CRA indicates that the vendor’s agreed reimbursement of the sold corporation’s legal costs of a failed suit in consideration for a dividend had the suit succeeded, likely was non-deductible

An individual agreed to sell all the shares of a corporation except that he also agreed with the purchaser that he would retain a preferred share in that corporation on which he would receive a dividend equal to a percentage of any damages award to the corporation in its action against a 3^rd party for lost profits – but that if the law suit was unsuccessful, he would reimburse the corporation for certain of its legal fees. The corporation received an unfavourable decision in the action, and the individual reimbursed legal fees related to the litigation - and also requested the redemption of his preferred share.

In finding that the individual (Mr. A) likely could not deduct his reimbursement payment, CRA stated:

… Mr. A's undertaking to reimburse the legal costs of the corporation only took effect if the corporation received an unfavourable decision … . This court decision then eliminated any possibility of dividend income … . In short … it becomes difficult … to demonstrate the existence of a sufficient link between the expense and Mr. A's source of property income.

This is debatable. The purpose for incurring the reimbursement obligation might instead relate back to the individual’s purpose at the time of the agreement, namely, generating the prospective dividend income.

Neal Armstrong. Summaries of 26 February 2025 Internal T.I. 2023-0985151I7 F under s. 18(1)(a) – legal fees and s. 42(1)(b)(ii).