Fernando v. The Queen, 93 DTC 5412, [1993] 2 CTC 173 (FCTD)

Rothstein, J. (orally):—This is an appeal from a decision of the Tax Court of Canada dismissing the plaintiff's claim for want of prosecution. However, the appeal in this court is treated as a trial de novo and the court has jurisdiction to hear and decide this case on its merits. The issues are:

1. whether legal expenses incurred in respect of the receiving of an amount by an employee as a result of a wrongful dismissal are deductible for the purposes of computing income for income tax purposes;

2. if the legal expenses are deductible, what amount should be deducted;

3. whether interest expense incurred by the employee on a loan needed to pay legal fees is deductible for the purposes of computing income for income tax purposes.

The plaintiff was employed by the Alberta Union of Public Employees. He commenced work on May 1, 1977 and was dismissed on August 20, 1981. Pursuant to the collective agreement that governed his employment, a grievance was commenced resulting in an award by an arbitration board.

The arbitration board made an interim award on December 4, 1981. The interim award stated in part, at page 4:

(D) Nature of the Grievance. The grievance (Exhibit 4) is dated August 24, 1981 and in the grievance the grievor alleges his dismissal by the employer on August 20, 1981 was unjust and requests that he be reinstated without any loss of seniority, salary, and benefits.

(E) Interim Award. At the conclusion of the proceedings I advised Ms. Freeland and Mr. Scott that this was, in my opinion, a situation in which I should communicate my decision immediately without written reasons, e.g. after reviewing the evidence it was my decision that the dismissal of Mr. Fernando had not been justified by the employer and as such any further delay would only add to the expense and the inconvenience of the parties.

Further on page 5 the interim award states:

. . .. dismissal was too severe a penalty for these offences and that a period of suspension was an adequate and sufficient penalty for the said offences and that was why I was reinstating Mr. Fernando effective immediately.

And on the next page the arbitrator states:

I then requested Ms. Freeland to make the appropriate arrangements for Mr. Fernando to return to work with the employer.

I further requested Ms. Freeland and Mr. Scott to attempt to agree on the compensation that was to be paid by the employer to Mr. Fernando.

The final award of the arbitrator dated April 22nd, 1982 allowed the claim of the plaintiff as follows, as found on pages 11 and 12 thereof:

Mr. Fernando is entitled to those payments that he actually paid for insurance benefits that would otherwise have been provided by the employer pursuant to Article 32. . . .

Mr. Fernando is entitled to the pension payment pursuant to Article 34 and is entitled to wages, vacation, and overtime. .. . .

Mr. Fernando is also entitled to paid holiday pursuant to clause 8.01. . . .

Mr. Fernando is entitled to interest on the amounts owing from the date the same were payable to the date of payment to the rate of 15 per cent.

In 1982 the plaintiff received accounts for and paid legal fees as follows:

The sum of $4497.74 was paid directly by the plaintiff's employer to the lawyer. This amount represented wages due to the plaintiff pursuant to the award less income tax and other deductions deducted at source.

The plaintiff did not pay the balance of $31,930.99 because he thought the billing was excessive. In 1985 a settlement was made between the plaintiff and his lawyer pursuant to which the plaintiff paid legal fees of $8,000 in full satisfaction of the claim of $31,930.99. The sum of $3,750 was paid in 1985 and $4,250 was paid in 1986.

The taxation years before me in this case are 1983 and 1985.

The plaintiff claims he is entitled to deduct legal fees paid pursuant to paragraph 8(1)(b) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act").

Paragraph 8(1)(b) provides:

8(1) In computing a taxpayer's income for a taxation year from an office or employment, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:

(b) amounts paid by the taxpayer in the year as or on account of legal expenses incurred the taxpayer to collect or establish a right to a salary or wages owed to him by his employer or former employer of the taxpayer;

Counsel for the defendant says that legal expenses are not deductible under paragraph 8(1)(b) in this case because they are not legal expenses incurred in collecting salary or wages. In her submission the legal fees were incurred to entitle the plaintiff to wages and she distinguishes between entitlement to wages and collection of wages.

She also submits that what the plaintiff obtained in this case was a retiring allowance and not wages. Retiring allowance is defined in subsection 248(1) of the Income Tax Act as:

“retiring allowance” means an amount (other than a superannuation or pension benefit, an amount received as a consequence of the death of an employee or a benefit described in subparagraph 6(1)(a)(iv)) received

(a) upon or after retirement of a taxpayer from an office or employment in recognition of his long service, or

(b) in respect of a loss of an office or employment of a taxpayer, whether or not received as, on account or in lieu of, damages or pursuant to an order or judgment of a competent tribunal

by the taxpayer or, after his death, by a dependant or a relation of the taxpayer or by the legal representative of the taxpayer;

“Salary or wages" is defined in subsection 248(1) as follows:

"Salary or wages” except in sections 5 and 63 and the definition "death benefit” in this subsection, means the income of a taxpayer from an office or employment as computed under subdivision (a) of Division B of Part I and includes all fees received for services not rendered in the course of the taxpayer's business but does not include superannuation or pension benefits or retiring allowances.

Counsel for the defendant relies on Tax Court authorities in Lyonde v. M.N.R., [1988] 2 C.T.C. 2032, 88 D.T.C. 1397 and MacDonald v. M.N.R., [1990] 2 C.T.C. 2269, 90 D.T.C. 1751 and others.

