WHEN ARE THEY DEDUCTIBLE?
Legal fees are deductible for advice about or the preparing of, or processing an objection or appeal over an assessment from National Revenue, Unemployment Insurance, or Canada Pension Plan. Any related accounting fees are also deductible. Legal Fees are also deductible to collect alimony or maintenance in `arrears', but not to negotiate the amount in the first place. However, they are deductible to obtain a court order for maintenance payments (assuming they are to be included in your income) when you must sue your former spouse in a Family court for maintenance. The legal fees for obtaining a divorce or separation are NOT deductible.
Legal and accounting fees paid to have an income tax return prepared are NOT deductible unless you have income from a business or property where it is `normal' in that kind of business to pay outside accountants.
NEW for 1989 (because of a court case)
Of all expenses which people have, legal expenses cause as much confusion as any other. The reason is that legal expenses fall into several categories and have been treated in weird and wonderful ways for years.
For instance, it is a generally accepted business principle that legal expenses incurred to avoid the paying of a deductible business expense are themselves legitimately a deduction. However, in 1985,John McCombe (see alimony section) lost his claim for legal expenses. He had paid legal expenses to eliminate or reduce his alimony payments. As such, he would reduce his future tax deductions, thus
increasing his taxable income. Judge Cardin of the Tax Court of Canada disagreed.
In another alimony case, in 1983, John David Philp lost his claim for accounting and legal expenses incurred in an effort
to reduce his alimony payments.
In 1982, Robert C. Ivey lost his deduction for legal
fees defending his wife's application for increased maintenance payments. He won his case with his ex-wife, but Member Bonner of the Tax Review Board ruled that the expenses were not incurred for the purposes of gaining or producing income and disallowed Mr. Ivey's appeal.
Collecting the alimony or maintenance does not mean an automatic tax deduction for legal fees either.
In the first week of March 1986, a lady client told
me her lawyer was going to give her a $3000 bill for negotiating the alimony she was receiving. He had told her that the amount was deductible, but there was no court appearance or collection procedures involved. The fee was just for negotiating the amount, the `right to which' existed by provincial law.
The following case would indicate that NO PART of a legal fee is deductible in negotiating a divorce (see Alimony section).
In 1981, Dr. Beverley A. Burgess lost her claim for
$4,400 of legal fees for negotiating maintenance for herself and her children in an divorce case. Judge Cattanach of the Federal Court <197> Trial Division ruled that the right to maintenance which existed
upon marriage dissolved upon the dissolution of the marriage. Therefore, the legal fees were incurred to establish a new right and were of a capital nature. Dr. Burgess had won her case before the Tax Review
Board in 1979. It took two more years for another answer in the Federal Court in June, 1981.
But the Tax Review Board was not consistent either.
In February, 1981, Dianne Wilson had also lost her claim for legal expenses incurred to negotiate alimony and maintenance in a divorce action. Member D. E. Taylor of the Tax Review Board ruled
that Mrs. Wilson had expended the fees to establish a `new' right, rather than to enforce an existing right.
On the other hand, in 1986, David Sadavoy won his case for legal fees. When his marriage broke down, he kept the children, but his ex-wife continued to collect the Family Allowance. He went to the Supreme Court of Canada to obtain a custody order solely to gain his right to the family allowance payments. DNR argued that the Burgess case above precluded his deduction for legal fees as he was
going to court to establish a new right. He argued that the right (and the amount already existed), he was going to court to get the legal right to collect it. Judge Brule of the Tax Court of Canada bought the argument. He also awarded costs to Mr. Sadavoy. -
WOW - But, But, But...
On January 7, 1988, Judge Teitlebaum of the Federal Court ruled against David Sadavoy and took it all away. He ruled that the legal costs were to obtain custody of the children, that since family allowance goes to the female parent, a male parent must obtain the `right' (capital in nature) and that family allowance was not income from a property or business anyway.
It has also always been a generally accepted business principle that legal fees were deductible when a person sued his employer for wages and won.
