Deductibility of Legal Expenses

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Deductibility of Legal Expenses

Gouveia v The Queen, 2013 TCC 414

[NOTE: Affirmed by 2014 FCA 289]

The taxpayer expended funds on legal fees so as to defend himself against a Ontario Securities Commission proceedings and a Class Action lawsuit.  He sought to deduct these expenses from his business income on the basis the amounts were incurred for the purpose of gaining or producing income from business.  The CRA reassessed and denied the deductions.

The TCC identified the relevant Income Tax Act (ITA) provisions as subsection 9(1) – Income from business – and paragraphs 18(1)(a) – expense must be incurred to gain or produce income – and (h) – expenses cannot be a personal or living expense of the taxpayer.

Subsection 9(1) defined income from business or property to be the profit therefrom, and “profit” is calculated by deducting expenses to the extent they are consistent with well accepted business/accounting/commercial trading practices (see Symes v The Queen, [1993] 4 SCR 965).

Section 18 restricts deductions for purposes of subsection 9(1) in several ways.  One general prohibition is found in paragraph 18(1)(a) such that no expense is deductible unless it is incurred for the purpose of gaining or producing income.  One specific prohibition is found in paragraph 18(1)(h) such that expenses that are personal and living expenses are not deductible (except specific travel expenses).

In determining whether an expense is incurred for the purpose of gaining or producing income, we look at:

  • whether the expense is one normally incurred by others in the same business, and whether it is normally allowed as a business expense;
  • whether the expense would have been incurred had the taxpayer not been engaged in pursuit of the business income;
  • whether the expense meet a business need – would the expense have arisen “but for” the pursuit of profit

The Court referred to the decision in Ironside v. The Queen, 2013 TCC 339, the expense must be one that cannot be separated from the income earning activity or one that is incurred because of a necessary risk involved in the income earning activity.

In this case, the court stated that expenses to defend oneself against regulatory charges are generally not considered to be a “usual and accepted business expense association with consulting services”, and the charges were brought as a result of the taxpayer acting as an officer and director and not as a consultant – thus as a result of his employment and not business activities. The onus is on the taxpayer to show the connection – a sufficient nexus – between the business and the expenses – see R. v. Doiron, 2012 FCA 71; 412237 Ontario Ltd. v. R., 1993 CarswellNat 1241 (TCC); Leduc v. R., 2005 CarswellNat 227; Cimolai v. R., 2006 CarswellNat 3558 (FCA). Also, expenses incurred to protect one’s reputation and capacity for future earnings are capital in nature, and not deductible pursuant to paragraph 18(1)(b) unless expressly permitted.

– Sas Ansari, JD LLM PhD (exp)
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