The Income Tax Act (Canada) distinguishes between
interest paid or payable by taxpayers on account of a business
venture and a personal venture. Essentially, interest expense
incurred on a business loan will generally be deductible to the
taxpayer or, in some cases, may be capitalized. Contrast this
treatment to personal loans, where interest on such loans is not
deductible. As such, it is not hard to imagine the incentive to
develop tax plans and to organize one's affairs in a manner
which qualifies as much interest expense as possible as tax
Singleton1, prior to
Lipson2, was the seminal case for this type of
tax planning. In the Singleton case, the taxpayer was a
partner of a law firm in Vancouver, B.C. The taxpayer had a
significant amount of equity built up in his partnership account.
In order to purchase a house, the taxpayer accessed his partnership
equity. The taxpayer then borrowed money to replace his depleted
partnership equity. The Canada Revenue Agency challenged the
deductibility of the interest expense claimed, on the principle
that the borrowed money was effectively used to finance the
purchase of a house to be used personally. In rejecting the
taxpayer's appeal, Bowman C.J. applied a "true economic
purpose" test. Based on this test, the court noted "the
true economic purpose for which the borrowed money was used was the
purchase of a house, not the enhancement of the firm's income
earning potential by a contribution of capital."3
Fortunately for the taxpayer, the Federal Court of Appeal
overturned the Tax Court decision on the principle that Bowman C.J.
had applied the wrong test. The majority for the Federal Court of
The Minister has presented no logical
reason why, if a partner invests his own funds in his firm, he
cannot withdraw those funds for personal use and refinance the
investment in the firm with borrowed money in respect of which
interest is deductible.4
Furthermore, the majority for the Federal Court of Appeal felt
they were bound by the decision of the Supreme Court of Canada in
Bronfman Trust5, which stated that the courts
cannot ignore the direct use to which a taxpayer puts borrowed
money. The majority concluded that so long as the direct use of the
borrowed funds satisfied the requirements of the Act, the interest
would be deductible.
In rejecting the Minister's subsequent appeal, the Supreme
Court also rejected Bowman C.J.'s true economic purpose test.
The court held:
22 [. . .] the Tax Court Judge, in
searching for the "true economic purpose", applied the
wrong legal test.
43 [. . .] it is irrelevant that by
his own admission the respondent structured the transaction for tax
purposes. Courts cannot search for the "economic reality"
or the "bona fide" purpose of the transaction in
this case. In giving effect to the legal relationships underlying
the transactions here, it is obvious that the borrowed money was
used directly to refinance the respondent's capital account.
This is a direct, eligible use within the meaning of s. 20(1)(c)(i)
of the Act. The respondent was entitled to deduct the interest
Based on Singleton, tax professionals and their clients
had some measure of comfort in deducting interest expense so long
as the direct use test had been met in terms of the particular
loan. This certainty, consistency and predictability has been put
into serious doubt as a result of Lipson. In
Lipson, the taxpayer attempted to conform to the
parameters set out in Singleton. In this case, the
taxpayer sold his shares in an investment company to his spouse.
The taxpayer's spouse borrowed money to pay for the shares. The
taxpayer then used the proceeds of disposition received on the
shares to acquire a house. While recognizing that the impugned
transaction technically complied with the interest deductibility
provisions of the Act, the court upheld CRA's reassessment
based on the General Anti-Avoidance Rule ("GAAR"). The
reasoning of Bowman C.J., channelling his reasoning in
Singleton, was as follows:
9 [. . .] [t]he purpose of the scheme
was to create the impression that money was borrowed to repay money
used to buy shares when in reality it was borrowed to buy a house
and to allow Earl to deduct the interest on borrowed money used to
buy the house.
32 In this case I am not looking to
any "overarching policy" that supersedes the specific
provisions of the ITA. I am simply looking at the obvious
purpose of the various provisions that are relied on and have
concluded that those purposes have been subverted and those
sections turned on their heads. I mentioned above that section 245
[the GAAR] must itself be subjected to a textual, contextual and
purposive analysis. If there ever was a case at which section 245
was aimed, it is this one.
The Federal Court of Appeal upheld the lower court decision and
53 Although no single element is
determinative of whether there has been abusive tax avoidance,
Bowman C.J. gave substantial weight to the series of transactions,
and its purpose, something which he was entitled to
In April 2008, the Supreme Court heard the taxpayer's appeal
but has yet to issue their judgment. It is hoped that the Supreme
Court will take this opportunity to provide some certainty,
consistency and predictability on this type of direct use interest
deductibility tax planning. Once the Supreme Court has ruled in
this case, we will provide a summary of this decision and discuss
any implications it may have on Singleton-type interest
deductibility tax planning in the future.
1.Singleton v. R.,  2 S.C.R. 1046, 2001 SCC
61 (S.C.C.) ("Singleton").
2.Lipson v. R.,  3 C.T.C. 2494, 2006 TCC 148
3.Singleton v. R.,  3 C.T.C. 2873, 96 D.T.C.
1850 (T.C.C.) at para 17.
4.Singleton v. R.,  3 C.T.C. 446, 99 D.T.C.
5362 (F.C.A.) at para 14.
5.(1987), 87 D.T.C. 5059 (S.C.C.).
6.Lipson v. R.,  3 C.T.C. 110, 2007 FCA 113
(F.C.A.) at para 53.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
To print this article, all you need is to be registered on Mondaq.com.
Click to Login as an existing user or Register so you can print this article.
The prospect of an internal investigation raises many thorny issues. This presentation will canvass some of the potential triggering events, and discuss how to structure an investigation, retain forensic assistance and manage the inevitable ethical issues that will arise.
From the boardroom to the shop floor, effective organizations recognize the value of having a diverse workplace. This presentation will explore effective strategies to promote diversity, defeat bias and encourage a broader community outlook.
Staying local but going global presents its challenges. Gowling WLG lawyers offer an international roundtable on doing business in the U.K., France, Germany, China and Russia. This three-hour session will videoconference in lawyers from around the world to discuss business and intellectual property hurdles.
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).