Citation: 2014 TCC 124
Date: 20140425
Docket: 2010-1252(IT)I
BETWEEN:
RICHARD A. KANAN CORPORATION,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Campbell J.
[1]
The Appellant is
appealing reassessments in respect to its 2006 and 2007 taxation years. In both
of these taxation years, the Appellant, in calculating its income, deducted
legal fees which had been paid to Olson Lemons LLP (“Olson Lemons”), a law
firm, and Olson Tax Consultants Inc. (“Olson Tax”), a corporation owned by the
law firm and engaged in the business of tax return preparation. The Minister of
National Revenue (the “Minister”) denied all of the expenses on the basis that
they were made or incurred for the benefit of Richard Kanan, the Appellant’s
major shareholder, the shareholder’s spouse and related corporations and that
they were not incurred for the purpose of earning income from the business.
[2]
To support the
deductibility of the expenses, the Appellant provided to the Minister copies of
legal invoices and a general description of the legal services. When the
Minister advised the Appellant that there was insufficient information to
support the deductibility of the claimed expenses and requested greater detail
of the legal services and advice provided, the Appellant claimed that the
information being required was subject to solicitor-client privilege, which it
would not waive.
[3]
The only issue is
whether there is sufficient evidence, either oral, documentary or both, to
support the deductibility of the claimed legal expenses.
[4]
Although heard pursuant
to the Tax Court of Canada Rules (Informal Procedure), these
appeals have a lengthy history associated with them. Prior to hearing the
present appeals, similar appeals were heard by Chief Justice Rip in Calgary in March and December of 2010. Although the Appellants in the appeals before Chief
Justice Rip were different than the Appellants in the present appeals, they
were utilizing the services of the same law firm, Olson Lemons, and the same tax
consulting company, Olson Tax. Consequently, the issue in those appeals,
concerning deductibility of expenses, was almost identical to the issue before
me.
[5]
A brief outline of the
history in the present appeals follows:
•
The Appellant filed a
Notice of Appeal on April 23, 2010.
•
The Respondent filed a
Reply on June 4, 2010.
•
The appeals were heard
on November 24, 2010 in Calgary.
•
Written Submissions
were provided by the Appellant and the Respondent on January 21, 2011.
•
I issued Interim
Reasons on April 15, 2011, directing the parties to meet to reconsider what
information could be provided under a limited and partial waiver of
solicitor-client privilege and to report back to the Court.
•
The Appellant provided
some additional information but the parties failed to reach a settlement.
•
On September 30, 2011,
the Appellant requested that the hearing be reopened to permit the introduction
of additional evidence.
•
A directive from the
Court was issued on October 20, 2011.
•
Written Submissions
were filed by the Appellant on October 31, 2011 in support of the request to
reopen the hearing.
•
Written Submissions
opposing the Appellant’s request to reopen the hearing were filed by the
Respondent on November 4, 2011.
•
Three appeals, which
Chief Justice Rip heard in March, 2010 and December, 2010, were also subject to
a similar request by those Appellants to reopen their hearings.
•
The Appellants’
application in the appeals being heard by Chief Justice Rip was scheduled for a
hearing and I directed that the similar application, in the appeals before me,
be held in abeyance pending a decision by Chief Justice Rip.
•
On December 10, 2012,
one day prior to the scheduled hearing of the application by Chief Justice Rip,
the Appellants withdrew their application to reopen the hearings.
•
On April 24, 2013,
Chief Justice Rip issued his reasons in all 3 appeals (Dr. Mike Orth
Inc v The Queen, 2013 TCC 123, 371501 B.C. Ltd. and 440214 B.C.
Ltd., 2013 TCC 124).
•
On May 24, 2013, the
Appellants appealed the decisions to the Federal Court of Appeal.
•
On July 24, 2013, the
parties were advised that I intended to hold my decision in abeyance pending
the outcome of the decision of the Federal Court of Appeal.
•
On February 5, 2014,
the FCA upheld the decision of Chief Justice Rip.
