set yourself up strategically.”

White reminds REM readers that the government is always looking for ways to generate more income. “There is a reason they call it the Canada Revenue Agency,” he adds.

For occasional or passive investors, White warns that the Smith Manoeuvre could be a costly mistake.

“If you are doing this with your principal residence and you claim 100 per cent of your mortgage interest as a business expense, then there is a strong argument that your home is a business and as such, you are not exempt from capital gains on the sale of the residence,” he writes.

White is not alone in criticizing the investment strategy.

Writing in the Star in January, 2007, Ellen Roseman quoted some critics of the Smith Manoeuvre. Among them was Gary Newby, a certified financial planner in Toronto.

In Roseman’s column, he warned, “It’s not good for the average person. Most of my clients wouldn’t understand it because it’s very complex.”

David Trahair, a Toronto chartered accountant, is also quoted in Roseman’s column.

“It’s a high-risk strategy,” he says, “because you’re betting the farm that some investment adviser can do better than you can.”

I agree with the critics of the Smith Manoeuvre. It’s far too risky for the average homeowner.

Always obtain tax advice from a qualified person, such as an accountant or tax lawyer, who is not selling or promoting anything, and to whom the client’s interests come first.

If the tax adviser stands to make a commission selling participation in a scheme like the Smith Manoeuvre, he or she is in an obvious conflict of interest and the advice can hardly be said to be impartial.

Bob Aaron is a Toronto real estate lawyer whose Title Page column appears Saturdays. He can be reached at bob@aaron.ca. His website is aaron.ca.

Posted in Tax Tips For Real Estate, Tax Tips | Print | 2 Comments »

January 21, 2008 by Dan White.

When investing in real estate, be sure to look at the tax implications of every penny you spend.

If you need to reduce your income tax payable, consider taking depreciation on Real Estate Properties. Depreciation is optional and can be accumulated, but can not be used to create a loss. You need to have a business strategy for your real estate business for this to make the best sense in your situation.

When purchasing real estate; make sure you create a separate schedule to the agreement of purchase and sale. For instance if a buyer wants the property cleaned up or fixed prior to closing have the price reduced by that amount and pay the vendor that amount as a credit on closing. That will ensure that the costs are 100% tax deductable and not part of the capital asset.

Avoid Tax Traps. If a real estate investor thinks they can buy and sell a lot of homes and just take capital gains, they risk falling into a tax trap. CRA’s position is that if you are actively trading properties, the money you earn is business income. So if you don’t have someone running the business for you and you are positioned as a passive investor, then the money you earn will be business income and taxed at your marginal tax rate.

Consider the smallest down payment possible. Zero Down is best. Down payments are capital in nature so are not tax deductible when they occur. The interest paid on income earning properties is tax deductible, passive or non-income earning properties interest is not tax deductible until you sell the property. If you are in Active Real Estate as a business then the interest is tax deductible.

Being a real estate investor means you need a good tax strategist and the proper business plan. The Q program, where they manage your real estate business, allows you to use the capital gains tax reduction strategy and still write off the interest.

Posted in Tax Tips For Real Estate | Print | 2 Comments »