Sandor

In case any of you saw the funny article in the Toronto Star by Bob Aaron, he is again 100% wrong! Here is his quote: “Earlier this month, the Supreme Court of Canada issued a decisive ruling that clarifies once and for all that the interest paid on a mortgage taken out to purchase a principal residence cannot be tax deductible under any circumstances.”

Did he read the ruling at all? Funny, isn’t it?

He quotes Dan White, who is obviously not a tax expert and does not appear to have any tax qualifications at all: “tax specialist Dan White wrote me to say that taxpayers simply “cannot convert their mortgage to tax-deductible interest.”

For anyone that reads this article, Bob Aaron is a lawyer and supposedly professional, but obviously does not check his facts – or perhaps he knows he is wrong and has some reason for a bias.

Dan White is flogging some strange tax scheme where, as I understand it, you create a series of sham buinesses to claim part of your home as tax deductible. After a year or 2, you shut it down and start another sham business. I read on the internet one of his clients recently lost a tax audit.

There was another article last year by Bob Aaron quoting Dan White where they were also totally wrong. In that article, Dan White claimed that doing the SM would mean you are using your home as a business and will lose the prinipal residence deduction.” I have no idea where he gets this crap.

In case anyone has any doubt, all the real tax experts, such as Jamie Golombek from CIBC Asset Management”, say the Supreme Court ruling finally clarifies that the SM, borrowing to invest in general and the Singleton Shuffle will not be questioned by CRA. The judges used the word “unimpeachable” when describing interest deductibility in a normal case of borrowing to invest.

It bothers me to see such obviously wrong articles in major papers. The Toronto Star should cancel Bob Aaron as a columnist, since he seems to be biased, has printed 2 articles that are the completely wrong on tax issues, and he clearly does not check his facts.

It’s a good thing the blog world is far more knowledgeable on tax issues.

Ed

“just decide to invest $50K he will pay the same fees for the same investments”.

Really? I do a bit of investing myself and my all-in costs are less than 50 basis points.

Secondly, my point is that if an investor simply pays down the mortgage and doesn’t engage in leveraged investing, YOU don’t get those fees and trailing commissions. If they implement a SM, YOU do. That’s a pretty powerful conflict of interest.

Let’s take an example. Bob owns a $200K home and has a $100K mortgage. Let’s say Bob decides to implement a SM and borrow more against home equity to invest. Now, he has a $100K mortgage, a $50K line of credit. In the second instance, YOU get $2,500 in deferred sales commission and another $500 in trailing commissions every year. In the first instance, Bob paid NO FEES. It is ridiculous to say “those fees and MERs are the same”. Clearly they are not.

I am sorry for dropping the line on this discussion and never answered your questions.
But perhaps it is not too late now.
Just like the first time, when we discussed this subject you and I, the answer you disregarded then is the same today: those fees and MERs are the same, whether you do, or you don’t do the SM! The SM has no effect whatsoever on those expenses.
If you decide to invest you will have to pay those fees anyway. They are in no way reflections on the Smith Manoeuvre.
The other matter is the choice of investment the client has to make. Again, those choices are independent from the SM.

CC, there is no point in mixing normal regular issues of investing with the application of SM. These issues of fees are important, but they are so without any regard given to the source of money used to invest. They are universally considered, whether the money is borrowed or not, whether the borrowing is done with, or without the SM.

Regarding, conflict of interest, here’s my question to you (since you say fees and costs are disclosed): what, if any, are the sales charges of the funds you use to implement the SM for your clients? What are your trailer fees? What is the MER of the funds you use?

As I understand it you cannot take any returns on capital from the fund because that would reduce the amount of interest that you could leagally claim. But, if one were invested in, say, and ETF, and the distributions were dividends, and you used those distributions to pay down your mortgage, that would be OK, would it not.