The Facts
[6]
The facts in these
appeals were described in detail in my Interim Reasons but, briefly, the
Appellant, a British Columbia corporation, operates a dental practice in Invermere, British Columbia. The Appellant receives legal counsel from Olson Lemons and tax
consulting advice from Olson Tax, which are based in Calgary, Alberta.
[7]
Thomas Olson, a partner
at Olson Lemons, was the only witness testifying on behalf of the Appellant. He
testified that the contents of the legal files, relating to the expenses, were
protected by solicitor-client privilege. Since his client had not waived that
privilege, he limited his testimony to unprivileged information, claiming that
the onus on the Appellant did not require it to disclose any information over
which privilege was claimed.
[8]
The Respondent claimed
that the Appellant provided insufficient information of the work completed.
Since this would not satisfy the Appellant’s onus in this Court, then the
expenses should not be deductible.
[9]
Although the
Appellant’s minute book and general ledger had been provided during the audit
process, only the T2 corporate tax returns and the invoices for the expenses
were introduced into evidence at the hearing. There are nine invoices in issue
during this period. They contain no description of the work completed for which
fees were charged. Except for charges for disbursements, all invoices simply
referenced the work generally as “Fees for Services”.
[10]
During the period under
appeal, there were essentially three categories of expenses for which invoices
were issued:
(a) General Retainer
Expenses – described as fees for day-to-day general advice to the Appellant in
areas such as tax-related and corporate matters (Transcript, pp. 17-18, 59
and 61);
(b) Preparation of Returns
– described as those invoices relating to tax and corporate compliance,
accounting and bookkeeping and preparation of returns (Transcript, pp. 105 and
130); and
(c) Projects – described
as the identification, analysis and advice given to the Appellant and Olson Tax
respecting specific legal issues and transactions, the consequent reporting of
these and preparation of the supporting documentation (Transcript, pp. 63-64).
[11]
Mr. Olson testified
that his firm would enter into a “retainer engagement arrangement” with the
Appellant at the commencement of each year. Pursuant to this engagement, the
Appellant would pay “set fixed costs”, in advance, for anticipated services
that Olson Lemons would be providing throughout the year. Clients were not
billed at an hourly rate. According to Mr. Olson, time recordings that were maintained
were not always accurate because they did not affect the quantum of the fee,
which was agreed to in advance. Mr. Olson stated that the fees were “… not
based on time records, it’s based [on] my experience doing these files.”
(Transcript, p. 116).
[12]
In respect to the
invoices relating to “projects”, Mr. Olson stated that, in both 2006 and 2007, he
dealt with compensation to employee shareholders, dividend issues and the payment
of bonuses. For example, in respect to dividend issues, the business and taxation
issues, relating to such payments, would be identified, resolutions and other
documents would be prepared to ensure compliance and advice would be provided
to Olson Tax, the tax preparers, on behalf of the Appellant. In 2006, shares
were issued and advice and documentation were provided for the Appellant and
the tax preparers relating to compensation and dividends as well as the share
issuance. Mr. Olson testified that information respecting the share issuance
was contained in the corporate minute book which had been provided to Canada
Revenue Agency (“CRA”) but which Mr. Olson did not provide to the Court. In
2007, the “project” fees related to compensation, dividends and changes to the
stated capital accounts.
[13]
According to Mr. Olson,
the fees attributable to the “projects” could be broken down as follows:
(a) 20 percent for
providing advice on preparation and filing of returns;
(b) two-thirds of the
remaining 80 percent for advising the Appellant on specific transactions
relating to payment of bonuses, dividends or issuance of shares, together with
all related documentation; and
(c) one-third of the 80
percent for compliance advice on tax and corporate compliance, including the
timing of bonuses and remitting of corporate withholdings and general reporting
obligations.
There seemed to be apparent overlapping between this
latter category (the one-third of the 80 percent division) and the projects
category assigned the 20 percent. The evidence did not clarify this.
Analysis
[14]
By basing income on profits
as opposed to revenue, subsection 9(1) of the Income Tax Act (the “Act”)
permits taxpayers to deduct expenses, such as legal expenses, in calculating
their income. Permissible deductions are limited, however, by paragraph 18(1)(a).
