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Citation: 2005TCC96
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Date: 20050201
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Docket: 2002-2632(IT)G
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BETWEEN:
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JACQUES LEDUC,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
Lamarre, J.
[1] This is an appeal against an
assessment made by the Minister of National Revenue
("Minister") under the Income Tax Act
("ITA") disallowing the deduction of legal
expenses in the amount of $140,000 that were claimed by the
appellant as a business expense in computing his income for his
2000 taxation year.
[2] The facts which gave rise to the
present appeal are partly summarized in the Admitted Statement of
Facts jointly filed by the parties. Those facts read as
follows:
1. The Appellant, a lawyer
practicing in Cornwall, Ontario filed his 2000 income tax return
and claimed $140,000 legal expenses as business expenses.
2. The Appellant paid
$40,000 to the law firm of Edelson and Associates and $100,000 to
the law firm of Skurka Pringle for defending him at a trial in
the Superior Court of Ontario on an indictment charging six
counts of sexual exploitation, one count of sexual interference
and one count of offering sexual services for consideration. The
indictment related to three complainants, one as young as 12
years old when the alleged sexual exploitation began. The charges
arose following an O.P.P. [Ontario Provincial Police] criminal
investigation of an alleged "pedophile ring" in the
Cornwall area.
3. The Minister disallowed
the deduction for legal expenses.
4. On July 24, 2003, the
Ontario Court of Appeal reversed the Superior Court decision
dated March 1, 2001 staying the indictment and ordered a new
trial. A copy of the Court of Appeal decision is attached as
Appendix "A" [R. v. Leduc, 66 O.R. (3d) 1
(Court of Appeal for Ontario)]. An application for leave to
appeal to the Supreme Court of Canada was dismissed without
reasons on January 12, 2004. To the extent that they are relevant
to this appeal, the parties admit the statement of facts found in
the Court of Appeal decision.
[3] In addition, the appellant
testified. According to that testimony, he was called to the
Ontario Bar in 1978 and is carrying on in the city of Cornwall a
general law practice, which includes real estate, estates, and
corporate and commercial work. He was charged in June and July
1998 with the above-mentioned criminal offences. In March
1999, the appellant received a letter from the Law Society of
Upper Canada ("LSUC") (Exhibit A-1) that
stated:
The Law Society has been advised that you have been charged
with the criminal offences of sexual assault, sexual
interference, invitation to sexual touching, sexual exploitation
by touching, sexual exploitation by invitation to touch and
attempting to obtain the sexual services of a minor for a
consideration.
I understand that a preliminary hearing regarding some of
these offences has been scheduled to begin on April 8, 1999 and
your first court appearance on the new charges is also scheduled
for April 8, 1999.
A file has been opened in the Department of Audit &
Investigation and I have been authorized to monitor this matter
through the court proceedings.
Would you please advise me if you have retained counsel in
order that I may correspond with him or her? In the alternative,
please advise me if you would prefer that I communicate directly
with you?
In the event that you are convicted of these charges or should
there be a finding of guilt, this matter will be brought before a
Proceedings Authorization Committee in order to determine whether
or not an Application will be issued alleging that you have
breached Section 33 of the Law Society Act by engaging in
professional misconduct or conduct unbecoming a barrister and
solicitor. Should the Law Society determine to pursue
disciplinary action against you, I will report this matter to the
Discipline Department by way of a counsel brief and document
book.
[4] The appellant testified that he
understood from this letter that he was put on notice of the
possible consequences of a conviction in relation to the criminal
charges, as an eventual conviction could affect his standing as a
member of the LSUC and his ability to practise law in the
province of Ontario.
[5] After receiving the letter from
the LSUC, the appellant retained a criminal lawyer to defend
himself against the criminal charges. The appellant said that at
the time he had two things in mind. First, he wanted to prove
that he was not guilty of the conduct alleged, and second, he
knew that if he was to be found guilty on these criminal charges,
it could terminate his professional life and his ability to earn
income as the LSUC could then decide to revoke his licence to
practise law.
[6] To date there have been no
proceedings started under section 33 of the Law Society
Act, R.S.O. 1990, chapter L.8, as amended
("LSA"). As a matter of fact, the
appellant's legal practice as a whole has continued to thrive
and in 2003 it registered the highest gross income in its
history. It should be pointed out, however, that at the time of
the present hearing the trial on the merits with respect to the
criminal charges had not yet taken place.
[7] After several years of litigation
regarding the criminal charges, the appellant has incurred
significant legal expenses (the $140,000 at issue in the present
appeal) in defending himself in procedural matters before the
courts.
