For the second time in six years, a taxpayer is appealing to the Supreme Court of Canada for the ability to use home equity to finance investing and then write off the interest charges.

British Columbia resident Earl Lipson is seeking permission from the SCC to appeal a decision released by the Federal Court of Appeal in March.

Lipson and his wife, Jordanna, undertook a complex series of transactions, with the intention of writing off mortgage interest against dividend income. The Tax Court of Canada ruled that the overall purpose of their transactions constituted abusive tax avoidance. The FCA agreed.

The immediate impact of the FCA’s decision is to quash a strategy that has been widely endorsed by financial advisors — known as the “Singleton shuffle” — unless the SCC decides otherwise.

The Singleton shuffle involves a taxpayer selling non-registered investments to pay off a mortgage. The taxpayer then obtains financing, secured by home equity, buys more securities and claims a tax deduction for interest paid on the financing.

The strategy gets its name from a 2001 case known as Singleton v. Canada, in which Vancouver lawyer John Singleton withdrew $300,000 from the capital account of his law firm to buy a home.

He refinanced his law firm by borrowing the same amount from a bank — against the equity in his home. Subsequently, he claimed interest deduction for $3,688 for the 1988 tax year and $27,415 in 1989.

The Canada Revenue Agency denied the deductions. The TCC agreed.

The purpose of Singleton’s transactions was to buy the home, wrote TCC Judge Donald Bowman, who also made the TCC’s Lipson decision. That purpose “cannot be altered by the shuffle of cheques,” Bowman wrote in his Singleton decision.

But the FCA disagreed with Bowman in the Singleton case. So did the SCC, which stated that taxpayers “are entitled to structure their transactions in a manner that reduces taxes, and the fact that the structures may be complex arrangements does not remove the right to do so.”

It seems, however, that Bow-man’s view will prevail, unless the SCC hears the Lipson appeal.

In the Lipson case, Bowman used the “general anti-avoidance rule” contained in Section 245 of the Income Tax Act to strike down the structure of the transactions.

Bowman cited the SCC’s first two GAAR decisions, The Queen v. Canada Trustco Mortgage Co. and Mathew v. Canada, both released in 2005, which established a three-point test for determining if GAAR is applicable:

> There must be a tax benefit, such as a reduction or deferral of taxes.

> The transaction or series of transactions will be considered an avoidance transaction if it wasn’t “reasonably undertaken or arranged primarily for a bona fide purpose other than to obtain a tax benefit.”

> The transaction is abusive because it cannot be reasonably concluded the tax benefit would be consistent with the “object, spirit or purpose” of the tax act provisions relied upon by the taxpayer to enable the transaction.

The taxpayer bears the burden of refuting the first two elements of the test. The CRA must prove the third.

In his FCA appeal, Lipson put forward an argument based the SCC’s Singleton decision — made before the SCC’s GAAR decisions — that “it is an error to treat a sequence of transactions as one simultaneous transaction. In order to give effect to legal relationships, individual transactions must be viewed independently.”

The FCA agreed, stating that in Lipson there was “no single element [that] was determinative of whether there has been tax avoidance.”

Unfortunately for Lipson, the FCA also stated that Bowman “gave substantial weight to the series of transactions, and its purpose, something which he is entitled to do under GAAR.”

Heather Evans, tax lawyer and partner at Deloitte & Touche LLP in Toronto, says, “It’s clear in this case that the Federal Court of Appeal was reluctant to subordinate its judgment for Bowman’s.”

Meanwhile, the FCA’s contradictory statements have left tax practitioners scratching their heads.

The biggest problem with this decision, says Jamie Golombek, vice president of tax and estate planning at AIM Funds Management Inc. in Toronto, is determining when a taxpayer gets into a series of avoidance transactions.

For example, he wonders whether a couple who sold their non-registered investments, paid off their mortgage but waited five years to get back into the market would run afoul of GAAR. “When does arranging your affairs — something you’re allowed to do — become abusive?” Golombek asks. “Five years, five days or five seconds?”

@page_break@As a result of the FCA decision, Golombek cautions advisors against endorsing the Singleton shuffle for their clients.

The facts of the Lipson. case began on Aug. 31, 1994. Jordanna borrowed $562,000 from the bank to buy Earl’s shares in a family company. The following day, the Lipsons took out a mortgage on their new home for $562,000 to pay off Jordanna’s loan.

The series of transactions was structured under Income Tax Act provisions governing interspousal transfers, so the dividend income earned on the shares by Jordanna, in addition to the loss resulting from payment of interest on the mortgage, would to be attributed back to Earl.

That way, he could claim the interest expense against the dividend income.

In the 1994, 1995 and 1996 tax years, Earl Lipson claimed total dividend income of $66,441 and interest expenses of $104,891.

The interest deductions were justified by Sec. 20(1)(c) of the Income Tax Act, which permits deductions for interest on money borrowed for the purpose of earning income from a business or property.

Bowman found it “passing strange” that Earl should derive the benefit of a tax deduction for interest on money “borrowed ostensibly” to enable Jordanna to buy Earl’s shares.

Bowman ruled that the purpose of using Sec. 20(1)(c) is to facilitate interest deductions for money borrowed for commercial reasons. Interest on financing borrowed for personal purposes, such as buying a home, is not deductible, he ruled.

Further, Bowman ruled that the Lipsons used the tax rules governing interspousal transfers “to achieve a purpose for which they never were intended.” The share transfer, he wrote, was “subservient to the objective of making the interest on the purchase of the house deductible by Earl.”

One of the outstanding arguments against the Lipson decisions is the CRA’s existing policy regarding interest deductibility.

Shortly after the SCC’s Singleton decision, the CRA released a new tax interpretation bulletin on interest deductibility, IT-533.

In effect, the CRA conceded that it would not be challenging the Singleton decision. For example, under paragraph 15 of the bulletin, entitled “Restructured Borrowing,” an example similar to the Singleton and Lipson cases is cited: the taxpayer sells 1,000 shares of a company for the purpose of paying off a condo mortgage. The taxpayer “may … use the proceeds … for any purpose, including paying down the borrowed money used to acquire the condominium, and subsequently obtain additional borrowed money to acquire another 1,000 shares.”

Notably, the IT-533 bulletin has never been revised, yet the TTC and FCA decisions in the Lipson case stand in direct contradiction to it. If the SCC hears the Lipson appeal, tax practitioners say, it could provide clarity for taxpayers about home equity and interest deductibility. IE