Mortgage interest can be deductible -- but it isn't easy
Financial planners and tax practitioners across the country are awaiting the
upcoming decision of the Supreme Court of Canada in the Singleton case. The case
involved a lawyer, Mr. Singleton, who was a partner in a law firm. He withdrew
$300,000 from the capital account of his law firm and he 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. Since borrowing for the
purpose of earning business income is tax deductible (ie. the loan to fund the
capital account contribution) whereas mortgage interest on a home is not, Mr.
Singleton was able to convert non-deductible interest into deductible interest.
Unfortunately, Mr. Singleton's case has landed him in the Supreme Court of
Canada. 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) reassessed Mr. Singleton denying his interest deduction
for each of those years. He appealed to the Tax Court of Canada, which dismissed
his appeal. The Federal Court of Appeal allowed the appeal and set aside the
lower court ruling that the interest was not deductible. The Tax Court of Canada
originally found that the money was not borrowed for business purposes since the
true purpose was to buy a home. The court held that all the transactions Mr.
Singleton undertook were related and should be considered as one transaction --
the purchase of the home. However, the Federal Court of Appeal disagreed and
found that the interest was deductible because the direct use of the funds was
to refinance his capital account in the partnership and was a valid business
expense. The Court stated 'the issue was whether the separate transactions
should be treated as independent transactions or as one transaction.' The court
held that the transactions should be considered independently. Mr. Singleton was
entitled to deduct his interest expense because he could clearly trace the
borrowed funds to a business earning purpose. The Supreme Court heard the case
on March 19 and has reserved its decision until later this year. Until then,
investors should be cautious before undertaking a similar plan.