Even though the 1990 guide says that legal expenses for negotiating a retiring allowance, in that same year, 1990, Gregory A. MacDonald lost his claim for $5,500 of legal fees in obtaining a judgement for $8,300 for wrongful dismissal. Judge Couture of the Tax Court of Canada ruled that the wrongful dismissal was a retiring allowance within the meaning of section 248(1) of the Act in 1983 and disallowed the expense. Legal expenses for negotiating retiring allowances have only been deductible for the past three years.
This is another 'unfair decision'. By the time he pays the tax on the $8,300 and the $5,500 legal bill, he will be lucky if the exercise did not cost him $1,000 to win.
But in 1985, John Maruscak lost his claim for legal expenses before Judge Christie of the Tax Court of Canada. He had sued his employer, Black and Decker, for wrongful dismissal, and accepted an out of court settlement. The Court refused to take salary or wage collection rules and apply them to what was referred to as a `retiring allowance.'
In 1988, Frederick Lyonde lost his try at deducting legal fees paid out in a successful suit for wrongful dismissal. He won $83,400 and tried to deduct the $4,000 legal fees. Judge Taylor ruled that the expenses were to `establish' the right, not to collect an existing right and were capital in nature and not deductible.
Another principle which was used successfully at the Tax Court level and lost at Federal Court is in the case of Pardaman Singh Malik's interest expense (see interest section) is that expenses to maintain a position to earn income are a deduction. This is certainly true of union dues or professional organization fees (see Dues section).
But 1985 was a bad year for generally accepted principles again when Border Fertilizer (1972) Limited lost its claim for legal fees. The president of the company had been charged with a criminal offense. The company paid out $21,000 for a successful defense of its president. The justification for the deduction was that it was to protect its interests and those of its shareholders. Judge Taylor of the Tax Court of Canada ruled that the legal fees had been expended protecting its goodwill and were therefore of a capital nature.
And 1990 was no better when Donald Edwin Wilson sought to deduct legal expenses to defend himself against rape and unlawful confinement charges. Judge Addy of the Federal Court found that the
deduction could not be considered to have been expended to collect salary or wages by any stretch of the imagination. But in a weird twist, he said that there was nothing to deduct them against anyway,
as Mr. Wilson had no salary or wages owed to him in 1983.
And, it didn't get any better in 1989 either. Claude Cote spent $12,000 obtaining injunctions to stop a Research centre from terminating a research contract he was working under. Judge Tremblay of the Tax Court of Canada ruled that the money was expended to protect the source of employment income, not `earn' income. I have a little problem with this but understand the principal DNR and Judge Tremblay were trying for. Unfortunately, Mr. Cote did not appeal. If he had, he likely would have won based upon the following Federal Court of Appeal case.
Judges Pratte, Marceau, and Hugessen of the Federal Court of Appeal, in 1989 did not agree with DNR, or maybe the different circumstances are not similar. The three judges allowed Dr. Eugene
Lalonde and Dr. Hubert Watelle to deduct legal expenses that they had incurred to try and force a school board to build a high school in the area. The Judges all agreed that building the high school
would have attracted people to the area and therefore increased the Doctors' income. See below for earlier decision.
On the other hand, the generally accepted principle was honoured in 1983, when Dr. Jaques St-Germain won his deduction for legal expenses incurred in defending a charge of criminal negligence.
He was originally convicted of the charge but successfully appealed his case. DNR turned down his legal expenses. However, Member Tremblay of the Tax Review Board ruled that the expenses were incurred defending and preserving his status as a doctor and thus maintained his source of income. He decided the legal expenses were properly deductible.
In 1983, Dr. Hoi Chau Tsang won a similar case. He was an acupuncturist who was convicted of filing false claims with an insurance plan for treatments to his patients. He incurred $22,000 of legal fees in his unsuccessful defense. However, Member Tremblay of the Tax Review Board decided that the legal fees were incurred for the purpose of producing income by maintaining and preserving his business and allowed the expense.
In a very convoluted case, in 1983, Dr. Eugene Lalonde and Dr. Hubert Watelle won their legal bills deduction. They had incurred large legal bills trying to force a school board to honour their previous commitment to build a school. Judge Decary of the Federal Court <197> Trial Division ruled that the legal bills were expended to earn income. If the school was built, the population would increase, and their income would increase. As shown 3 paragraphs preceeding, they won DNR's appeal in 1989. It only took SIX MORE YEARS.
