REASONS
FOR JUDGMENT
Jorré J.
Introduction
[1]
The issue in this appeal is whether the
Appellant is entitled to deduct $74,566 in legal fees in computing his business
income for the 2014 taxation year. The legal fees in question were incurred
with respect to a lawsuit that began in 2012 and which was still ongoing at the
time of hearing of this appeal.
[2]
There is a subsidiary procedural issue which I
shall deal with at the end of these reasons.
The Facts
[3]
The only witness was the Appellant.
[4]
The Appellant testified that he and his spouse
sponsored the immigration of his mother‑in‑law and father‑in‑law.
Prior to their arrival in Canada, the in‑laws sold all their property in
Russia and sent the money, an amount of approximately $260,000, to Canada. Also
prior to the arrival of the in‑laws, an agreement was reached over the
telephone that the money was to be invested by the Appellant for the purpose of
generating a lifetime income for the in‑laws.
[5]
Subsequently, the agreement was reduced to
writing. The terms are as follows:
Loan/Activity
Agreement between Family Members
AGREEMENT made
this 14-th day of June, 2008, in Toronto by and between, Pavel Danilov, DOB . . .,
SIN . . ., hereinafter referred as the “Borrower”, Valentin Nikityuk,
DOB . . ., SIN . . . and Alla Nikityuk, DOB . . .,
SIN . . . hereinafter referred to as the “Lenders”.
The Lenders
lend the money (the Loan) with the purpose of receiving life time financial
support from The Borrower in the form of interest investment income.
The Borrower
accepts the Loan, invests it, and provides life time financial support for the
Lenders in the form of interest investment income.
1. LOAN
By the time of
signing of this Agreement the Lenders already transferred to the personal US
Dollar account of Pavel Danilov at TD Canada Trust, part by part, overall
amount of 260802.71 US dollars (see TD Canada Trust statement in Appendix
1), which has been converted to Canadian dollars and formed the main loan
amount 263586.91 CAD (the “Principal Sum”). The Principal Sum can be increased
insignificantly after this Agreement signed, if at some point The Lenders have
extra cash and The Borrower agrees to accept and invest it.
The statements
reflecting the current status of the Loan should be attached to this Agreement
on December 31 of each year during the life time support period and signed by
both sides.
2. PURPOSE
The Borrower
shall use the Principal Sum for the investment purposes at his discretion.
The Borrower
shall provide interest income on the outstanding principal balance of the loan
calculated annually to make the Lenders’ total taxable income minimal but
enough to cover all mandatory living expenses, such as, but not limited to: household
expenses, automobile expenses, insurance premiums, etc.
Annual interest
investment income shall be paid on a schedule verbal agreed between the Lenders
and the Borrower in the form of direct deposits to the Lenders’ Personal
Banking Account specified below. The schedule must provide cash flow necessary
to cover ahead of time all mandatory monthly living expenses.
3. REPAYMENT
The repayment
of the principal amount of said loan has not been specified in this Agreement
as the purpose of the above said loan for The Lenders is to generate life time
support income.
The Borrower
has the right to make complete or partial repayments of the remaining principal
amount in case of
1. At some point both
sides agree that The Borrower will cover part or all mandatory living expenses
of The Lenders from other sources and therefore the annual income of The
Lenders can be reduced without reducing quality of life of The Lenders.
2. The repayment gives
The Borrower an opportunity to reduce mandatory monthly living expenses of The
Lenders without reducing quality of life of The Lenders.
[6]
As we can see above, under the second heading
“Purpose”, it is stated that the Appellant may invest the loan at his discretion.
[7]
While I am going to refer to the agreement as
the loan agreement, I am not entirely sure that is an accurate characterization
of the nature of the agreement given that on its face the agreement does not
require repayment although it permits repayment of the capital sum of the loan.
[8]
The Appellant’s spouse is not a borrower. Her
only connection to the loan agreement is that she signed as a witness.
[9]
The Appellant was employed full‑time at
all times relevant to the appeal and he also had a proprietorship. The
proprietorship developed automated software for trading stocks, options and
currencies.
[10]
The Appellant decided to invest the sum borrowed
from his in‑laws in his proprietorship. The money was used to fund
trading with the software.
[11]
The loan agreement makes no mention whatsoever
of the proprietorship.
[12]
At some point relations broke down between the
Appellant and his spouse and the mother‑in‑law and father‑in‑law.
[13]
In early 2012, there was an exchange of
correspondence between a paralegal acting on behalf of the in‑laws and a
law firm acting on behalf of the Appellant and his spouse. The first letter dated February 23
from the law firm to the paralegal refers to the in‑laws seeking to
receive $1,400 per month from the Appellant and his spouse.