[8] The appellant testified that he
became the target of allegations related to the Project Truth
investigation (of which mention is made in the decision of the
Court of Appeal for Ontario referred to in the Admitted Statement
of Facts) as a result of being involved as counsel in sexual
misconduct cases. He believes that the charges against him arose
out of some form of conspiracy.
Appellant's position
[9] The appellant submits that the
legal expenses are deductible against his income earned from a
business. That position is based on the argument that if he did
not defend himself against the charges and was convicted, he
would lose his licence to practise law. Although he admits that
he was also motivated by an urge to prove his innocence and stay
out of jail, he submits that his ancillary intention to preserve
his ability to earn income is sufficient for the deduction to be
allowed.
Respondent's position
[10] The Minister argues that pursuant to
section 18 of the ITA the expenses are not deductible
because they were not incurred "for the purpose of gaining
or producing income from [a] business" and are personal in
nature.
Analysis
[11] The calculation of income from a
business is outlined in section 9 of the ITA. Income for a
taxation year from a business is the profit from that business
for the year. Under section 9, a taxpayer can deduct expenses
that are incurred to earn that profit, subject to the limitations
set out in the ITA. Paragraph 18(1)(a) contains the
general limitation on deductible expenses. An expense is only
deductible "to the extent that it was . . . incurred by the
taxpayer for the purpose of gaining or producing income from the
business". This is further restricted by paragraph
18(1)(h), which disallows the deduction of "personal
or living expenses of the taxpayer".
[12] Section 9 and paragraphs
18(1)(a) and 18(1)(h) read as follows:
SECTION 9: Income.
(1) Subject to this Part, a taxpayer's income for a
taxation year from a business or property is the taxpayer's
profit from that business or property for the year.
SECTION 18: General limitations.
(1) In computing the income of a taxpayer from a business or
property no deduction shall be made in respect of
(a) General limitation - an outlay or expense
except to the extent that it was made or incurred by the taxpayer
for the purpose of gaining or producing income from the business
or property;
. . .
(h) Personal and living expenses -
personal or living expenses of the taxpayer, other than travel
expenses incurred by the taxpayer while away from home in the
course of carrying on the taxpayer's business.
[13] The question here is whether the legal
expenses are deductible against the appellant's professional
income.
[14] As Thorson P. said in The Royal
Trust Co. v. M.N.R., 57 DTC 1055 (Exchequer Court
of Canada), which statement was quoted and accepted by
Iacobucci J. in Symes v. Canada, [1993] S.C.J.
No. 131 (Q.L.), [1993] 4 S.C.R. 695, at
paragraph 36:
. . . the first approach to the question whether a particular
disbursement or expense was deductible for income tax purpose was
to ascertain whether its deduction was consistent with ordinary
principles of commercial trading or well accepted principles
of business ... practice ... [Emphasis added.]
[15] Iacobucci J. added the following
comments at paragraphs 38 and 40 in Symes
(supra):
¶ 38
Adopting this approach to
deductibility, it becomes immediately apparent that the well
accepted principles of business practice encompassed by
s. 9(1) would generally operate to prohibit the deduction of
expenses which lack an income earning purpose, or which are
personal expenses, just as much as ss. 18(1)(a) and
(h) operate expressly to prohibit such
deductions. For this reason, there is an artificiality
apparent in the suggestion that one can first examine
s. 9(1) in order to determine whether a deduction is
authorized, and can then turn to s. 18(1) where another analysis
can be undertaken . . .
. . .
¶ 40
There is no doubt that, in some
cases, s. 9(1) will operate in isolation to scrutinize deductions
according to well accepted principles of business practice. In
this respect, I refer to cases, also noted by the trial judge, in
which the real issue was whether a particular method of
accounting could be used to escape tax liability: e.g.
Associated Investors of Canada Ltd. v. Minister of National
Revenue, [1967] 2 Ex. C.R. 96; Canadian General Electric
Co. v. Minister of National Revenue, [1962] S.C.R. 3. In
other cases, including the present case, however, the real issue
may be whether a deduction is prohibited by well accepted
principles of business practice for the reason that it is
not incurred for the purpose of earning income, or for the
reason that it is a personal or living expense. In such
cases, any treatment of the issue will necessarily blur s. 9(1)
with ss. 18(1)(a) and (h).
