Friedland v. The Queen, 89 DTC 5341, [1989] 2 CTC 79 (FCTD)

Collier, J.:—There are here three related appeals from reassessments of income tax by the Minister of National Revenue. Technically, the appeals are from the then Tax Review Board. But the Board did not hear or decide the appeals on the merits.

The first essential issue between the taxpayers and the Minister is the deductibility and treatment of certain legal expenses incurred. There is a second issue as to the deductibility of certain automobile expenses.

These reasons are given in action T-4181-80. The reasons will apply in the other two appeals. The taxpayers in the other two appeals are S.F. Research Associates Ltd. and Camar Consultants Limited.

It is necessary to set out the facts in some detail. Seymour Friedland was the main witness in his own appeal and in the others. I say, at the outset, I found him to be a credible and trustworthy witness.

The plaintiff is an American educated economist. He holds a Ph.D. in Economics from Harvard University. Prior to coming to Canada in 1967, he did academic teaching. He published a large number of articles. He did, as well, some outside counselling work. His specialty has been in business economics and finance.

In 1967 he came to York University in Toronto, Ontario. York did not have a graduate business school until 1966. Aside from his academic endeavours, Professor Friedland began doing outside consulting work. In 1968, he was engaged by Dominion Securities Corporation Limited (“Dominion”) to write quarterly market projection letters. There was no written contract in respect of that matter. He subsequently did other work for that company. He attracted other clients. I think it fair to say Professor Friedland became quite well known as a consultant and an authority in the business economics field. He was, of course, paid fees by his clients.

On the advice of his accountant, Professor Friedland incorporated, on January 13, 1970, S.F. Research Associates Limited ("SFRA"). He was, at all times, a shareholder, director, and chief operating officer of SFRA. Professor Friedland's clients, past and future, were channelled to the company. The professor did all the work. If he required help, the company, through him, engaged assistants, typically another academic.

SFRA was reasonably successful until some matters arose giving rise to the legal expenses issue. From 1970 to December 1972, it received something over $120,000. One of the largest sources of fees was Dominion.

In 1970 SFRA became investment advisor in respect of a pension fund. The fund came mostly from the Asbestos Workers' Union. Econocom Management Limited (Econocom) was the manager of the fund; Professor Friedland was the president of Econocom. Standard Trust Company was the trustee. SFRA (for practical purposes, Friedland), gave advice when necessary or requested. In 1971 and 1972, SFRA received a little over $10,000 in fees.

Some problems arose in respect of a loan which had been made by the pension fund. Professor Friedland had attested to the soundness of the loan. At one stage, in drafting these reasons, I had considered it necessary to go into more detail in respect of that transaction. The defendant, in argument, had suggested Professor Friedland's dealings had been, at the least, very questionable.

I do not accept that criticism.

The evidence indicated, to me, Dr. Friedland was an unknowing victim of some actions by his personal stockbroker. I need not go into the details.

But the matter had unfortunate repercussions. Claims, not just in respect of that loan, but in respect of the management of the fund, were made. Ultimately, in August 1974, litigation was commenced by the Union against Econocom, Standard Trust, Friedland personally, and others.

At this point, I digress.

Because of the Econocom problems, and other legal ones to which I will shortly refer, it was decided SFRA was no longer practically viable as a consulting business. A new company was incorporated on January 15, 1974: Camar Consultants Ltd. SFRA and Dr. Friedland are shareholders of Camar. After incorporation, any consulting fees, earned through the plaintiff's efforts, were paid to Camar.

I now go back in time.

In 1972, SFRA had a client, Phisor Investments Limited. SFRA gave investment advice to Phisor. The principals of that company were, as I understand it, one Philip Rosenblatt and his wife. Dr. Friedland recommended Phisor invest in a company called Creative Patents and Products Limited. That investment went sour.

Again, claims and two lawsuits developed, brought by Phisor and the Rosenblatt family, against Professor Friedland and SFRA. The Phisor suit was launched in April 1973. Solicitors were engaged to defend those suits. Legal expenses were incurred.

I add, at this point: The lawsuits, as against Dr. Friedland and SFRA, were ultimately settled. Camar paid $1,000 in respect of the Union litigation, and $500 in respect of the Phisor proceedings.

Finally, another problem arose. Professor Friedland was charged, in September or October 1974, under Ontario securities legislation, for acting as a security advisor, without having a license. The next day, Dominion severed their connection with him. A well known counsel, Austin Cooper, was instructed to defend. The defence was successful. The plaintiff was found not guilty by a jury.

I now go directly to the specific legal fees paid in respect of the legal problems which I have recounted. Camar paid the legal fees incurred in respect of Professor Friedland and SFRA. It claimed, in its 1974 taxation year, a deduction of $6,910; for 1975, a deduction of $14,112. The Minister of National Revenue disallowed the deductions.

In respect of the reassessment of SFRA's income tax, the Minister increased that company's income for 1974 by $521, and $1,000 for 1975. The additions were described as follows:

“Add: Shareholder's benefit re legal fees."

In respect of this plaintiff, Dr. Friedland, the Minister added into his tax income for 1974, an amount of $3,639.11, and for 1975, an amount of $14,607.50. These additions were described as follows:

“Shareholder benefit. Re: Legal Fees”.

I turn to the submissions on behalf of these litigants.

The three plaintiff taxpayers argue that the legal expenses were incurred in the carrying on of Camar's business; they were incurred for the purpose of gaining or producing income from that business; the amounts were therefore deductible (paragraph 18(1)(a) of the Income Tax Act). Camar's only asset, the submission runs, was Professor Friedland; SFRA's only income producing source was, once again, Professor Friedland. Further, it was said, while Professor Friedland and SFRA may have received a practical benefit in respect of the resolution of the civil litigation, and the criminal charge, this does not translate into a deemed income benefit for taxable purposes.

