Citation: 2008TCC481
Date: 20080828
Docket: 2007-4202(IT)I
BETWEEN:
DENNIS A. KEAY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Webb J.
[1]
The Appellant claimed
$15,065.22 as an expense for legal fees in computing his income from his
consulting business in 2004. This claim for legal fees was denied and the
deductibility of this amount is the issue in this appeal.
[2]
The legal expenses that
were claimed in 2004 were incurred during the period from April 29, 2002 to
September 29, 2004. It is obvious from the invoice that was rendered by the
lawyer that a significant portion of the legal fees did not relate to the 2004
taxation year, and therefore even if the amount incurred was otherwise
deductible, it could not all have been claimed in 2004. Counsel for the
Appellant acknowledged that the legal fees that were incurred in 2002 could not
be considered as part of this appeal as the 2002 taxation year is not under appeal.
Counsel for the Appellant argued that the 2003 and 2004 taxation years are
under appeal as these were the years that had been reassessed. Since the only
issue identified in the Notice of Appeal “is whether the Minister erred by
disallowing deduction for Mr. Keay’s claimed legal expenses in the 2003 and
2004 taxation years” and since the legal fees were only claimed in 2004, there
is an issue whether the 2003 taxation year is under appeal to this Court.
As a result of my findings in this case it is a moot point whether the 2003
taxation year is under appeal.
[3]
The issue in this case,
in relation to the expenses that were incurred in the year or years under
appeal, is whether the legal fees were incurred for the purpose of earning
income or whether they were personal expenses or expenditures incurred on
account of capital. Paragraphs 18(1)(1)(a), (b) and (h) of the Income Tax
Act (“Act”) read as follows:
18. (1) In computing the income of a taxpayer from a business or
property no deduction shall be made in respect of
(a) 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;
(b) an outlay, loss or replacement of capital, a payment on account
of capital or an allowance in respect of depreciation, obsolescence or
depletion except as expressly permitted by this Part;
…
(h) 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;
[4]
The Appellant engaged
Gary Manthorne for the services rendered that are the subject of this appeal in
April 2002, because the Appellant’s then spouse indicated that she was
commencing divorce proceedings. A petition for divorce was issued on August 22,
2002.
[5]
The Appellant had
submitted that since he and his former spouse had entered into a pre-marriage
contract, most of the issues arising as a result of the divorce had already
been settled. His argument was that the primary issue for which he retained a
lawyer related to the rental property that was owned jointly by the Appellant
and his former spouse. However when he was asked by his lawyer to describe the
legal services that were provided in relation to the rental property, he stated
as follows:
Q. Could
you -- did he, and, if so, if he did, could you please explain the legal services
he provided with respect to the property during the separation?
A. Well,
I mean, in terms of the property itself, I mean, it’s whatever one needs for
the notarizing of the documents, and the -- you know, the basic stuff. I mean,
there was nothing in terms of re-negotiating the terms of the mortgage. It --
that was only because he had the deeds. He had everything else that was there,
and just made life easier.
The other part
that went to it was from a business point of view, and that was the other
experience that I had had with him, and those were the rationales or reasons
that led me to go to him again.
Q. I
see.
A. Okay?
Q. Okay.
So in regards to -- with your dispute with Ms. Keay, the co-owner of the rental
property, what legal services did Mr. Manthorne provide?
A. To
be truthful, as little as possible, but it was more so from the point of view
-- when I say that, I say that, in part, in -- tongue in cheek. There were a
number of things sitting in there, have given me guidance. He knew I knew
enough about running a business, so basically a lot of it where there is an
upset with a business partner, in this case, my wife, when you’re still running
a business, there are certain areas of conduct, and you got to do certain
things.
When it came
to the issues of the opening and closing of the bank accounts, the biggest
issue got into it was after all of these things, somewhere along the line, the
bank decided they were re-opening the joint accounts.
I’ve been
around long enough, and so has he, and so have most of us in here, that once a
joint account is closed, it’s closed, okay? And regardless of how good a
customer you’ve been with the Royal Bank for how many years, you just don’t do
this.
So when I went
into my branch, and they said there was nothing they can do, so guess what? I
went straight upstairs into the tenth floor, or eleventh floor of the Royal
Bank Building, and found myself in this -- couldn’t get in anywhere, and
somebody came up, “What do you want?” and I said, “I got a fiduciary problem.”
