Court blesses tax dodge that makes interest deductible

National Post


Financial planners and tax practitioners across the country breathed a sigh
of relief yesterday after the Supreme Court of Canada released its long-awaited
decision in the Singleton case in favour of the taxpayer. The case involved a
lawyer, John Singleton, who was a partner in a law firm. He withdrew $300,000
from the capital account of his law firm and used the money to purchase a home.
He then went to a bank and borrowed $300,000 and used that money to repay his
capital account at the law firm. Because borrowing for the purpose of earning
business income from the partnership is tax deductible (the loan to fund the
capital account contribution), whereas mortgage interest is not, Mr. Singleton
was able to convert non-deductible interest into deductible interest. Mr.
Singleton originally deducted interest of about $3,700 in 1988 and $27,000 in
1989 on his tax returns for those years. The Canada Customs and Revenue Agency
(CCRA) denied Mr. Singleton's claims for each of those years. He appealed to the
Tax Court of Canada, which sided with the taxman. However, Mr. Singleton
appealed to the Federal Court of Appeal, which set aside the lower court's
ruling that the interest was not deductible. The CCRA took the case to the
Supreme Court, which sided with Mr. Singleton. The Tax Court of Canada
originally found that the money was not borrowed for business purposes because
the purpose of the loan was to buy a home. The tax court said that all the
transactions Mr. Singleton undertook were related and therefore they should be
considered as one transaction -- the purchase of the home -- for which interest
is not tax deductible. However, the Federal Court of Appeal disagreed and found
the interest was deductible because the direct use of the funds was to refinance
his capital account in the partnership and, therefore, a valid business expense.
The facts in the Singleton case are similar to the advice Canadians receive from
their financial planners before buying a home. The strategy often suggested is
to liquidate non-registered investments and use the cash to buy a home. The
homeowner would then acquire an 'investment loan' and buy back the securities
previously sold -- with the result that non-deductible interest expense on the
mortgage has now become tax deductible.