In MacDonald, Couture, C.J.T.C.C. states at page 2271 (D.T.C. 1752):

The amount in question in my opinion was in respect of loss of his employment received as on account or in lieu of payment of damages pursuant to a judgment of a competent tribunal as provided in paragraph 248(1) and was therefore a retiring allowance within the meaning of this definition. In addition the word "salary" as defined by the dictionary does not include an amount of the type received by the appellant. The Concise Oxford Dictionary defines salary: n.“ "fixed payment made by employer at regular intervals, usually monthly or quarterly to person doing other than manual or mechanical work".

In my opinion, by his action against his former employer, the appellant was seeking the right to damages for wrongful dismissal and not salary or wages as he had never performed any services for his former employer to be entitled to a salary or wages.

What paragraph 8(1)(b) contemplates, in my opinion, is the situation whereby a taxpayer having performed the duties of his employment, his employer has refused to pay him his salary for whatever reasons he may invoke. In other words, the employee has earned the salary or wages in question, but his employer has not paid him and he had to incur legal expenses to collect what was owing to him.

Counsel for the defendant reminded me that the definition of retiring allowance in the Income Tax Act that was relevant in the case at bar and which I have cited above was different than the definition of that term that was relevant in McDonald.

The Tax Court cases indicate that in ordinary circumstances an amount paid to an employee for wrongful dismissal is considered a retiring allowance. Since legal fees in paragraph 8(1)(b) are only deductible where they are incurred to collect wages or salary, it appears that legal fees are not deductible to collect a retiring allowance.

I have serious difficulty understanding why parliament intended to restrict paragraph 8(1)(b) in that way. No interpretation bulletin or other explanatory material was provided to me to explain the rationale for the distinction. In my view, parliament recognized in paragraph 8(1)(b) that if an employee had to incur expense to earn income, such expense directly related to the earning of income should be deductible.

It may be that, as counsel for the defendant stated, the difference is one between the right to income and the right to establish a right to income as that distinction is made in Lyonde, supra. However in the context of wrongful dismissal, I have difficulty understanding why such distinction is relevant. An employee is required to incur legal expenses to obtain salary or wages that was owing to him by virtue of the fact that he was wrongfully dismissed without notice. The amount he receives is salary or salary related amounts such as pension contributions. He must pay tax on the amount he receives. Why should he not be entitled to deduct the legal expenses he incurred to obtain the salary or wages that he would have earned had he not been wrongfully dismissed?

Counsel for the defendant did point out to me that within the last few years paragraph 8(1)(b) of the Income Tax Act has been amended and now provides that amounts paid by the taxpayer in the year as or on account of legal expenses incurred by the taxpayer to collect or establish a right to salary or wages owed to the taxpayer by the employer or former employer of the taxpayer are deductible.

Apparently now there is no doubt, if indeed there ever was one, that legal expenses are deductible if incurred to collect or establish a right to salary or wages.

However it seems to me, on the facts of this case that I must determine whether the plaintiff received salary or wages or whether he received a retiring allowance as these terms are defined in section 248 of the Income Tax Act.

Under section 248 a retiring allowance means an amount received upon or after retirement from an office or employment in respect of a loss of the office or employment. In this case the plaintiff was ordered reinstated. The amount paid to him must have been paid after reinstatement since the arbitrator’s interim award ordered him to be reinstated immediately. It cannot be said that the amount he received was paid upon or after retirement because he didn't retire. He went back to work.

Nor can it be said that the amount was paid in respect of a loss of office or employment. In the case of reinstatement, no office or employment is lost.

The definition of retiring allowance seems to contemplate a situation in which an employee's employment was permanently terminated because it speaks of receiving an amount after retirement and in respect of the loss of office or employment. Neither of these conditions apply in the case at bar because there was reinstatement without delay upon the arbitrator's interim award being issued.

There were no legal fees paid in 1983. The legal fees paid in 1985 were $3,750. Counsel for the defendant argues that the legal fees paid cannot be attributed to the recovery of wages or salary because the settlement amount of $8,000 was in full satisfaction of the outstanding fees of $31,930.99 some of which was unrelated to the claim for wages or salary.

However, of the total legal fees outstanding, close to 75 per cent related to the arbitration proceedings and proceedings before the Alberta Labour Relations Board. I think it is not unreasonable to consider that the $3,750 of the $8,000 paid was in respect of the collection of wages. The award uses the term "wages" when describing the amount, among other ancillary amounts related to employment, that should be paid to the plaintiff. I am satisfied that the basic amount ordered and paid in this case was wages and not a retiring allowance. Accordingly I am of the view that the deduction of legal fees under paragraph 8(1)(b) is appropriate.

The plaintiff also claimed interest in respect of the amount he had to borrow to pay legal fees. Paragraph 20(1)(c) of the Income Tax Act provides for deductions for interest in computing income from business or property. Para- graph 20(1)(c) refers to interest on borrowed money used for the purpose of earning income from a business or property or interest on an amount payable for property required for the purpose of gaining or producing income therefrom or for the purpose of gaining or producing income from a business. I am unable to see how interest on a loan to pay legal fees to obtain wages fits under paragraph 20(1)(c).

I would remit this matter back to the Minister of National Revenue to reassess the plaintiff for the year 1985 by allowing a deduction for legal fees of 3,750.

In all other respects I would confirm the Minister's assessments for 1983 and 1985. There will be no order as to costs.

Appeal allowed in part.