The article about the Smith Manoeuvre by Bob Aaron (http://www.thestar.com/article/345271) is a veritable collection of misunderstandings, misstatements and obfuscations. It is very likely that the author of the article has actually never read the book he is quoting, and possibly neither have the other authorities he quotes.
As a practitioner of the Smith Manoeuvre, (SM) I must note a few inaccuracies.
The most important aspect of the SM is that it is based on, and supported by, one of the Supreme Court decisions that makes it clear: “…the requisite test to determine the purpose for interest deductibility under s. 20(1)(c)(i) is whether, considering all the circumstances, the taxpayer had a reasonable expectation of income at the time the investment is made.”
So, if the purpose and use of the borrowed money is following the above criteria, then the interest is tax-deductible. This simply means that the borrowing and investing all businesses are doing at all times is also available to the house owner as long as the rules are followed. To my knowledge, in the twenty-five year history of the SM the strategy has never been challenged.
An important distinction must be made however, as the book also points out, that while the mortgage interest is not tax-deductible indeed, a line of credit on the other hand, borrowed for the purpose of investing, would be.
The article is correct in saying that the full mortgage interest would not be tax-deductible, but no one has ever stated such nonsense, so it is useless to argue it.
As far as Allen Roseman’s article is concerned, I suggested to her at the time that she also has a problem understanding the strategy, and offered to make a test case for her, but she declined. The most salient argument quoted from her article here is that the strategy “is very complex.” Well, “complex” is in the eye of the beholder and as far as complexity is concerned, the SM although isn’t quite simple, is far from being really that complex in comparison to some other financial strategies. Nevertheless, an expert practitioner wouldn’t have much difficulty with it, nor did many of my clients, in view of the benefit it presents to the homeowner.
What about the risk?
The article stigmatizes the SM as a “high risk” strategy. So, let’s compare it to the simple mortgage. If homeowner Mr. A buys a house with 20% down payment, he will have 20% of a house and a debt of 80%. In comparison, if homeowner Mrs. B has a mortgage of 50% and a portfolio of investments for the remaining 30%, then the degree of leverage is the same. So what is the difference, you may ask. The difference is that for Mrs. B the 30% portfolio earns an income and with every mortgage principal payment she can increase the investment in the portfolio by the same amount. The portfolio eventually would grow greater than the mortgage, much sooner than the typical twenty-five years required to pay off that mortgage. At the same time, the tax refunds will also contribute to the growth of the portfolio.
So, how would they end up? Mr. A in twenty-five years will have no mortgage, no investments, but will have a paid off house, while Mrs. B will have a paid off house in possibly ten, or twelve years, a portfolio of hundreds of thousands of dollars worth, and a large yearly tax refund that will come to her possibly as long as she lives. She would also make a handsome profit by the time the house is paid off.
The risk is also mitigated by the differences in compounding methods: the mortgage is compounded twice yearly, while the line of credit interest is not compounded at all. Also, the interest paid for the line of credit is straight, simple interest, while the returns on the investment are compounded.
My contention is therefore, that the SM is actually less risky then a leveraged mortgage. Many people make the mistake, just like the author of the article does, of considering the two examples in the comparison as the “state of affaires.” This is not correct. The two should be considered as processes and their long-term effect should be compared.
Finally, let’s address the conflict of interest.
The article suggests using advisors’ help, but it considers the fee for that help as a conflict of interest. This is a crude contradiction. If the lender of a mortgage, while charging double-compounded interest for the loan, without explaining that fact (as most lenders do not), is not in a conflict of interest, or the mortgage broker, who also charges a fee, why would the advisor be in conflict, when he gets paid for saving those expenses to the client? Isn’t the work, and the benefit it brings, worthy of the same consideration? Where in this is the conflict of interest?
As long as the fees and costs of the transaction are disclosed in advance, and the client understands and accepts the strategy, there is no conflict.
A very important aspect of the SM is that when this strategy is implemented, the homeowner doesn’t actually spend money, because the strategy is merely the rearrangement of the family’s finances with possibly some low cost. And if there is any cost, it is negligible in comparison to all the mortgage interests they would have to pay otherwise.
Indeed, the SM is not suitable for everybody, but for those who qualify, it is a very beneficial strategy indeed.

Sandor Kerekes
Financial Advisor
faconaire@sympatico.ca