Deduction of Legal Expenses from Income – Kelso Patry

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When are Legal Expenses Deductible From Income From a Business or Property?

Kelso Patry v The Queen, 2013 TCC 107

At issue was the deductibility of legal fees paid by a taxpayer, and their character as current or capital expenses.

Legal expenses, to be deductible, must (1) be incurred for the purpose of gaining or producing income from business or property; (2) not be capital outlays; and (3) not be personal or living expenses. This requires real and objective evidence that show manifestations of income purpose and a direct link between the reason for the proceeding on which legal expenses are expended and the income generating activities of the taxpayer.


The Taxpayer earned professional business income (as a Physician) and rental income from rental properties.  She claimed legal expenses arising out of a tenant dispute gone wrong, but the MNR denied these amounts.

The taxpayer had an issue with a tenant regarding some damage to a unit. She opted for arbitration but lost. In light of this, she made complaints about the arbitrator that resulted in a suit being brought against her.

The Appellant argued that the legal expenses were incurred for the purpose of producing income from rental properties and for maintaining her license to practice medicine and as such are deductible.  She relied on the decisions in Mercille v. The Queen, [1999] TCJ No. 941 (QL)., and 65302 British Columbia Ltd. v. Canada, [1999] 3 S.C.R. 804, and sought to distinguish Leduc v. The Queen, 2005 TCC 96, and more closely resemble those in Vango v. Canada, [1995] T.C.J. No. 659 (QL).

The Crown argued that the legal expenses were personal in nature and not business expenses. Alternatively, the fees incurred to protect professional reputations are on capital account and non-deductible pursuant to paragraph 18(1)(b).


The Court began by referring to subsection 9(1) which identifies that income from business or property is the “taxpayer’s profit from that business or property for the year”, which according to Symes v Canada, [1993] 4 S.C.R. 695, is a “net concept which presupposes business expense deductions”.  However, business deductions are limited for tax purposes by a number of other provisions, including paragraphs 18(1)(a) – requirement that outlay or expense be for purpose of gaining or producing income –  (b) – no deduction for capital, depreciation, obsolescence or depletion unless expressly permitted –  and (h) – no deduction for personal or living expenses other than specific travel expenses.

The purpose of an expense is not determined merely by looking at the taxpayer’s subjective intention, but by looking at the objective manifestations of purpose in light of the relevant circumstances. [14]

Thus, the legal expenses are deductible only IF they were: (1) incurred for the purpose of gaining or producing income from business or property; (2) not capital outlays; and (3) not personal or living expenses.

Legal expense deductions have been considered often. In Leduc, the TCC held that legal expenses to defend against sexual criminal offenses are not deductible because the existence of the business activity and the legal expenses were not related – ie the legal expenses would have been incurred irrespective of the business activity, and were not incurred for the purpose of gaining income.  The condition that must exist, according to Leduc, for legal expenses to be deductible are:

26        One may conclude from the above-cited case law that if the activities that led to the charges were carried on in the normal course of the income-earning operations, then an expense incurred to defend those activities is a direct result of the activities themselves, and hence may be deductible under paragraph 18(1)(a) of the ITA. Consequently, it is the activity that resulted in the charges and its connection to the business that determine the deductibility of the legal expenses associated with the defence.

[emphasis added]

In Poulin v. Canada, [1996] F.C.J. No. 960 (QL), the expenses incurred by a realtor for unsuccessfully defending fraud and false representation allegation by former clients were held by the FCA to be non-deductible. This was because to be deductible, the expense must be:

[..]seen as the unfortunate consequence of a risk that the taxpayer had to take and assume in order to carry on his trade or profession. And in order for the payment to be seen as such, it is an essential condition, I believe, that it be directly related to an act that was necessary in order to carry on the trade or profession and that it could potentially have been considered to have been performed improperly.

[emphasis added]

Compare Poulin with Doiron v. Canada, 2010 TCC 519, rev’d. 2012 FCA 71, where the lawyer who was defending himself against criminal charges was doing so on the accusation that he, in performing the duties of his business, acted criminally. The TCC allowed the legal expenses and interest because the charges arose “directly from the Appellant’s law practice and his acting on behalf” of his clients.  The FCA reversed the decision of the TCC in Doiron because on the facts it was not shown “how he could hope to regain his license to practice” despite the outcome of the criminal charges.  Thus, in the outcome of the proceedings on which the legal fees were expended would not have affected the earning of income.

The proceedings on which the legal fees are expended must be directly related to the income activity of the taxpayer, and directly related to the functions that the taxpayer performs as part of the income generating activity.  There must be real evidence connecting the relevant legal expense with the income generating operations in a direct manner.   His must be more than a mere incidental relationship.

The TCC denied the Appeal here because there were only incidental connections between the dispute and the taxpayer’s income generating activities, and there was insufficient evidence produced that the income generating activities were truly at risk due to the proceedings.  The expenses were held to be personal in nature.

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