Teskey, T.C.C.J.:— The appellant appeals his assessments of income tax for the years 1986, 1987 and 1988.
Issue
The sole issue before me is the deductibility of legal fees in the amount of $60,000 and $34,737 in the years 1986 and 1987 respectively. It was agreed that the 1988 appeal depends on the outcome of the 1986 and 1987 appeals and therefore is not in issue.
Facts
The facts herein are not in dispute. The pertinent ones being:
(a) The appellant, pursuant to two written agreements with Winpower Corporation ("Winpower") of Iowa, U.S.A. dated November 11, 1976 and October 3, 1977 became a commission representative to sell electrical generators, parts and accessories firstly for the industrial market and secondly for the farm market in the Province of Ontario.
(b) All commissions earned by the appellant were paid to the appellant without deduction, who deposited the moneys into an account with the Midland Bank in Buffalo, New York.
(c) At the time, the appellant obtained a legal opinion from a solicitor in Ontario, to the effect that Canadian income tax was not payable on this money, or on the interest earned thereon, until it was transferred into Ontario.
(d) The two commission agreements were cancelled by Winpower by letter dated November 21, 1979.
(e) As of November 1979, the appellant no longer sold Winpower products. He did receive commission cheques in 1980 and on into 1981 that arose out of sales negotiated before November 21, 1979.
(f) On or about March 1, 1985, the appellant was charged with six counts of making, participating in, assenting in or acquiescing in the making of false or deceptive statements in filing his tax returns pursuant to the provisions of section 239 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). These all dealt with the income earned by the sale of Winpower generators that was held in the Midland Bank.
(g) On February 16,1987, His Honour Judge M.E. Charles dismissed all the charges.
(h) The appellant since 1959 has also been a full-time employee of Sommers Motor Generator Sales Ltd., a company started by his father in 1936. The appellant received from this company both wages and commissions.
(i) The legal fees at issue were those paid by the appellant to his solicitors for legal services rendered arising out of the defence of the six charges.
(j) The moneys in the Midland Bank in Buffalo represent the profit and the interest accumulated thereon from the appellant's business of selling Winpower generators.
Analysis
In order for the appellant to be successful, the deductions sought must fall within the purview of paragraph 18(1)(a). Section 18 of the Act is found under the heading “Deductions” and the subheading “general limitations". Paragraph 1 reads:
In computing the income of a taxpayer from a business or property no deduction shall be made in respect of
Subparagraph (a) reads:
. . «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.
Obviously, if I cannot conclude that the two expenditures were for the purpose of gaining or producing income that is the end of the matter.
The appellant relies heavily on the decision of my colleague Rip, T.C.C.J. in Ben Matthews & Associates Ltd. v. M.N.R., [1988] 1 C.T.C. 2372, 88 D.T.C. 1262 (T.C.C.). The appellant therein was a retailer and wholesaler of lumber. At year end, it reduced its cost of inventory in respect to damaged, stained or obsolescent lumber. The appellant was charged under section 239 of the Act. At issue was the deductibility of the legal fees paid to defend those charges. Rip, T.C.C.J. said at page 2380 (D.T.C. 1267):
Legal expenses incurred by a taxpayer in defending itself from criminal charges arising out of its business operations, namely, to defend its business practices, have been found by the Court to be deductible: M.N.R. v. L.D. Caulk Co., [1952] C.T.C. 1, 52 D.T.C. 1034 (Ex. Ct.), aff'd by [1954] S.C.R. 55, [1954] C.T.C. 28, 54 D.T.C. 1011 and Rolland Paper Co. v. M.N.R., [1960] C.T.C. 158, 60 D.T.C. 1095 (Ex. Ct.).
And at page 2380 (D.T.C. 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 Bronfman Trust v. The Queen, [1987] S.C.R. 32, [1987] 1 C.T.C. 117, 87 D.T.C. 5059. 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.
Rip, T.C.C.J. allowed the appeal.
The appellant relies upon the decision of my colleague Kempo, T.C.C.J. in Cormier v. M.N.R., [1989] 1 C.T.C. 2092, 89 D.T.C. 44 (T.C.C.). The issue in Cormier was again the deduction of legal expenses in defending charges of making false or deceptive statements which hid income pursuant to section 239 of the Act. Kempo, T.C.J. said at pages 2102 (D.T.C. 51-52):
I would concur with the respondent's counsel’s submission that the Ben Matthews & Associates case, supra, is distinguishable on its facts in that the section 239 charges alleging criminal wilful evasion of the payment of taxes by way of the making of false and deceptive statements in its financial statements arose out of and were in respect to reductions of inventory valuations concerning damaged, stained and obsolete goods, all of which had been openly and properly recorded in the proper and adequate records of the company. Rip, T.C.C.J. of this Court found that the legal expenses incurred to defend the prosecution arose directly from that taxpayer's practice of preparing financial statements in the normal course of its business and the defence of that practice.
In the case at bar, the appellant had been charged and convicted of wilfully failing to report substantial amounts of income which, in the context of this case, cannot be described as a normal business activity carried out in the course of business operations or which had been carried out for the purpose of gaining or producing income. The facts here simply do not support counsel for the appellant's submission that the legal expenses arose and occurred directly in defending the appellant's practice of paying assistants and employees in the course of his business and in computing the income from that business. Rather, and as noted earlier by counsel for the respondent, the false statements wilfully made concerned non-reporting of over fifty per cent of the appellant's business income for each of the subject years. This activity on these particular facts, lacks commer- ciality and simply does not fit within jurisprudential phraseology of incurring expenses to defend a way of doing business to preserve a system under which a business operates.
I do not believe Sommers’ success in having the charges dismissed is a relevant consideration herein.
Like Kempo, T.C.C.J., I do not see how Sommers can describe the expenses herein as moneys spent to defend a normal business activity carried out in the course of business operations or which had been carried out for the purpose of gaining or producing income. The money in the Midland Bank in Buffalo was the profit from the business. There is no dispute as to its calculation or as to the amount. The decision to declare or not to declare the income when earned is not a business decision, but a personal one.
The appellant's argument that he was defending his way of doing business is not a valid argument. The charges against him arose because he did not report the United States income. The reporting or non-reporting of this income was not an integral part of his business. The legal expenses herein cannot be characterized as an outlay made for the purposes of gaining or producing income. The income had been gained or produced, it simply was not reported.
For these reasons, the appeals are dismissed with costs.
Appeals dismissed.