[16] Thus, in order to be deductible as
business expenses, the expenses in question must have been
incurred "for the purpose of gaining or producing income
from the business" within the meaning of paragraph
18(1)(a) of the ITA. The purpose of a particular
expenditure is ultimately a question of fact to be decided with
due regard for all the circumstances (Symes, supra,
paragraph 68). Iacobucci J. referred to some factors to consider
in answering such a question. Thus, it may be relevant to
consider whether a deduction is ordinarily allowed as a business
expense by accountants. That could indicate whether a particular
kind of expenditure is widely accepted as a business expense
(Symes, supra, paragraph 69). Similarly, it
may be relevant to consider whether the expense is one normally
incurred by others involved in the taxpayer's business
(Symes, supra, paragraph 69). It may also be
relevant to consider whether a particular expense would have been
incurred if the taxpayer was not engaged in the pursuit of
business income. If indeed such is the case, there is a strong
inference that the expense has a personal purpose (Symes,
supra, paragraph 70).
[17] It may also be helpful to resort to a
"business need" test. Would the need exist apart from
the business? If a need exists even in the absence of business
activity, then an expense incurred to meet the need would
traditionally be viewed as a personal expense (Symes,
supra, paragraph 73).
[18] In this context, it is clear, in my
view, that the legal expenses incurred by the appellant to defend
himself in the criminal proceedings relating to the sexual
assault charges laid against him are personal expenditures. They
do not constitute expenses normally incurred by others involved
in the appellant's profession. It can also be inferred from
the evidence that if the appellant had not been engaged in his
professional activities, he would nonetheless have paid the legal
fees to defend himself before the courts against the criminal
charges. These factors, analyzed in the context of the
circumstances of this case, suggest that the legal expenses at
issue cannot be classified as business expenses pursuant to
section 9 and paragraphs 18(1)(a) and
18(1)(h) of the ITA.
[19] The appellant argues, however, that his
ability to carry on the law profession was imperilled by the
criminal charges. Indeed, under the LSA, the LSUC has the
authority to hold inquiries into such matters and the sanctions
that can be imposed include the suspension or revocation of the
licence to practise law[1].
[20] In the appellant's view, the legal
expenses have a personal element but they were also essential and
necessary to allow him to carry on his practice of law in the
future. The appellant argues that for an expense to be deductible
the intention to generate revenue through the incurring of the
expense need not be the only motivation for incurring it. The
appellant relied on the Supreme Court of Canada's decision in
Ludco Enterprises Ltd. v. Canada, [2001] 2 S.C.R.
1082, in submitting that if one of the appellant's purposes
in incurring the legal expenses was to preserve his
income-generating capability, this is sufficient for those
expenses to be deductible under section 9 of the ITA.
In his view, the fact that there is an element of personal
motivation in an expense does not result automatically in that
expense not being deductible. In Ludco, supra, it
was decided that an ancillary purpose to earn income was
sufficient to meet the purpose test for interest
deductibility.
[21] I cannot accept the appellant's
argument. First, we saw earlier that the legal expenses at issue
are, in the particular circumstances of this case, personal
expenses. Indeed, in the absence of evidence to the contrary, it
would appear that, had he not practised law, the appellant would
nonetheless still have incurred the legal expenses to defend
himself before the courts against the criminal charges.
Therefore, those expenses are not deductible pursuant to
paragraph 18(1)(h) of the ITA. The purpose
test analysed in Ludco, supra, is of no application
under paragraph 18(1)(h).
[22] Second, I am not even convinced that
one purpose of incurring these legal expenses was to earn income.
In Ludco, supra, the Supreme Court of Canada
established that the requisite test to determine purpose for
interest deductibility under subparagraph 20(1)(c)(i) is
whether the taxpayer had a reasonable expectation of income at
the time the investment was made. If, as suggested by counsel for
the appellant, this test should be applicable in the
determination of the purpose of an expenditure, I do not find
that the legal expenses at issue meet the test. Indeed, the
appellant testified that during the period when the legal
expenses were incurred his earning capacity from the law
profession was not affected at all. On the contrary, his legal
practice has continued to thrive. There was no need to incur the
legal expenses in order to have an expectation of income, as
income was already flowing from the appellant's legal
practice.
