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Who wants to have a tax deductible mortgage in Canada?
The Supreme Court of Canada have paved the way, with proper planning, for mortgage interest to be tax deductible.
Most people do not write off the interest on their mortgage. Yes many homeowners write off a portion of their mortgage payment as it relates to a home office space. But that is not the same as writing off the interest on their mortgage.
Your principal homes mortgage interest is deductible, when the borrowed money is used to earn income from a business or investment that has an expectation of making a profit, even if your home is the pledged security.
How the funds are spent determines interest deductibility of your mortgage, not the collateral. If a direct link can be established between the loan and its business/investment use, it is immaterial that the security for the loan is a mortgage against your principal residence.
Example: You have money invested in the equity market, and you want to buy real estate. Assume you liquidate the equities, buy real estate all cash, then mortgage the real estate and reinvest the borrowed funds in equities. Could you then write off the mortgage interest, arguing the proceeds were used to buy stocks rather than the house?
That was the issue facing the Supreme Court of Canada, in a decision handed down September 28th 2001.
Some background:
On October 27th, 1988, John Singleton had $300,000 in his business capital account. The court noted, he wanted to use $300,000 of his equity to assist in the purchase of a house. He then borrowed that same amount, in the form of a mortgage on the real estate he just purchased, to refinance his partnership capital account. He did all that on the very same day.
When the dust settled, Singleton had a new house,a mortgage on the new house, and $300,000 back in his capital account.
Singleton deducts the mortgage interest on his 1988 and 1989 tax returns.. The government disallows the deduction. Singleton sues - he loses in the Tax Court of Canada - wins the next round in the Federal Court of Appeals.- in October 2001 the Supreme Court of Canada sides with Singleton.
This case boiled down to one issue: were the borrowed funds used to earn income from his law firm, or finance his home purchase? Put another way, should the same day transactions be viewed as a series of connected activities, or each a distinct tranaction? The Supreme Court of Canada ruled they are distinct seperate transactions.
The Honourable Mr. Justice Major said, "It is an error to treat this as one transaction - the transactions must be viewed independently." The direct use of the borrowed funds was to refinance Singleton's capital account. Treating the borrowed funds as used for financing the purchase of the home ignores what Singleton did, ie used the borrowed funds to replace the funds required for his capital account at the firm.
Structuring your affairs to shrink your tax burden is 100% legal, the Courts have ruled that Singleton could write off his mortgage interest.
The way is paved for homeowners, who apply the same principles, to make non-deductible principal mortgage interest tax deductible.
When you are ready to explore the possibility of making your own mortgage tax deductible give me a call. Who should call: everyone self-employed, everyone who owns a business, everyone with investments, and anyone who wants a tax rebate at the end of the year. Best of all it is free.
Proper professional advice before proceeding is a must.
A taxpayer borrows money
Is the interest deductible? When is borrowed money considered personal use or to earn income? This question was asked in 1988 by John Singleton and answered in September 2001 by the Supreme Court of Canada.
The Loan
In 1988, John Singleton, a partner in a law firm, withdrew $300,000 from his partnership capital account. He used the funds to purchase a house. Singleton then mortgaged the house by borrowing $298,750 from the Bank and deposited the money into his partnership account, along with $1250 of his own money.
The Fun Begins
When time came to do his tax return, Singleton deducted $3,688 of interest on his 1988 tax return and $27,415 on his 1989 return. Singleton believed the borrowed funds, not the withdrawn funds, were used for investment purposes. A required distinction to understand this question and answer. Of course the tax guys disagreed and disallowed his deductions.
Very Appealing Case
Singleton appealed to the Tax Court of Canada, but his case was dismissed. He then appealed to the Federal Court of Appeal which allowed his appeal by a majority decision. Not wanting to be less appealing the Tax Guys look for a friendlier decision from the Supreme Court of Canada.
The Decision
By a five to two decision, the Supreme Court dismissed the Tax
Guys appeal. The Court held the opinion that Singleton used the borrowed funds to invest in his partnership. Therefore, the direct use of the funds was for the purpose of producing income, making the interest deductible.
Tax Planning Mantra
The Court quoted the mantra of tax planning in making the decision.
Taxpayers are entitled to structure their transactions
in a manner that reduces taxes; the fact that the
structures may be complex arrangements does not
remove the right to do so.
The Court was unequivocal in its view that the funds were borrowed to refinance Singleton's capital account. It stated:
Viewing the transactions as one simultaneous transaction, thereby treating the borrowed funds as used for financing the purchase of the home, ignores what the respondent actually did: he used the borrowed funds to replace the funds required for his capital account at the firm..
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