“Go to your branch.” I said, “That’s why I’m here.”
At which point
in time, I sat down with -- I don’t know, Dale Baker, I think she was the big
boss, and a lawyer. “No, we have to open these.” And I said, “Well, I’m
sorry, you are not breaking your fiduciary things with me. I’ve got enough
issues as it is. The bank accounts are closed and they’re going to be, remain
closed. We’re going -- if anything has to be established, we do a proper paper
trail.”
And they were
insistent they weren’t doing it, so, “What do I need a lawyer for?” Well, it
was very simple: guide me; was to get it documented. End of story.
Q. I
see. And did you go to -- who did you go for to guide you in document ---
A. Gary.
Q. Gary.
If you go to ---
A. Gary
Manthorne. I -- Mr. Manthorne, yeah.
[6]
On cross-examination
the Appellant stated that the primary reason for retaining his lawyer was to
enforce his rights under the pre-marriage contract. The following is the
exchange between the counsel for the Respondent and the Appellant:
Q. So
would you agree that Mr. Manthorne’s services primarily included addressing the
prenuptial agreement that you had mentioned that you guys executed shortly
after the marriage, or before the marriage, as well as the matrimonial assets?
A. The
joint -- he was -- his primary services were protecting, (a), my pre‑existing
right that was established by my marriage contract.
Q. So
that would be the prenuptial agreement, then. Okay, for ---
A. Yes.
Okay?
Q. Same
terms. Okay.
A. The
second thing that was in there, and I think I’ve said it this morning, in terms
of -- part of his major task was that the, my former spouse and her legal
counsel/advisors, all were endeavouring to re-characterize my marital, or
matrimonial regime as represented by the contract.
The things in
there, if you will, that go to a personal issue, and I repeat, they go to the
payment in lieu of alimentary support, and they go to all of the household
furnishings. That which was joint, jointly owned is represented by the Deeds
you see this morning, and everything else over the -- since 1990 is a
jointly-owned benefit, or beneficial business. That was the major issue.
And so that
you understand a little further, in their Petition for Divorce, okay, my ex-spouse
filed for spousal support. When you have -- if you want enforcement of the
marriage contract for which the terms for spousal support are fairly clear,
then going and asking for something that you’ve already got is not enforcing an
existing right; it’s petitioning for more.
[7]
To the extent that the
legal fees were incurred to prevent his former spouse from establishing her
right to spousal support, such amounts would not be deductible. As noted by the Federal
Court of Appeal in Nadeau v. Minister of National Revenue, 2003 FCA 400;
2003 D.T.C. 5735; [2004] 1 C.T.C. 293:
18 Conversely,
the expenses incurred by the payer of support (either to prevent it from being
established or increased, or to decrease or terminate it) cannot be considered
to have been incurred for the purpose of earning income, and the courts have
never recognized any right to the deduction of these expenditures (see, for
example, Bayer, supra).
[8]
The Appellant submitted
into evidence a copy of the invoice issued by Gary Manthorne for his
services. However, the Appellant did not call Gary Manthorne as a witness.
The only evidence of the services rendered by Gary Manthorne was provided
by the testimony of the Appellant, the information contained in the invoice
rendered by Gary Manthorne’s law firm and copies of letters written by Gary
Manthorne. The Appellant’s evidence failed to establish that the legal expenses
were incurred primarily to earn income or what part, if any, of the legal
expenses may have been incurred for the purpose of earning income.
[9]
The Appellant testified
that there were a number of issues related to the rental property, including
issues related to the tenants and ensuring that the mortgage payments were
being made. There was no evidence of the amount of the legal fees that were
related to the issues concerning the tenants, nor was there any evidence of the
amount of legal fees that related to the other particular services that were
provided. Reviewing the individual items identified in the invoice rendered by
the law firm is of little assistance since the entries are only short summaries
of the work. As well, the Notice to Tenant, that the Appellant testified was
prepared by the Appellant with the assistance of Gary Manthorne, was dated June
28, 2002 and therefore any expense related to the preparation of this notice
would have been incurred in 2002 and would not be deductible in 2003 or 2004.
