Top Court Rules On Tax Scheme

So, while taxpayers will still have to be wary of offending the GAAR through the application of legitimate tax breaks, it's clearly acceptable for couples or individuals to use investment or business assets to pay for a home or to retire a mortgage, and to immediately borrow money to replace those assets and to deduct the interest cost as an expense at tax time.

The Supreme Court had already ruled in 2001 that Vancouver lawyer John Singleton was perfectly justified in taking $300,000 from the capital account of his law firm to help buy a house in his wife's name and, on the same day that he wrote the cheque for the house, borrow money to replace the partnership capital and claim a tax deduction for his interest costs.

Top court says no to family's tax scheme TheStar.com - Business - Top court says no to family's tax scheme

Judges rule 4-3 that husband's deduction of wife's expenses was `abusive tax avoidance'
January 09, 2009 James DawBusiness Columnist
Earl Lipson has lost his final appeal over his right to deduct his wife Jordanna's interest expenses and leave them with more money to pay for a $750,000 home they bought in Toronto in 1994.

But thousands of other taxpayers can breathe easier, says their lawyer, Edwin Kroft of McCarthy Tétrault LLP in Vancouver, and others familiar with yesterday's widely anticipated Supreme Court of Canada ruling, which also applies to Lipson's brother Jordan.
A four-to-three majority of judges ruled that a series of transactions and the use of available tax breaks resulted in abusive tax avoidance, contrary to the general anti-avoidance rule, or GAAR.
But Kroft says it will be significant to many taxpayers that the court's general endorsement of two lower court rulings did not give the Canada Revenue Agency everything it might have wanted.

The top judges saw nothing wrong with the taxpayers' wives deducting interest expenses for a loan used to purchase shares in a family company, and for the brothers to apply the proceeds of the loans to buy family homes.

"The tax benefit of the interest deduction resulting from the refinancing of the shares of the family corporation by Mrs. (Jordanna) 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," wrote Justice Louis LeBel for the majority.

The brothers had made use of the option to report the sale of company shares at their adjusted cost instead of the fair market value, as is permitted.

They would thus have had to report any income their wives earned from dividends. But interest expenses on loans produced a loss that gave them the major tax benefit questioned by the CRA, and which has now been ruled inappropriate by the four Supreme Court judges.
"I don't know whether Mrs. Lipson had other sources of income (than dividends from the family company), but to the extent she did, she could claim the interest expense deduction, or she could carry forward such deductions and claim them in future years," said lawyer Brian Kearl of Gowling Lafleur Henderson LLP in Calgary.

"At the time, the carry-forward period was only seven years. Now it is 20 years."

So, while taxpayers will still have to be wary of offending the GAAR through the application of legitimate tax breaks, it's clearly acceptable for couples or individuals to use investment or business assets to pay for a home or to retire a mortgage, and to immediately borrow money to replace those assets and to deduct the interest cost as an expense at tax time.

The Supreme Court had already ruled in 2001 that Vancouver lawyer John Singleton was perfectly justified in taking $300,000 from the capital account of his law firm to help buy a house in his wife's name and, on the same day that he wrote the cheque for the house, borrow money to replace the partnership capital and claim a tax deduction for his interest costs.

"So unless the transaction is very similar to the Lipsons' – if it's a plain vanilla debt swap strategy – I think it's okay," said Jamie Golombek, managing director, tax and estate planning at CIBC Private Wealth Management.

Kroft said "his decision still leaves lots of uncertainty for taxpayers – and the Crown" over the use of complicated tax planning strategies.

With the division of opinion among judges about Canada Revenue's use of the general anti-avoidance rules, "there is no clarity that they are going to win."