Lipson Loses Supreme Court Decision
After a fairly long wait, the Supreme Court
released a split decision in the Lipson case, which
dealt with whether interest on a home mortgage
was deductible for income tax purposes. And,
unfortunately for Mr. Lipson, his appeal was
denied. However, as we will see, the outcome was
not as negative as it could have been, and that will
be good news for some taxpayers.
Before we deal with what the Supreme Court said,
a review of the facts is in order.
The Facts
Mr. and Mrs. Lipson needed to borrow funds to buy a home. However, rather than simply borrowing the
money using a conventional mortgage, the couple
entered into a series of transactions which, they
believed, would allow them to deduct the interest
on the loan. The specific steps were as follows:
- Mrs. Lipson obtained a demand loan and
purchased shares of the family’s company from Mr. Lipson. Since the direct use of the funds
was to buy the investment, interest on this loan
would be deductible.
- Mr. Lipson then used the funds to buy the
home.
- The couple took out permanent financing
secured by a mortgage on the new home,
and used the proceeds to repay the demand
loan. Under a specific tax rule, a new loan
will be treated in the same way as the loan it
replaces when determining whether interest is
deductible.
As the transfer of shares from Mr. Lipson to
his spouse would presumably create a gain, he
allowed the tax-free spousal rollover rule to apply
to the sale of the shares. As a result, the income
attribution rules also became applicable, and
consequently, any income or loss on the family
company shares would attribute to the transferor
(Mr. Lipson) even though Mrs. Lipson was holding
the shares. Based on this, he deducted the
mortgage interest as a loss from property.
Tax Court Decision
The Canada Revenue Agency denied Mr. Lipson’s
deduction of the mortgage interest, so he appealed
to the Tax Court. Although there was a direct
eligible use for the demand loan (and by extension,
the mortgage), the Tax Court judge ruled that
the general anti-avoidance rule (GAAR) applied.
Specifically, he felt that the planning was abusive
tax avoidance since the taxpayer had frustrated the
interest deductibility rules. The judge reached this
conclusion in spite of the fact that the Supreme
Court in the Singleton case allowed a taxpayer
to rearrange his affairs to maximize his interest
deductions for tax purposes in a somewhat similar fashion. In addition to pointing out his general
observations on the overall purpose of the loan
(to buy the home), the Tax Court judge ruled that
the series of transactions, including the use of the
spousal rollover and income attribution rules,
was abusive.
The Supreme Court’s View
After losing in Tax Court, Mr. Lipson appealed
to the Federal Court of Appeal. However, under
guidelines set by the Supreme Court in another
case, the ability of the Federal Court of Appeal to
overturn a GAAR ruling is limited and they chose to
deny the appeal. Mr. Lipson then appealed to the
Supreme Court of Canada.
In a split decision, the majority of the Supreme
Court also denied Mr. Lipson’s appeal. Although
the Court appears to believe that it would be
acceptable to buy an asset from a spouse and
deduct interest on money borrowed for the
purchase as a general rule, they believed that using
the spousal rollover and thereby triggering the
income attribution rules went too far. In particular,
they held that creating such a series of transactions
was an abuse, and they denied Mr. Lipson’s
interest deduction. In reaching their decision, the
majority focused on the specific effect of the series
of transactions but they did not endorse the Tax
Court judge’s comments on the overall purpose of
the loan. The majority also seems to suggest
that Mrs. Lipson should be entitled to deduct
the interest.
Conclusion
Despite the result for Mr. and Mrs. Lipson, this
case may well be a positive development for
other taxpayers. First, it would seem that using
GAAR to deny an interest deduction based on a
perceived overall ineligible purpose for a loan is
not appropriate. In addition, for spousal transfers
in particular, it appears that the planning used
by the Lipsons would be acceptable as long as
the spousal rollover and therefore, the income
attribution rules do not apply.
For more information on this case, and how it may affect
you, contact your BDO advisor.
Next Section: Required Minimum Withdrawal for RRIFs Reduced for 2008
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