[14]
The second letter dated March 1 is from the
paralegal to the law firm and demands that the in-laws’ money be returned
forthwith or, alternatively, that a support amount of $3,000 per month be paid
to the in‑laws together with certain additional sums. In addition, the letter
demands that the Appellant and his spouse provide information with respect to
the investments.
[15]
There is also a letter dated April 23 from the
paralegal to the law firm that, among other things, alleges that the in‑laws
had been promised $24,900 a year.
[16]
In 2012 the Appellant and his spouse sued the Appellant’s
in‑laws as well as a third individual and a local YMCA association. While
the original statement of claim is not in evidence, the amended statement of
defence and counterclaim of the in‑laws is.
[17]
According to the Appellant, he and his spouse
brought the lawsuit against the in‑laws for breaking the sponsorship
agreement and the loan agreement causing the plaintiff severe financial
damages; similarly, according to the Appellant, the claim against the third
individual and the YMCA was brought because they encouraged the in‑laws
to breach the sponsorship agreement and the loan agreement.
[18]
The amended statement of defence replies to the
plaintiffs’ claim in paragraphs 35 to 37; it alleges, among other things, that
the defendants caused no damages to the Appellant and his spouse.
[19]
In the counterclaim, the in-laws sue the
plaintiff and his spouse alleging a variety of things. For instance, they
allege that they reasonably believed that the money was to be used to acquire a
risk‑free investment earning 10% a year. They seek various remedies
including substantial damages.
Analysis
[20]
The essence of the Appellant’s case is the
following: the money he borrowed was used by his trading business and therefore
the legal expenses to prevent a return of those funds are properly deductible
in computing his income for the year because the business could not operate
without the funds.
[21]
The following provisions of the Income Tax
Act (Act) are relevant to this appeal:
9(1) Subject to
this Part, a taxpayer’s income for a taxation year from a business or property
is the taxpayer’s profit from that business or property for the year.
. . .
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;
. . .
(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;
[22]
Paragraph 18(1)(a) is the most important
in this case. It limits deductible expenses only to those made for the purpose
of gaining or producing income; further, such expenses are deductible only to
the extent that they are made for such a purpose. Paragraph 18(1)(h) is
also important because it clearly states that personal expenses are not
deductible.
[23]
The Respondent brought to my attention two decisions
which discuss the application of paragraphs 18(1)(a) and (h). The
first is the decision of the Supreme Court of Canada in Symes v. Canada,
[1993] 4 S.C.R. 695. The second is the decision of Justice Lamarre, as she then
was, in Leduc v. The Queen, 2005 TCC 96. After reviewing the relevant
portions of Symes, Justice Lamarre summarizes key considerations in
applying paragraph 18(1)(a) as follows:
16 Thus, in order to be deductible as
business expenses, the expenses in question must have been incurred “for the
purpose of gaining or producing income from the business” within the meaning of
paragraph 18(1)(a) of the ITA. The purpose of a particular expenditure
is ultimately a question of fact to be decided with due regard for all the
circumstances (Symes, supra, paragraph 68). Iacobucci J. referred
to some factors to consider in answering such a question. Thus, it may be
relevant to consider whether a deduction is ordinarily allowed as a business
expense by accountants. That could indicate whether a particular kind of
expenditure is widely accepted as a business expense (Symes, supra,
paragraph 69). Similarly, it may be relevant to consider whether the expense is
one normally incurred by others involved in the taxpayer's business (Symes,
supra, paragraph 69). It may also be relevant to consider whether a
particular expense would have been incurred if the taxpayer was not engaged in
the pursuit of business income. If indeed such is the case, there is a strong
inference that the expense has a personal purpose (Symes, supra,
paragraph 70).
17 It may also
be helpful to resort to a “business need” test. Would the need exist apart from
the business? If a need exists even in the absence of business activity, then
an expense incurred to meet the need would traditionally be viewed as a
personal expense (Symes, supra, paragraph 73).
[24]
In that particular case, the appellant, a
lawyer, sought to deduct legal expenses incurred in defending himself in
criminal proceedings relating to sexual assault charges because it was possible
that as a result of the criminal proceedings he might at a future date lose his
licence to practice law. Justice Lamarre concluded that:
18
. . . the legal expenses incurred by the appellant to defend himself
in the criminal proceedings relating to the sexual assault charges laid against
him are personal expenditures. They do not constitute expenses normally
incurred by others involved in the appellant’s profession. It can also be
inferred from the evidence that if the appellant had not been engaged in his
professional activities, he would nonetheless have paid the legal fees to
defend himself before the courts against the criminal charges. These factors,
analyzed in the context of the circumstances of this case, suggest that the
legal expenses at issue cannot be classified as business expenses . . . .
[25]
I note that there is no hard and fast set of
factors to consider.
[26]
Before applying these considerations, I shall
begin with the following two observations.
