[Old Bumped Thread] Supreme Court rules against making mortgage interest deductible

[tvp2003]

Any comments from the financial and/or real estate guys on CP?

OTTAWA - A Toronto couple who attempted a complicated manoeuvre to effectively make the mortgage on their home tax deductible abused federal income tax laws, the Supreme Court of Canada ruled Thursday.

"It has long been a principle of tax law that taxpayers may order their affairs so as to minimize the amount of tax payable," Justice Louis LeBel wrote for the 4-3 majority. "However, this principle has never been absolute."

The split decision is a defeat for Earl and Jordanna Lipson, a Toronto couple who swapped non-deductible interest for deductible interest while buying their $750,000-home in 1994.

The scheme involved paying down their mortgage immediately after obtaining it, then using the repaid principal as collateral for an investment loan, which is tax deductible under the Income Tax Act.

http://www.canada.com/topics/news/story.html?id=1155182

[Slava]

I don't know the specifics of this case, but its a shocking decision. The whole practice has become more and more commonplace over the past few years and the ramifications are going to be interesting.

[Wookie]

Will this have an implications on something like the "smith maneuver"

[Claeren]

I think it is good.

Obviously one important aspect of 'fairness' is that all people are all on the same playing field, which this ruling maintains.


In terms of the principle behind 'no tax deductions for home mortgage interest' I think it is again a good thing. One, it encourages people to get equity into their homes unlike in the USA where people benefit (until recently I guess! lol) by carrying huge mortgages, and two, it means you can still sell your home and enjoy equity appreciation/capital gains without paying taxes on it.

Some might be willing to trade the two (mortgage interest deduction for taxes on capital gains) but personally I think a lot of Canadians like the way it is now?



I am not sure how this impacts on that whole RRSP move though? (Smith maneuver you call it Wookie?)



Claeren.

[troutman]

This is allowed in the US:

http://www.irs.gov/publications/p936/ar01.html

This publication discusses the rules for deducting home mortgage interest.

Part I contains general information on home mortgage interest, including points and mortgage insurance premiums. It also explains how to report deductible interest on your tax return.

Part II explains how your deduction for home mortgage interest may be limited. It contains Table 1, which is a worksheet you can use to figure the limit on your deduction.

http://en.wikipedia.org/wiki/Home_mo...rest_deduction

A home mortgage interest deduction allows taxpayers who own their homes to reduce their taxable income by the interest paid on the loan which is secured by their principal residence (or, sometimes, a second home). Most developed countries do not allow a deduction for interest on personal loans, so countries that allow a home mortgage interest deduction have created an exception to those rules. The Netherlands, Sweden, Switzerland, and the United States each allow the deduction. The standard justification for the deduction is that it encourages home ownership. Countries that tax imputed income on home ownership may allow the deduction under the theory that it is no longer a personal loan, but a loan for income-producing purposes. Standard criticisms are that it does not significantly impact home ownership, that it allows taxpayers to circumvent the general rule that interest on personal loans is not deductible, and that the deduction disproportionately favors high-income earners.

Canadian federal income tax does not allow a deduction from taxable income for interest on loans secured by the taxpayer's personal residence. But homes used in businesses as a landlord who owns a rental residential property can deduct interest as any other reasonable business expense. The difference being the deduction is allowed only when the property is not used for the taxpayer's personal use but is used as in any other type of business. However, there may be additional exclusions for passive activity losses.

While politically popular, economists are basically united in their opposition to it.[7] The Tax Foundation has stated that few low- and middle-income taxpayers benefit,[8] calling it subsidization of the real estate industry.[9]

[Wookie]

Originally Posted by Claeren

I am not sure how this impacts on that whole RRSP move though? (Smith maneuver you call it Wookie?)



Claeren.

http://www.smithman.net/home.html

[Slava]

For sure we are better off with the system in Canada as compared to the United States; I would definitely not want that system.

I'm not 100% sure that there are implications for the Smith Manoeuvre here. I am very familiar with that plan, and it looks like there are differences between what this couple was doing and what the Smith Manoeuvre entails. That being said I will be investigating this link for sure and post here what I dig up.