Legal fees to buy or keep property are usually not deductible as they are a capital expense and `usually' get added to the adjusted cost base of the land or property.
In 1982, Thomas Sammut found this to be the case.
He had granted a lease option to purchase a piece of residential property. The case was confusing in that the arrears of rent meant that part of the legal fees, if not all, could be considered to be for the collecting of the rent. In this case Mr. Sammut lost his property to the tenants who exercised the option even though they were behind in their rent (beware all you equity share people out there). He expended many thousands of dollars in an effort to get the property back. Mr. Goetz, member of the Tax Review Board, ruled that the fees were expended on account of capital and were not deductible against rental income.
In 1989, Helene Gellinas lost her claim for legal expenses incurred to probate a will. She was trying to gain shares of a company. Judge Tremblay ruled that she was seeking to reclaim ownership of a capital property.
However, Lawrence Belair won his deduction for $2,300 for legal and accounting fees to enforce a shareholder's agreement allowing him to `sell' his minority shareholdings. Judge Mogan of the Tax Court of Canada obviously considered `selling' capital different than `purchasing' capital.
REAL ESTATE AGENT
In 1982, Ernest A. Lavoie won his deduction for legal expenses incurred in defending a misconduct charge arising out of his actions as a real estate agent. Mr. Bonner of the Tax Review Board ruled that the expenses arose as a result of his employment and were properly deductible.
In 1980, BP Petroleum Limited lost its claim for a deduction for legal fees expended in fighting a neighbour who tried to get an injunction stopping them from operating a service station.
Judges Pratte, Ryan, and Lalande of the Federal Court of Appeal ruled that the expenses were capital in nature, therefore no deduction.
In 1986, Leopold Langlois lost his claim for legal expenses expended in successfully preserving and earning income which was exempt from income tax because the original actions took place in 1965 (21 years before). Judge Tremblay of the Tax Court of Canada ruled that the fees to preserve a partnership and keep money from the sale of mining claims were non-deductible.
DEFENDING CORPORATIONS DURING MARITAL DISCORD
In 1980, Jager Holdings (Calgary) Ltd. and Jager Homes Ltd. won their deduction for legal fees. The fees were expended to stop the enforcement of a petition to wind up the company. The petition was filed because of marital difficulties of the principals of the Companies. Mr. Cardin, Chairman of the Tax Review Board ruled that the fees were to produce income and did not represent fees of a capital nature. In 1983, they won again in Federal Court. However, In 1988, they lost in the Federal Court of Appeal before Judges Urie, Mahoney and Stone (unanimously). The three judges found that the legal
fees were expended to preserve the corporate structure and entity, not to earn income (and it only took 8 years).
DEFENDING CRIMINAL TAX EVASION CHARGES
In 1988, Ben Matthews and Associates Limited successfully won their case that the legal fees to defend the company and one of its officers were a deduction in the ordinary course of business.
Judge Rip of the Tax Court of Canada agreed with the premise that the fees were paid out in the course of the company's business. The fees arose as a direct result of the preparation of the financial
statements in the normal course of business. It was also an implied term of the employees contract that he would be defended if charged as a result of his employment. However, at the end of 1988, Judge
Kempo of the Tax Court of Canada ruled against Mario Cormier. Mr. Cormier had tried to deduct legal expenses for criminal tax evasion charges for the years 1983 and 1984. Judge Kempo ruled that there
was no commercial reason (they had not been laid out to earn income or `protect' the earning of income).
DEFENDING CIVIL LITIGATION
In 1989, Seymour Friedland and two consulting corporations he owned were allowed legal fees paid to defend himself and his companies against suits brought by dissatisfied clients. Judge Collier of the Federal Court ruled that the fees were expended to keep income flowing and that the corporations were dependent upon his services unsullied by civil judgments or convictions against him. The tax office had also tried to add the costs of the legal fees to his income as a taxable benefit conferred on him by the companies. (Yep, they were not going to allow the deduction, but were going to tax him.... double taxation which is what they do with Shareholder's appropriation - see section on Shareholder's appropriation). Of course, if the company had paid the amounts of the fees to Mr. Friedland as wages, he still might not have got the deduction, but the company would have.
CEN-TA Cross Border Services - Tax, Visas, Immigration