In the Federal Court of Appeal decision in Dr. Mike Orth Inc v Canada,
2014 FCA 34, one of the three appeals originally heard by Chief Justice Rip and
referenced earlier in these reasons, Justice Sharlow referred to the applicable
test as the “statutory purpose test”, that is, whether the legal expenses were
incurred for the purpose of earning income from a business or property and were
not outlays on account of capital or personal expenses.
[15]
In my Interim Reasons,
at paragraph 29, I came to the following conclusion as to how an appellant will
be expected to justify the deductibility of legal expenses:
[29] When a taxpayer deducts an expense from
his or her income, he or she may be called upon to justify that deduction – to
convince the Minister, or failing that, the Court, that it is a properly
deductible expense. Where the expense is a lawyer’s fee, the proof that is
required will often be covered by solicitor-client privilege. While these
Interim Reasons are not intended to provide the CRA with a licence to access
privileged information, it is clear that a taxpayer who presents a claim for
deductions in a return must also accept that at least some disclosure will be
necessary to properly dispose of that claim.
[16]
In Dr. Mike Orth
Inc. v The Queen and the related appeals, Chief Justice Rip reviewed in
detail the jurisprudence respecting the onus, which an appellant has in this
Court, to establish a prima facie case that “demolishes” the Minister’s
assumptions of fact that form the basis of the assessment. If an appellant successfully
demolishes those assumptions of fact, the onus shifts to the Minister to rebut
the appellant’s prima facie case and prove the assumptions. Chief
Justice Rip, at paragraph 20, concluded:
[20] A taxpayer wishing to establish a prima facie case
to demolish all or any of the Minister’s assumptions must not only present
evidence of a high degree of probability that must be accepted by the Court but
must allow for a fair and open cross-examination of the evidence by
Minister’s counsel. Counsel is entitled to vigorously challenge the evidence of
the taxpayer by cross-examination. A taxpayer claiming privilege in cross-examination on
matters he or she leads in examination-in-chief, thus limiting the cross-examination, must
consider possible consequences. A taxpayer claiming privilege who wishes to
shift the onus must still make a case that will survive cross-examination.
[17]
Chief Justice Rip, at
paragraph 21 of his reasons, noted that one of the issues before him was a
determination as to “… whether the appellant while maintaining his right to
solicitor-client privilege has presented evidence reversing the onus placed on
the appellant by the Minister’s assumptions.” I have that same determination to
make in the present appeals.
[18]
The Respondent does not
challenge the Appellant’s argument that it had a right to maintain
solicitor-client privilege over the advice provided to it by Olson Lemons.
However, the Respondent contends that, by invoking privilege, the Appellant has
failed to meet its onus of demolishing the assumptions. Justice Sharlow in Dr.
Mike Orth Inc. v Canada, at paragraph 13, in assuming that the claims of
solicitor-client privilege were valid claims for the purpose of those appeals,
went on to state:
[13] … However, neither the Minister nor the Court is obliged
to determine a factual dispute in the taxpayer’s favour merely because the
taxpayer asserts and refuses to waive a claim of solicitor and client privilege
with respect to evidence that could resolve the dispute.
[19]
While I recognize the
Appellant’s right to claim solicitor-client privilege, I came to much the same
conclusion that Chief Justice Rip did in the three similar appeals concerning
the testimony of Mr. Olson. At paragraph 49 of the reasons in Dr. Mike Orth
Inc. v The Queen, Chief Justice Rip stated the following:
[49] … However, most of Mr. Olson's testimony describing the
various invoices in question which, while interesting, is not illuminating to
the extent that I actually learned the purpose for which the legal fees were
incurred and be able to come to a reasonable conclusion as to whether the fees
were incurred for business or other reasons. …
Mr. Olson responded with generalities to much of the
questioning. In many instances, he claimed that he either did not recollect or was
not sure. Some of his responses contained estimations. Some of his evidence
could have been supported by the documentation, such as the minute book
records, that he had provided to CRA but not the Court, leaving one with the
impression that he felt that was sufficient to satisfy this Court. When asked
on cross-examination which items were reconciled with the general ledger, his
response meandered as follows:
A. I - - I don’t recall. Sometimes we reconcile
inter-companies, sometimes we reconcile bank loans, but not always, and often
not, but sometimes at the request of a client you do, but I don’t recall what
reconciliations were requested of us.
