In what the media labeled a “mortgage manoeuvre,” the Supreme Court of Canada, in the Lipson case, seems to have upheld a common refinancing technique as legal, although denying the Lipsons the right to shift an interest deduction from the wife to the husband.
The appeal raised the issue of what constitutes abusive tax avoidance for the purposes of the general anti-avoidance rule (“GAAR”) provided for in the Income Tax Act (“ITA”).
The issue was whether a series of transactions beginning with a wife borrowing money to purchase shares in a family corporation and leading to the husband, who then deducted the interest on the couple’s home mortgage loan, resulted in an abuse and misuse of one or more provisions of the ITA.
In the end, the Supreme Court agreed with the courts below that, in the instant case, abusive tax avoidance was established. GAAR was found to apply to one of the transactions within the series and, accordingly, was used to deny one of the tax benefits sought by the appellant.
Here are the facts in greater detail. The appellant, Earl Lipson, conducted a series of transactions whose purpose, he concedes, was to minimize his income tax.
First, Mr. Lipson and his wife, Jordanna, entered into an agreement of purchase and sale for a family residence in Toronto. The purchase price was $750,000.
Jordanna Lipson borrowed $562,500 from the bank (the “Share Loan”) to finance the purchase from her husband at fair market value of shares in Lipson Family Investments Limited, a family corporation. (The bank was aware it would be paid back the following day, as Mrs. Lipson did not qualify on her own for the Share Loan). In any case, Mrs. Lipson paid the borrowed (Share Loan) money directly to her husband, who transferred the shares to her.
Mr. and Mrs. Lipson then obtained a mortgage from the Bank of Montreal for $562,500 (the “Mortgage Loan”), that was advanced on the closing date. They were joint chargers under the mortgage. That same day, they used the Mortgage Loan funds to repay the Share Loan in its entirety.
Based on the interaction of rules that attribute income/deductions of one spouse to another, and interest deduction deeming rules, Mr. Lipson reported all dividends paid on the shares of the family corporation transferred to his wife, but more importantly, deducted all interest paid on the Mortgage Loan under s. 20(3) of the Act, any net loss being used by him to offset other income. Section 20(3) of the Act allows a deduction for interest on money borrowed (the Mortgage Loan) to repay previously borrowed money (the Share Loan), if the interest on the original loan (the Share Loan) was originally deductible.
The majority of the Court found that the tax benefit of the interest deduction from the refinancing of the shares of the family corporation was not abusive in isolation, a victory for refinancing tax planning. However, the benefit of the tax attribution rules which operated to attribute Mrs. Lipson’s interest deduction to Mr. Lipson was abusive. In this case, the attribution of the interest deduction to Mr. Lipson was disallowed, leaving the interest deduction in the hands of Mrs. Lipson.
While in this case Mr. Lipson clearly failed, the decision is nevertheless heralded as approval for the refinancing tax planning often suggested by experts that income-producing assets be sold and the proceeds be used to pay down the home mortgage. The home mortgage can then be refinanced and the mortgage monies be used to replace the income-producing assets and, in that case, interest on the mortgage becomes deductible.