[fredr123]

This is that GAAR decision everyone was waiting for.
http://csc.lexum.umontreal.ca/en/200.../2009scc1.html

[troutman]

How is the Smith manoeuvre going to avoid GAAR now?

A central issue in the case is the interpretation of an Income Tax Act principle, called the General Anti-Avoidance Rule (GAAR).

Enacted in 1988 to reduce abusive tax avoidance, the GAAR can make legal transactions illegal for being a "misuse or abuse" of the rules.

If something seems to good to be true . . .

[Slava]

Originally Posted by troutman

How is the Smith manoeuvre going to avoid GAAR now?

A central issue in the case is the interpretation of an Income Tax Act principle, called the General Anti-Avoidance Rule (GAAR).

Enacted in 1988 to reduce abusive tax avoidance, the GAAR can make legal transactions illegal for being a "misuse or abuse" of the rules.

If something seems to good to be true . . .

I just read the decision that fredr123 posted (and thanks for that!). There is a significant distinction here between the Smith Manoeuvre and this decision; these funds were borrowed and bought shares of a family owned business.

I'm certainly no expert on the law, but that is a huge distinction between the plain-jane Smith Manoeuvre and what took place here. That is not to say that the Smith Manoeuvre is fool-proof; there are certain versions that I think are offside and its a matter of time.

[fredr123]

Someday, I hope to have a manoeuvre named after me. That would be awesome. Realistically, if something is named after me it will probably be a syndrome or disorder.

[troutman]

Smith Manoeuvre debate:

http://www.canadiancapitalist.com/20...noeuvre-debate

http://www.canadianbusiness.com/colu...14_163446_5516

[edn88]

What I don't get is, if you are going to borrow money for an investment and you can afford to pay off your mortgage, why not buy their home for cash in the first place, then use your home for the collateral for the investment loan?

[Bertuzzied]

Isn't that the reason why the US is in such trouble? Is because you can write off your mortgage interest, so everyone took on a mortgage even though they might not have needed one.

[Slava]

Originally Posted by edn88

What I don't get is, if you are going to borrow money for an investment and you can afford to pay off your mortgage, why not buy their home for cash in the first place, then use your home for the collateral for the investment loan?

You can do that. Its referenced in the decision as the Singleton decision (aka the "Singleton Shuffle"). The difference is that these people borrowed the money against the house and invested it into a business that they also owned.

[Resolute 14]

Originally Posted by Bertuzzied

Isn't that the reason why the US is in such trouble? Is because you can write off your mortgage interest, so everyone took on a mortgage even though they might not have needed one.

Well, the US is in trouble because people wrote off the interest, then used their giant tax returns to buy vacations, plasma TVs and other non-essentials.

If Canada was like the US in this regard, I'd use the tax break to pay down the mortgage faster. But that would probably put me in the 0.001% of people who actually would do that.

[Bobblehead]

Interesting article from last March discussing this. This quote kind of caught my attention.

Of significance, Justice Bowman, the trail judge, placed great weight on the fact the overall purpose of the series of transaction was "to make interest on money used to buy a personal residence deductible" which, under our tax laws, cannot be deductible but for some type of supportable tax transaction(s) (it is the exact opposite in the U.S. where interest is deductible).

http://blogs.money.aol.ca/2008/03/19...e-lipson-case/

[Slava]

^ I read that blog as well. To me the interesting point was that the whole thing is legitimate, but too aggressive for the CRA's liking.

[troutman]

Originally Posted by Bobblehead

Interesting article from last March discussing this. This quote kind of caught my attention.



http://blogs.money.aol.ca/2008/03/19...e-lipson-case/

SM, in essence, got too popular for its own good and, regardless of the decision, CRA may begin to scrutinize all SM's with a greater frequency since the SCC will most likely give some clarity on when and where the CRA may challenge the SM using GAAR and, donuts to dollars, CRA will use this to their advantage (after all, the economy is slowing down and CRA will need to find sources of tax revenue elsewhere).

[Bobblehead]

GAAR is sounding a lot like REOP to me. I could see the same thing happening.




*translation:
GAAR = General Anti-Avoidance Rules
REOP = Reasonable Expectation Of Profit