[10]
The following letters
written by Gary Manthorne in 2003 or 2004 were submitted into evidence:
(a)
a two page letter dated
February 20, 2003 which deals with 12 different points including the
division of assets, the assumption of liability with respect to the vehicle and
the income from the rental property;
(b)
a one page letter dated
July 2, 2003 dealing with the Appellant’s interest in the rental property;
(c)
a one page letter dated
January 16, 2004 acknowledging the solicitor of record for the Appellant’s
former spouse and providing the mailing address for Gary Manthorne;
(d)
a one page letter dated
March 22, 2004 to the solicitor for the Appellant’s former spouse which states
as follows:
Further to a letter from The Dominion of Canada
Insurance Company dated March 11, 2004, I am writing to inform you that your
client is now in arrears on the insurance policy covering the income property situate
in Wellington, NS.
Please be advised that your client is the sole recipient of all
rental income from said property as per her unilateral decision and is
therefore responsible for any and all expenses incurred therefrom.
I have enclosed a copy of the letter and ask that you forward to
your client so that we may resolve this matter.
(e)
a two page letter dated
June 24, 2004 dealing with a call that the Appellant’s former spouse had made
to the Appellant, requesting information concerning the tenants, raising the
issue of whether the Appellant’s former spouse had taken possession of the
property, dealing with an appraisal of the property and dealing with a proposal
that had been made to the previous solicitor for the Appellant’s former spouse.
[11]
These letters do not
support a claim that the total cost of preparing each letter was incurred for
the purpose of earning income. The letter of March 22, 2004 does not demand
payment from the Appellant’s former spouse of one-half of the net rental income
from the property but appears to concede that the Appellant’s former spouse can
retain the income by stating that she is responsible for any and all expenses. It
is impossible to determine how much of the time spent in writing any one of
these letters that deal with several issues would have been spent on any one
particular issue.
[12]
There is, however,
another significant concern in relation to the deductibility of the legal fees
that were incurred. The following are excerpts from the Appellant’s testimony
during the hearing:
A:…we’re
getting into a scenario where, if a divorce was coming, you’ve got to protect
the assets.
Credit
reputations have to be protected, and it was as much in my interest as it was
in hers to make sure that the credit was protected. It goes to your good
name. So I got that rectified.
I don’t know
what she did with the rest of it, but by the time the Divorce Petition came in,
and a lot of other things that were going, it was very clear to myself, and my
legal counsel at the time, this was when we really knew what we were up
against.
…
Q. Yeah.
And you stated that you received the amount just to cover the mortgage payment.
A. That’s
correct. And that was going to protect the liability, credit reputations.
That was the first and foremost part. The second, obviously, you don’t pay a
mortgage on a rental property; you don’t stay in business very long.
…
Q. Okay.
Could you just briefly explain if, and if so, how this letter relates to your
rental property business?
A. Well,
very simply put, it -- the major account in there was going through for the
mortgage payments. She wanted to open that up, so that -- by putting the
mortgage payments, going back into our joint names, okay? And I’ll use that
account now, for this.
What was not
stated in here, and I can only go from record, because the records, as I say,
fell off the truck, at the time -- the records were -- the deposits had been
going from a joint account in the TD Bank in to pay the mortgage, and that’s
what she closed.
So all that I
was making sure of is, (a), I did not want to go through the aggravation of
more phone calls from the bank, saying the payment hasn’t come in, and I’ve
taken full responsibility for it, okay? I just couldn’t rely on what was
happening, at the time. That was the major purpose behind this.
I mean, to me,
the common sense issue in all of this -- you’re running a business, and I’ll
repeat myself -- if you’re -- the potential for encumbering a property, or a
business, going through foreclosures, I’ve had all of those routes, and there’s
just no excuse -- I spent a number of years recovering my credit, my
reputation, all kinds of things -- just -- this wasn’t happening. That’s why
this is all happening.
And, really,
it -- when you -- asking about this, it -- the personal side of it, if there
was a personal side, it’s going to my personal reputation running a business;
it goes to my personal reputation in my consulting things.
But in terms
of this business here, you get into certain other things. Oh, well, they
haven’t been paying the mortgage. The bank comes to them, “You pay us.” I
mean, do you see where this goes with the business, and you get liabilities?
Uh-uh, wasn’t having anything to do with it.