(Transcript, pp. 83-84)
This response was in respect to a document (the
general ledger) that had been freely handed over to CRA. I would expect any
taxpayer, and particularly a lawyer, to have reasonably anticipated such
questions and to be prepared and forthcoming in their response. When asked to
confirm the accuracy of the authorized share structure and changes to the
corporate structure and the stated capital, he could not do so without supporting
documents, one being the minute book which was not produced in evidence. It was
obvious that it had not been reviewed by Mr. Olson, as one would expect, prior
to coming to Court to testify.
[20]
In response to how many
employees the dental practice employed, Mr. Olson testified that Mr.
Kanan’s wife was “involved in the business” and that there were other staff but
that he was not aware whether they were employees or contractors (Transcript,
p. 117). When he was re-directed back to the original question of how many
employees were working, his response again showed how little effort he put into
his preparation for giving evidence on behalf of the Appellant: “… I’m sure they’re
in my records somewhere, but I don’t remember now.” (Transcript, p. 118). When
questioned about bonuses paid in the 2006 taxation year, he could not recall
the specifics, or whether, in fact, they were actually accrued and paid in that
year. To this response, he added: “… but that would be information that’s
readily available in the financial statements. If I had a copy, I could tell
you.” (Transcript, p. 141).
[21]
I was not impressed
with Mr. Olson’s lack of preparation or his flippant responses. While a
solicitor has a duty to respect a client’s refusal to waive otherwise
privileged information, there were many instances where Mr. Olson could have
provided specifics. Those specifics were detailed in the ledger, financial
statements and minute book, but Mr. Olson apparently did not think it was essential
to bring these documents to Court or to review them in advance of the hearing.
While credibility was not an issue, Mr. Olson was less than an ideal witness.
[22]
Following the Federal
Court of Appeal’s comments in Dr. Mike Orth Inc. v Canada, notwithstanding the Appellant’s right to claim solicitor-client privilege and
the duty of CRA not to violate that privilege when claimed, the Appellant
nevertheless bears the burden of proof to demolish the Minister’s assumptions
of fact in these appeals. With this in mind, I turn now to a review of the 9
invoices and a determination of whether the amounts contained in those invoices
are deductible by the Appellant in calculating its income in the 2006 and 2007
taxation years.
The Invoices
General Retainer
|
Tax
Year
|
Date
|
Invoice
No.
|
Amount
for Fees
|
Total with Disbursements
and Taxes
|
|
2006
|
February 1, 2005
|
0501200
|
$2,675.00
|
$2,863.05
|
|
January 6, 2006
|
0601135
|
$2,675.00
|
$2,864.88
|
[23]
Mr. Olson described the
fees charged in these two invoices as relating to a “general retainer”. He
stated that the retainer involved answering day-to-day questions but he did not
elaborate further on the nature of those questions. Consequently, I have
almost no evidence before me to assess what types of questions were asked, what
advice was provided and to whom or what work would be covered by these fees.
[24]
In Dr. Mike Orth
Inc v The Queen, at paragraph 55(i), Chief Justice Rip disallowed similar
invoices that were given for general advice because he could not “determine any
allocation or even if these fees were deductible in computing income because
there is no evidence before me…”. Since I have no evidence relating to the
nature of the questions or the resulting services, the Appellant has not established
a prima facie case that the expenses, relating to Invoices numbered 0501200
and 0601135, should be deductible.
Tax Return Preparation
|
Tax
Year
|
Date
|
Invoice
No.
|
Amount
for Fees
|
Total with Disbursements
and Taxes
|
|
2006
|
April 19, 2005
|
0504555
|
$4,000.00
|
$4,280.00
|
|
2007
|
June 6, 2006
|
0606644
|
$5,000.00
|
$5,448.31
|
[25]
Mr. Olson testified
that these expenses related essentially to tax return preparation. “It was
solely for the preparation of income tax returns, we call that tax compliance.”
