6 February 1996 Internal T.I. 9532477 - LEGAL FEES - GUARANTEE AND RECEIVERSHIP

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

Whether legal fees incurred by a taxpayer to avoid having to honour his guarantee, to revive his corporation and to oppose the sale of the business by the receiver-manager are deductible or can be claimed as an allowable business investment loss.

Position:

The legal fees are neither deductible as an allowable business investment loss, expenses of disposition, eligible capital expenditures or current expenditures.

Reasons:

They were not incurred for the purpose of gaining or producing income from a business or property, nor were they incurred to dispose of capital property.

							February 6, 1996

	Calgary Tax Services Office	HEADQUARTERS
	Business Audit				C. Chouinard
							957-8953
	Attention: D.J. Schneider
							7-953247

Allowable Business Investment Loss

This is in response to J. Cunningham's memorandum which we received December 12, 1995, wherein our comments were requested regarding the deductibility of legal fees incurred by a taxpayer as an allowable business investment loss.

Facts

We understand the facts to be as follows:

The taxpayer's business, XXXXXXXXXX was placed into receivership in XXXXXXXXXX and as a result, the business' bank called upon the taxpayer to honour the personal guarantees he had given in respect of the business' debts. The taxpayer deducted the amount of the guarantee as an allowable business investment loss. Subsequently, the taxpayer requested an adjustment to the amount he had reported as an allowable business investment loss to include legal fees he incurred in the period from XXXXXXXXXX. Although it is not entirely clear, it appears from the documentation you provided that part of these legal fees were incurred by the taxpayer to revive XXXXXXXXXX while another part was incurred to oppose the Receiver-Manager's application for an Order approving and authorizing the sale of the business to third parties whose bid for the business had been accepted by the Receiver, notwithstanding that it was lower than the taxpayer's bid. It also appears that part of the fees are attributable to the filing of a counter-claim by the taxpayer against the

XXXXXXXXXX

to defend their action for foreclosure of the property personally owned by the taxpayer.

Your Position

In your opinion, the legal fees cannot be considered to be an allowable business investment loss, since they were not incurred for the purpose of generating income.

Our Comments

The Department's general views concerning the treatment of legal fees for tax purposes are stated in Interpretation Bulletin IT-99R4. As indicated in paragraph 1 of IT-99R4, in the absence of a specific provision in the Income Tax Act (the "Act") dealing with legal fees, such fees are only deductible if they were incurred for the purpose of gaining or producing income from a business or property and are not outlays of a capital nature. Generally, legal fees are deductible where they are incurred in connection with normal activities, transactions or contracts incidental or necessary to the earning of income from a business or property.

As regards the legal fees incurred by the taxpayer to defend the action for foreclosure of his personal property, as these fees were incurred in connection with the enforcement of the personal guarantees provided by the taxpayer, in our view, they are not deductible as a current expense or an allowable business investment loss. In our view, legal fees incurred by a taxpayer to avoid having to honour a personal guarantee do not form part of any capital loss or allowable business investment loss, as they are not incurred as a result of a disposition of capital property. They are in fact personal expenses of the taxpayer and are not in any way paid in respect of his corporation. Therefore, any part of the legal fees incurred for such purposes can neither be claimed as an allowable business investment loss, nor deducted by the taxpayer.

As regards the legal fees incurred to revive XXXXXXXXXX and to oppose the sale of the business to third parties, in our view, these fees are not deductible as a current expense or an eligible capital expenditure, since they were not incurred to produce or gain income from a business or property. They were in fact incurred in an abortive attempt to retain control of the corporation and, in some respect, are akin to legal fees incurred to fight a bid to take over control of a corporation. As indicated in paragraph 15 of IT-99R4, such fees relate to the ownership of the shares themselves (i.e., the capital structure of the corporation) and are not laid out for the purpose of gaining or producing income from the business. In addition, since the legal fees were not incurred for the purpose of making a disposition as required by subparagraph 40(1)(a)(i) of the Act, in our view, they cannot be regarded as expenses of disposition of property.

Assuming the legal fees were incurred by the taxpayer for the purposes mentioned above, in our view, no part of the fees would be deductible as either an allowable business investment loss, expenses of disposition, eligible capital expenditures or current expenditures.

We are returning all of the original documentation submitted with your request.

R. Albert
for Director
Business and General Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

Encl.