[23] Furthermore, the appellant's
earning capacity was not, in my view, in jeopardy at the time the
legal expenses were incurred. The appellant himself acknowledged
that the LSUC had not commenced any investigation. He recognized
that there was no certainty as to the implications of an LSUC
investigation in the event that he is found guilty in the
criminal proceedings. Indeed, according to Exhibit A-1, if he is
found guilty, the matter will be brought before a Proceedings
Authorization Committee in order to determine whether or not an
application will be issued alleging that he has breached
section 33 of the LSA. Then, should the LSUC
determine to pursue disciplinary action against the appellant,
the matter will be reported to the Discipline Department. The
sanctions available in the event of disciplinary action are
listed in subsection 35(1) of the LSA and do not
necessarily entail the revocation of a member's membership in
the LSUC or the member's being disbarred and having his name
struck off the roll of solicitors. Instead, for example, there
could be an order that the member obtain treatment or
counselling. There are as well other forms of sanctions which may
not affect a member's capacity to earn income from his legal
practice. The fact that an eventual conviction could possibly
affect the appellant's practice in the future is, in my view,
purely hypothetical and speculative at this stage and, in any
event, too remote to justify the deduction of the legal expenses
in the taxation year at issue pursuant to paragraph
18(1)(a) of the ITA.
[24] This case is distinguishable from this
Court's decisions in Vango v. Canada, [1995] T.C.J.
No. 659 (Q.L.) and Mercille v. Canada, [1999]
T.C.J. No. 941 (Q.L.), referred to by counsel for the
appellant. In those cases, the charges faced by the taxpayers
were directly related to their work, as an investment advisor in
one case and as a stockbroker in the other. The charges with
respect to which they incurred the legal fees were directly
related to their functions. In Vango, the taxpayer was
directly faced with the loss of his licence. It was decided in
both cases that the legal fees were deductible as employment
expenses pursuant to section 8 of the ITA. In the present
case, the criminal offences with which the appellant is charged
have nothing to do with his legal practice. The legal expenses
paid to defend himself against several sexual offence charges did
not arise out of his law practice. The acts regarding which a
defence is being mounted do not relate to his business.
[25] As Judge Rip stated in Thiele
Drywall Inc. v. Canada, [1996] T.C.J. No. 623 (Q.L.),
referred to by counsel for the respondent, at paragraphs 19,
20, 23 and 24:
¶ 19 The question for me to
decide, then, is whether the appellant's evasion to comply
with the Act was a normal or ordinary incident of carrying
on its business. If so, the legal costs of defending the
action, whether the appellant was guilty or not, is deductible;
if not, then the costs are not deductible. In my view they
are not.
¶ 20 Where the courts have
allowed appeals to permit the taxpayers to deduct legal expenses,
the expenses were incurred in accordance with sound accounting
and commercial practices and were incurred to defend the
taxpayers' trade practices in the conduct of their businesses
and to preserve the systems that helped produce their
incomes: Caulk, supra, and Rolland
Paper, supra. The legal expenses in
Heininger, supra, also related to a taxpayer's
way of doing business . . .
. . .
¶ 23 For expenses to be
deductible, the Caulk and Rolland Paper
cases, supra, require the activities in which expenses
were incurred be carried on in the normal course of the
taxpayer's income earning operations.
¶ 24 As I wrote in
Matthews, supra, at p. 1268:
Where a business carries out activities in the normal course
of its operations, and the cost of those activities is deductible
in computing the income of the business, any expense incurred to
defend those activities is a direct result of the activities
themselves and is permitted by paragraph 18(1)(a) to
be deducted: vide The Queen v. Phyllis B. Bronfman
Trust, (supra). The legal expenses in the case at bar
were incurred to defend a prosecution against the appellant which
arose directly from the practice of preparing financial
statements in the normal course of business.
[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.
[27] Furthermore, counsel for the appellant
relied on another decision of the Supreme Court of Canada,
65302 British Columbia Ltd. v. Canada, [1999]
3 S.C.R. 804, in arguing that public policy considerations
should not dictate that a particular expense ought not to be
deductible. Indeed, in 65302 British Columbia Ltd. it was
held that, absent a specific provision to the contrary, the fines
or penalties ought to be deductible if they were incurred for the
purpose of generating income.
[28] The present case is not like the
situation in 65302 British Columbia Ltd., supra,
referred to by the appellant, where the taxpayer wanted to deduct
the payment of levies that were incurred as part of its
day-to-day operations and where the decision to produce over
quota was a business decision made in order to earn income.
[29] In the present case, the charges did
not arise in the course of the appellant's business. In his
testimony, the appellant suggested that they arose because of his
role as the lawyer for several Catholic priests and the local
Catholic diocese. In his capacity as a lawyer he helped reach a
settlement regarding a priest's "sexual
misconduct". Indeed, his name became highly publicized as
the lawyer for the Church. The appellant suggested that his role
led to a "conspiracy" to elicit testimony against
him.
