REASONS
FOR JUDGMENT
Graham J.
[1]
Ohad Kondor separated from his wife in 2010. In
2011, Mr. Kondor spent $12,171 in legal fees relating to the division of
property between himself and his wife. Mr. Kondor deducted those legal fees
from his income when he filed his 2011 tax return. The Minister of National
Revenue denied that deduction. Mr. Kondor has appealed the denial.
[2]
Mr. Kondor owns 50% of the shares of DPX Capital
Inc. Mr. Kondor takes the position that the legal fees were incurred to earn
income from DPX’s business. The Respondent takes the position that the legal
fees were personal living expenses. Alternatively, the Respondent takes the position
that if the legal fees were incurred to earn income, they were incurred to earn
income from the DPX shares, not DPX’s business and they were incurred on
capital account.
[3]
Therefore, the issues on this Appeal are:
(a) whether Mr. Kondor incurred the legal fees to earn income from DPX’s
business;
(b) if not, whether Mr. Kondor incurred the legal fees to earn income
from the DPX shares; and
(c)
if so, whether the expenditure was on income
account.
Were the legal
fees incurred to earn income from DPX’s business?
[4]
Mr. Kondor’s assertion that the legal fees were
incurred to earn income from DPX’s business is without merit. The legal fees
cannot have been incurred by Mr. Kondor in order to earn income from DPX’s
business as Mr. Kondor does not carry on DPX’s business and thus did not earn
any income from it. Mr. Kondor’s interest in DPX was as a shareholder.
Thus, to the extent that the legal fees were incurred to earn income, they were
incurred to earn income from the DPX shares.
Were the legal
fees incurred to earn income from the DPX shares?
[5]
Following Mr. Kondor’s separation, his wife
informed him that, in addition to some other assets, she expected to receive
$2,100,000 in cash from him as part of the division of property from the
marriage. Mr. Kondor’s only significant asset at the time was his shares in
DPX. There was no market to sell those shares and his wife was not prepared to
accept shares in lieu of cash. Therefore, Mr. Kondor’s only means of obtaining
the necessary cash was through DPX.
[6]
DPX borrows money from third parties (generally
the friends and family of Mr. Kondor and of the other 50% shareholder of the
company) and invests that money in various complex securities. DPX takes steps
to hedge its risk in those investments. The investments are highly leveraged.
While DPX believes that there is minimal risk involved in its investments, its
brokerage does not share that view. Thus, the brokerage regularly reviews DPX’s
account to ensure that it is maintaining sufficient margin and, when it
believes it is not, requires DPX to either unwind some of its investments or
inject additional capital. Just as DPX’s brokerage believes that DPX’s
investments are risky, so too do conventional lenders. Thus DPX is not in a
position to borrow funds from traditional lenders.
[7]
Mr. Kondor explained that, because of its highly
leveraged positions, withdrawing that amount of money from DPX in the short
term would have been disastrous for DPX. Similarly, it would have had a
disastrous impact on the value of Mr. Kondor’s shares in DPX. He testified that
he was in a position to extract the necessary funds from DPX but that he needed
a significant amount of time if he wanted to do so without impacting the value
of the company.
[8]
Mr. Kondor’s strategy to deal with this problem
was to stretch out negotiations with his wife over the division of assets as
long as possible. He succeeded in obtaining a delay of approximately three and
a half years. Mr. Kondor testified that the legal fees that he incurred
were incurred for the purpose of obtaining that delay. Mr. Kondor argues that
the fees should therefore be deductible as they were laid out for the purpose
of earning income from his shares in DPX.
[9]
In keeping with his duty as an officer of the
court, counsel for the Respondent drew my attention to a decision of former
Chief Justice Bowman that supported Mr. Kondor’s position. The appellant in Muggli
v. The Queen was a
farmer who was separating from his wife. The appellant’s wife claimed that she
was entitled to 50% of the value of the farm. The appellant spent money having
the farm valued and incurred legal fees resolving the division of property. The
appellant argued that those funds had been expended to protect his interest in
the farm and thus to allow him to continue to earn income from his farming
business. The Minister argued that the funds had been expended for personal or
living expenses. Former Chief Justice Bowman held that there was a “sufficient
nexus between the preservation of the farm, his principal means of livelihood,
and the legal expenses claimed that I would not be justified in rejecting his
claim on the basis of paragraph 18(1)(a) alone”. He went on to conclude that although there was also a personal
element to the expenditure, that element did not detract from the commercial
element. He stated that where an expenditure had both a commercial and a
personal purpose it was up to the Court to determine which one was the
predominant purpose. I agree with the reasoning in Muggli.
[10]
The Respondent submits that the legal fees
related to Mr. Kondor’s separation from his wife and were thus personal in
nature. The Respondent argues that the fees were a cost that Mr. Kondor would
have had to pay regardless of his ownership of the DPX shares. While I agree
that Mr. Kondor would have had to pay at least some legal fees in order to deal
with his separation, the evidence that I have before me is that the fees in
question were paid to obtain the delay, not to obtain the separation. The
Respondent did not cross-examine Mr. Kondor on this point, preferring instead
to take the position that all of the fees were personal in nature. In fact, the
Minister made an assumption of fact that the legal fees were “incurred and paid
to contest immediate payment to [Mr. Kondor’s wife] of the amount that [Mr.
Kondor] owed from his shareholdings in DPX”.
[11]
Based on the foregoing, I find that the
predominant purpose for which Mr. Kondor incurred the legal fees was to
protect the value of his shares in DPX. Accordingly, I find that those fees
were incurred for the purpose of gaining or producing income from property.
Were the legal
fees incurred on income account or capital account?
[12]
Having found that the legal fees were incurred
for the purpose of gaining or producing income from the DPX shares, I must now
determine whether they were incurred on income account or capital account.
[13]
In Muggli, having found that the
appellant had expended funds for the purpose of gaining or producing income,
former Chief Justice Bowman had easily concluded that the funds had been
expended on capital account since they had been expended to preserve the
ownership of a capital asset. That reasoning is equally applicable to Mr.
Kondor’s case. Mr. Kondor expended the legal fees in order to preserve the
value of his DPX shares.
[14]
Mr. Kondor argued that he had effectively
borrowed money from his wife for three and a half years, that the cost of doing
so was the legal fees that he expended and thus that those fees should be
deductible on income account. I agree that that is the economic reality of what
occurred but taxation is based on the actual transactions that occurred, not on
the economic reality of the situation (Shell Canada Limited v. The Queen). Mr. Kondor did not settle the division of property and then
borrow funds back from his wife. He paid legal fees to delay the division of
property and thus maintain the value of his DPX shares. Therefore, his
expenditure was not laid out to borrow money but rather to preserve a capital
asset. Accordingly it was incurred on capital account.
Conclusion
[15]
Based on all of the foregoing, I find that the
legal fees were incurred to earn income from the DPX shares but that they were
incurred on capital account. The Appeal is therefore dismissed without costs.
Signed at Ottawa, Canada, this 15th day of October
2014.
“David E. Graham”
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