[27]
First, I failed to see any basis upon which one could
say that the original lawsuit, which was started by the Appellant and his
spouse, against the in‑laws is in any way “for
the purpose of gaining or producing income from the” Appellant’s
proprietorship. There is nothing in the evidence to suggest that there is any
link between the sponsorship agreement and the business. In addition, I am
unable to see, based on the evidence before me, how at that point one could say
that the in‑laws were in breach of the loan agreement. The evidence in
front of me is that they had provided the money to the Appellant and that,
through the efforts of a paralegal that they retained, they were attempting to
obtain greater monthly payments or the return of their money as well as an accounting
for the funds provided; there is no breach by the in‑laws at that point
in time.
[28]
Thus, that portion of the lawsuit reflected in
the original statement of claim is not in any way related to the Appellant’s
business. To that extent the legal expenditures are personal expenditures
falling within paragraph 18(1)(h) of the Act.
[29]
Secondly, insofar as the Appellant’s spouse is a
plaintiff in the original statement of claim and a defendant in the
counterclaim and given that the Appellant’s business is a proprietorship in
which his spouse has no interest, there is simply no way that that portion of
the lawsuit relates to the Appellant’s business. Again, to the extent the legal
expenditures relate to the Appellant’s spouse as a defendant, those
expenditures are personal expenditures falling within paragraph 18(1)(h)
of the Act.
[30]
I now turn to the remaining portion of the
lawsuit, the counterclaim, insofar as it relates to the Appellant.
[31]
It is worth emphasizing the fact that, whatever
the Appellant’s intended use of the money from the loan prior to using it for
his business, nothing in the agreement specifies that the money is to be
invested in the Appellant’s proprietorship.
The money only went into the Appellant’s business as a result of his decision
to use it in that business and as a result of his implementation of the
decision; that decision and that action are separate from the loan agreement.
[32]
It is also worth noting that the Appellant was
not in the business of investing money for others; the loan arrangement was a
private family arrangement.
[33]
Are the legal costs of defending the remaining
portion of the lawsuit deductible? Let us consider this in terms of the kind of
considerations described in Symes and Leduc, above.
[34]
Is this kind of expense one normally incurred by
people in such a business? Undoubtedly, the answer is no since it is one
clearly related to particular family arrangements in this case.
[35]
More importantly, the litigation is not directly
linked to the business because the money was not loaned for investment in the
business. Having agreed in a private family arrangement to invest the money,
the Appellant would have had to defend the action in any event. This is seen
most clearly if one imagines a situation where A, who is not in the business of
investing other peoples’ money, as a favour to his friend B, agrees to invest a
sum on behalf of B without any restriction on the nature of the investment. If
subsequently a dispute arises, A’s legal expenses would fail the test in
paragraph 18(1)(a); the result does not change because A decides to take
the money and invest it in his own new proprietorship to, for example,
subdivide and sell land.
[36]
Thus, the legal expenses, even to the extent
that they relate to the counterclaim insofar as it relates to the Appellant,
are not deductible.
[37]
The litigation as a whole is in relation to
private family arrangements between the Appellant and the Appellant’s spouse,
on one hand, and his in-laws, on the other hand and both paragraphs 18(1)(a)
and (h) of the Act apply to prevent the deduction.
[38]
Accordingly, the appeal must be dismissed. Before concluding, I should
deal briefly with a procedural issue raised by the Appellant.
Late Service of the Reply to the Notice of Appeal on the
Appellant
[39]
The Appellant sought to have the Minister of
National Revenue’s reply struck out because it was late. On examination, it
turned out that the reply was filed with the Court within the 60‑day
period provided for in subsection 18.16(1) of the Tax Court of Canada Act.
However, the reply was not served on the Appellant within the five‑day
period provided for in subsection 6(2) of the Tax Court of Canada Rules
(Informal Procedure). Apparently, the reply was mailed to the wrong
address, seemingly the previous address of the Appellant.
[40]
When the reply is not filed on time with the Court,
there is a sanction provided for in subsection 18.16(4) of the Tax Court of
Canada Act and, unless a time extension is granted to the Minister pursuant
to that subsection, “the allegations of fact contained
in the notice of appeal are presumed to be true for the purposes of the appeal”.
[41]
There is no sanction provided for failing to
serve the reply in a timely manner.
[42]
I would note that I am satisfied that the
Appellant suffered no prejudice from the late receipt.
[43]
In these circumstances, there is no consequence
that should flow from the Appellant’s late receipt of the reply. Finally, I
would note that even if the “allegations of fact
contained in the notice of appeal” had been “presumed
to be true for the purposes of the appeal” that would have had no practical
consequence given that the facts of the case are quite clear from the evidence
before the Court.
Conclusion
[44]
For the above reasons, the appeal is dismissed
without costs.
Signed at Ottawa, Ontario, this 20th day of June 2017.
“Gaston Jorré”
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