For the defendant, it was said the legal expenses incurred did not relate to Camar's business; that company was not party to any of the difficulties and suits which arose; the liability for the legal expenses was solely that of the other two taxpayers; by Camar paying them, a benefit was conferred.

A large number of authorities were cited, many dealing with the question of deduction of legal fees. I agree with counsel for the taxpayers that cases of this kind must depend on their own particular facts. Here, the facts are paramount.

Professor Friedland was, as I see it, the sole and real source of income, first of SFRA, and then of Camar. Camar came into being because of the claims and allegations asserted against SFRA and its principal. Camar then carried on the income producing business. The claims against SFRA and Professor Friedland blew into active litigation in 1974 and 1975. There were, as well, the criminal charges which came to trial in 1975. If all those proceedings had not been defended, or unsuccessfully defended, it is obvious, from a practical business point of view, Professor Friedland's services to clients and potential clients would have been tarnished and diminished. Camar's business would then have been affected.

It was, to my mind, a sound business decision to defend the litigation proceedings, and to incur the consequent expenses. They became deductible, in my view, under paragraph 18(1)(a) of the statute.

The most recent decision, in this court, on the deductibility (or not) of legal fees paid by a company, in respect of criminal charges laid against its president, is Border Chemical Company Ltd. v. The Queen, [1987] 2 C.T.C. 183; 87 D.T.C. 5391 (Muldoon, J.).

The expenses were held to be not deductible as a business expense. In the course of his reasons, Muldoon, J. dealt with several of the legal authorities cited in these appeals heard by me.

Counsel here each sought to rely on, or distinguish, the Border Chemical case. As so often appears, the facts there were quite different to those here. Muldoon, J. found the company's interjection into its president's affairs:

. . . even though he exerted a great influence in its policies and operations, is too remote, too long a reach, for the purposes of the Income Tax Act. (p. 193)

Later, on the same page, the court referred once more to the transaction as "too remote".

That is not the situation here. There was nothing remote about the relationship here of Professor Friedland and Camar, and the consequent intervention or interjection by Camar. The relationship and interjection can be aptly described as direct, not remote. Camar's business income depended on the ability of Dr. Friedland to produce, unsullied by convictions, or tarnished by verdicts against him in civil law suits.

The taxpayers advanced an alternative, or perhaps, additional argument: that there was an obligation on the part of the corporate taxpayers to indemnify him, as a director, from the legal expenses he incurred. This is a novel, and somewhat difficult, argument. In view of the above conclusions I have come to, I do not intend to comment on it.

The plaintiff's appeal in respect of the legal expenses, is allowed. The assessment is vacated in respect of the inclusion into income, for the years 1974 and 1975, of the legal fees, as a shareholder benefit.

For the same reasons, the reassessment of Camar's 1974 and 1975 income tax, by disallowing the legal fees paid is vacated (action No. T-4182-80).

Again, for these same reasons, the reassessment, including in SFRA's income, shareholder's benefits for 1974 and 1975, is vacated or set aside.

There remains the issue of automobile expenses, and their treatment and disposition.

The facts giving rise to this dispute were given in evidence by Professor Friedland, and to some extent, by Mr. S.A. Burns, a chartered accountant, with Beallor Beallor Burns. That firm were the accountants and auditors for the three taxpayers.

The three taxpayers did not have a true business office. Dr. Friedland used his own home as a consulting office. Neither SFRA nor Camar owned an automobile. In 1973 and 1974, Professor Friedland owned a used Rolls Royce; in 1975, he replaced it with a used BMW. The Friedland family had a family car, a Toyota. The oldest child was allowed to drive the Toyota, but not the Rolls or the BMW.

Professor Friedland used the Rolls and BMW for the business purposes of the other two taxpayers. He used them to get back and forth, three days a week, to York University. Occasionally, they were used in the evenings for social events. He went downtown to Dominion a minimum of two days a week. He used the cars to call on other clients as well. He estimated the cars were used 80 per cent to 90 per cent of the time on the business of the two companies.

As I have earlier written, I found Professor Friedland to have been a credible, trustworthy witness. I accept his evidence as to the use of the cars, and his estimate between personal and business use.

The claim for deductibility of the automobile expenses was made by Camar. The Minister disallowed the following amounts for the following years:

In respect of Professor Friedland's taxation years, the Minister added into income in respect of “personal use of Auto":

(The figure of $593.77 for 1975 appeared in the reassessment and the pleadings. It is obviously an error).

Mr. Burns, in Exhibit 18, and in direct testimony, explained the allocations. The taxpayers made an estimate of what it would have cost to rent a comparable car. A monthly "allowance" of $540 was calculated for the Rolls when it was in use; and $450 per month for the BMW in 1974, reduced to $400 for 1975. In addition, a proportionate share of gas and oil was included in the car expense calculation. Car allowances payable to Professor Friedland were then calculated. All this was done on the basis of a generous personal use estimate by Mr. Burns of approximately 30 per cent.

The Minister, according to Mr. Burns, drastically reduced the calculations, as well as adding some of the allowances to Professor Friedland's income.

I am satisfied, from the evidence adduced by the appellant taxpayers, the automobile expenses claimed as deductions by Camar were reasonable, and properly deductible as business expenses. I am further satisfied that there were no grounds for adding the amounts, earlier set out, into Professor Friedland's income for the years in question.

The taxpayers have, in my opinion, demolished the Minister's assessments. The assessments are, therefore, vacated.

The taxpayers have been successful on all counts. They are entitled to their costs of these appeals. But there will only be one set of counsel fees for the trial, taxable in this action.

Appeals allowed.