…
A. And
the reason that I was out to do was to protect the business of -- and the
income that was coming, to make sure -- I wanted no repeat. I had expressed,
from that point, or then on, that I would buy the business, buying the house.
To do so is protecting the particular income. That’s the way I looked at it.
In -- to the
next parts of what -- going on here, part of the things that were ongoing
throughout the communications is expressing -- I wanted to get in -- we wanted
to get in to do an appraisal. If you’re going to go along with this, then let
us get in to do the appraisal.
[13]
One theme that ran
throughout the Appellant’s testimony was his concern about protecting the
rental asset from foreclosure and potential damage to his credit reputation. He
did not want to lose the rental asset as a result of mortgage payments not
being made and he did not want to suffer any damage to his credit reputation.
[14]
In Muggli v. The
Queen, [1994] 1 C.T.C. 2705, Justice Bowman (as he then was) stated
as follows:
9 The real hurdle in the way of the appellant
is paragraph 18(1)(b). Even accepting that the cost of protecting his ownership
of the farm was an expense or outlay made for the purpose of gaining or
producing income, it was, nonetheless, a cost of preserving his ownership of a
capital asset. The law is clear that such expenses are on capital account and
their deduction is prohibited by paragraph 18(1)(b). This case is in my view
squarely within the principle stated by Martland, J. in Farmers Mutual
Petroleums Ltd. v. Minister of National Revenue, [1968] S.C.R. 59,
[1967] C.T.C. 396, 67 D.T.C. 5277, at pages 65–66 (C.T.C. 400–01,
D.T.C. 5280):
It can certainly be said that the appellant, in resisting the
lawsuits launched against it, was seeking to protect its income, because it was
seeking to protect the assets from which its income was derived. It can,
therefore, be argued that the expenses were properly deductible under paragraph
12(1)(a). This is not contested by the respondent. The object and purpose of
the lawsuits, however, was to compel the restoration to the land owners of the
mineral rights which the appellant had purchased. The learned trial judge has
found, and the evidence establishes, that those rights were items of fixed
capital, and were so regarded by the appellant. At the time the litigation
occurred, the sum total of the mineral rights acquired by the appellant, all of
which were of the kind involved in the litigation, represented all of the
appellant's capital assets. The appellant did not trade in them, but intended
to retain them perpetually.
It was to protect those capital assets from attack that the legal
costs of the litigation were incurred, and, to quote the words of Dixon, J.
(later Chief Justice) in Hallstroms Pty. Ltd. v. Federal Commissioner of
Taxation (1946), 72 C.L.R. 634 at page 650, referring to the costs of
defending title to land:
Next to the outlay of purchase money and conveyancing expense in
acquiring the title to land, it would be hard to find a form of expenditure in
relation to property more characteristically of a capital nature.
The fact that the leases acquired by the appellant, along with the
mineral rights, were more immediately connected with the production of income
than was the franchise involved in the Dominion case does not affect the matter
in principle. It is relevant in relation to the application of paragraph
12(1)(a), but in relation to paragraph 12(1)(b) we must ask the question, was
this outlay for the purpose of preserving a capital asset? In my opinion it
clearly was and, if that is so, paragraph 12(1)(b) prevents its deduction.
10 See also, Brault v. Minister of
National Revenue, [1988] 2 C.T.C. 2316, 88 D.T.C. 1736 (T.C.C.); The
Queen v. Burgess, [1981] C.T.C. 258, 81 D.T.C. 5192 (F.C.T.D.).
[15]
Since the Appellant had
stated on more than one occasion that he was concerned about protecting the
rental property from foreclosure and protecting his own credit reputation, this
is another reason why the Appellant cannot succeed since, as noted by Justice
Bowman in Muggli, an expense incurred for the purpose of preserving the
ownership of a capital asset is on account of capital and not deductible.
[16]
The Appellant has
failed to establish what part, if any, of the legal expenses that were incurred,
was incurred for the purpose of earning income and not on account of capital
and was not a personal expense. In the Reply that was filed the Respondent did
not plead paragraph 18(1)(b) of the Act, however the Appellant was not
prejudiced by this as the Appellant specifically addressed this paragraph in
the written pre-hearing submissions of Counsel for the Appellant.
[17] As a result, the appeal is dismissed without
costs.
Signed at Toronto,
Ontario, this 28th day of August 2008.
“Wyman W. Webb”
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