[30] The appellant's allegations at this
stage are pure speculation. There is no evidence as such of any
conspiracy. The test as outlined in the case law allows the
deduction of legal expenses when the activity that led to charges
is shown to be a normal part of the production of income. This is
clearly not the case here.
[31] I therefore conclude that the legal
expenses at issue were not paid in order to produce income from a
business. Those expenses were personal in nature and not
deductible in the computation of income.
[32] The appeal is dismissed with costs.
Signed at Ottawa, Canada, this 1st day of February 2005.
Lamarre J.
SCHEDULE A
Law Society Act
PART II
CONDUCT
Prohibited conduct
Prohibited conduct: members
33. (1) A member shall not
engage in professional misconduct or conduct unbecoming a
barrister or solicitor.
. . .
Conduct application
34. (1) With the authorization of the
Proceedings Authorization Committee, the Society may apply to the
Hearing Panel for a determination of whether a member or student
member has contravened section 33.
. . .
Conduct orders
35. (1) Subject to the rules of practice and
procedure, if an application is made under section 34 and the
Hearing Panel determines that the member or student member has
contravened section 33, the Panel shall make one or more of the
following orders:
1. An order revoking the member's or student member's
membership in the Society and, in the case of a member,
disbarring the member as a barrister and striking his or her name
off the roll of solicitors.
2. An order permitting the member or student member to resign
his or her membership in the Society.
3. An order suspending the rights and privileges of the member
or student member,
i. for a definite period,
ii. until terms and conditions specified by the Hearing Panel
are met to the satisfaction of the Secretary, or
iii. for a definite period and thereafter until terms and
conditions specified by the Hearing Panel are met to the
satisfaction of the Secretary.
4. An order imposing a fine on the member or student member of
not more than $10,000, payable to the Society.
5. An order that the member or student member obtain or
continue treatment or counselling, including testing and
treatment for addiction to or excessive use of alcohol or drugs,
or participate in other programs to improve his or her
health.
6. An order that the member or student member participate in
specified programs of legal education or professional training or
other programs to improve his or her professional competence.
7. In the case of a member, an order that the member restrict
his or her practice to specified areas of law.
8. In the case of a member, an order that the member practise
only,
i. as an employee of a member or other person approved by the
Secretary,
ii. in partnership with and under the supervision of a member
approved by the Secretary, or
iii. under the supervision of a member approved by the
Secretary.
9. In the case of a member, an order that the member
co-operate in a review of the member's practice under section
42 and implement the recommendations made by the Secretary.
10. In the case of a member, an order that the member maintain
a specified type of trust account.
11. In the case of a member, an order that the member accept
specified co-signing controls on the operation of his or
her trust accounts.
12. In the case of a member, an order that the member not
maintain any trust account in connection with his or her practice
without leave of the chair or a vice-chair of the standing
committee of Convocation responsible for discipline matters.
13. In the case of a member, an order requiring the member to
refund to a client all or a portion of the fees and disbursements
paid to the member by the client or, in the case of a student
member, an order requiring the student member to pay to a person
an amount equal to all or a portion of the fees and disbursements
paid by the person in respect of work done by the student
member.
14. In the case of a member, an order requiring the member to
pay to the Society, for the Lawyers Fund for Client Compensation,
such amount as the Hearing Panel may fix that does not exceed the
total amount of grants made from the Fund as a result of
dishonesty on the part of the member.
15. In the case of a member, an order that the member give
notice of any order made under this section to such of the
following persons as the order may specify:
i. The member's partners or employers.
ii. Other members working for the same firm or employer as the
member.
iii. Clients affected by the conduct giving rise to the
order.
16. In the case of a student member, an order that the student
member give notice of any order made under this section to his or
her articling principal.
17. In the case of a student member, an order revoking any
credit in the Bar Admission Course to which the student member
would otherwise be entitled.
18. An order that the member or student member report on his
or her compliance with any order made under this section and
authorize others involved with his or her treatment or
supervision to report thereon.
19. An order that the member or student member be
reprimanded.
20. An order that the member or student member be
admonished.
21. Any other order that the Hearing Panel considers
appropriate.
. . .
PART III
PROHIBITIONS AND OFFENCES
Prohibition as to practice, etc.
50. (1) Except where otherwise provided by
law,
(a) no person,
other than a member whose rights and privileges are not
suspended, shall act as a barrister or solicitor or hold themself
out as or represent themself to be a barrister or solicitor or
practise as a barrister or solicitor; and
(b) no temporary member
shall act as a barrister or solicitor or practise as a barrister
or solicitor except to the extent permitted by
subsection 28.1 (3).
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