Smith Manoeuvre

Couple abused tax laws
Homeowners tried to make mortgage deductible

Janice Tibbetts, Canwest News Service
Published: Friday, January 09, 2009

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 yesterday.

"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.

The federal tax collector went after Earl Lipson, who then took his fight to the Tax Court of Canada.

A judge ruled that the Lipson transactions did not technically break the law, but that the scheme "was an obvious example of tax avoidance" because it was clearly intended to make the mortgage interest tax-deductible.

The court's conclusion that the purpose of the transaction should be taken into account in deciding its legality was later upheld by the Federal Court of Appeal.

The case, which is a test of the legal limits of tax avoidance, has drawn enormous attention among tax advisers and the Supreme Court chamber was packed last April when the appeal was heard.

Toronto tax expert Jamie Golombek said that manoeuvring to make mortgage interest tax-deductible has become increasingly commonplace in Canada but "a cloud has been hanging over this technique" for the past couple of years in light of the Lipson court battle.

A central issue in the case is the interpretation of an Income Tax Act principle, called the General Anti-Avoidance Rule. Enacted in 1988 to reduce abusive tax avoidance, the GAAR can make legal transactions illegal for being a "misuse or abuse" of the rules.

Writing in dissent, Justice Ian Binnie described the GAAR as "a weapon that, unless contained by the jurisprudence, could have a widespread, serious and unpredictable effect on legitimate tax planning."

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