(Transcript, p. 105). In addition, accounting services, including bookkeeping
and account reconciliations, would have been provided. Legal advice, that may
have been given with respect to the tax returns, would be invoiced separately
(Transcript, p. 130).
[26]
In Dr. Mike Orth Inc
v The Queen, Chief Justice Rip allowed the Appellant to deduct its fees to
Olson Tax, where those fees related to tax-related and compliance services.
Similarly, in the appeals before me, Mr. Olson stated that the services
included attendance on the Appellant’s T2 and the ancillary returns together
with bookkeeping and reconciliation. This establishes a prima facie case
to support these expenses being deductible. Although Mr. Olson admitted that
the firm may have prepared Dr. Kanan’s personal tax returns and those of his
family members, he stated, and I have no evidence to the contrary, that they
were completed free of charge (Transcript, pp. 112‑113).
Projects
|
Tax
Year
|
Date
|
Invoice
No.
|
Amount
for Fees
|
Total with Disbursements
and Taxes
|
|
2006
|
March 11, 2005
|
0503135
|
$2,200.00
|
$2,354.00
|
|
2006
|
January 20, 2006
|
0601208
|
$2,675.00
|
$2,895.30
|
|
2006
|
January 20, 2006
|
0601209
|
$2,500.00
|
$2,675.00
|
|
2007
|
August 2, 2006
|
0607089
|
$2,950.00
|
$3,127.00
|
|
2007
|
September 27, 2006
|
0609074
|
$3,300.00
|
$3,498.00
|
[27]
According to Mr.
Olson’s testimony, any task, that requires more work than simply picking up the
phone and answering a quick question, moves out of the “General Retainer”
category and falls instead within the category of so-called “Projects”.
Approximately 20 percent of the fees, under this category, related to providing
legal advice and analysis in respect to specific transactions during a
particular year, including documentation required and necessary reporting.
Mr. Olson divided the remaining 80 percent into two sub-categories:
(a) 2/3 (53.33 percent of
the 80 percent total) which related to advice on business and tax issues
respecting specific transactions together with the preparation of related
documents; and
(b) 1/3 (26.67 percent of
the 80 percent total) which related to advice on corporate and tax compliance
and reporting obligations.
[28]
It appears that both
the first 20 percent estimate of the fees and the 26.67 percent of the 80
percent relate to legal advice and analysis. The distinction between the
categories, however, was unclear and, from the evidence before me, they appear
to cover the same items. Mr. Olson attempted to explain the 26.67 percent
as relating to the advice that might be required in respect to payment of
bonuses, remittance of tax and other reporting obligations. While communication
relating to providing such advice is privileged, since I have no evidence to
distinguish between these two categories or to confirm these categories
represent expenses incurred for the purpose of earning income from business or
property and where it appears they duplicate each other, I am allowing only the
initial 20 percent of the total amount of fees listed in these “Project”
invoices, but not the 26.67 percent of the 80 percent estimate. Of the
remaining 53.33 percent of the 80 percent, Mr. Olson’s evidence is that it
included some business and legal advice together with drafting documents for
specific transactions, such as compensation issues, payment of dividends and
adjustments to stated capital. The portion of this 53.33 percent relating to
advice or communications, of course, would be privileged. Although there was no
attempt to differentiate between the portion attributable to advice and the
portion attributable to documentation, the result of the firm’s analysis would
be available to CRA in the Appellant’s tax returns and minute book. Therefore,
I am allowing 53.33 percent of the invoice amounts as well as the initial 20
percent.
[29]
In summary, the appeals
for the Appellant’s 2006 and 2007 taxation years are allowed, without costs,
and the reassessments are referred back to the Minister for reconsideration and
reassessment to allow the Appellant to deduct the fees for services as follows:
1) The fees in Invoices
numbered 0504555 and 0606644 are fully deductible.
2) The fees in Invoices
numbered 0503135, 0601208, 0601209, 0607089 and 0609074 are deductible to the
extent of 73.33 percent of the total amount in each invoice.
The fees in Invoices numbered
0501200 and 0601135 will not be deductible.
Signed at Ottawa, Canada, this 25th day of April 2014.
“Diane Campbell”
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