Jager Holdings (Calgary) Ltd, Jager Homes LTD v. Minister of National Revenue, [1980] CTC 2345, 80 DTC 1315

The Chairman:—The appeals of Jager Holdings (Calgary) Ltd and Jager Homes Ltd from assessments in respect of the 1974 taxation year, were, at the request of the parties, consolidated and heard on common evidence in Calgary, Alberta on February 25, 1980.

Issue

The sole issue to be determined in these appeals is the nature of the payments made by the appellants, as legal fees incurred in the defence of a petition commenced in the Supreme Court of Alberta, to have the appellant companies wound up pursuant to provisions of the Companies Act (Alberta).

By agreement with the Department of National Revenue the said legal fees in issue are in the amounts of $36,800 viz, $19,404 and $17,396 paid by Jager Holdings (Calgary) Ltd and by Jager Homes Ltd, respectively.

The Facts

The facts are not in dispute. Counsel for the appellants called as witness Mr William Jager, president of both appellant companies who by his testimony and the nine documents he produced as Exhibits, provided the Board with a complete background of the facts which can be summarized briefly as follows.

Mr Jager, who has lived in Calgary since 1946, was in the business of building houses and incorporated his first company in 1949. Several construction companies were subsequently incorporated by Mr Jager.

On July 24, 1958 a company known as Jager Holdings (Calgary) Ltd (hereinafter referred to as Jager Holdings), one of the appellants, was incorporated, Mr William Jager holding 51% shares of the company and Mrs Helen Jager, his wife, held 49% shares. Both were directors of the wholly owned company, Mr Jager acting as president and Mrs Jager acting as secretary-treasurer. (Exhibit A-1)

On February 28, 1962, five companies were amalgamated as one company under the name of Jager Homes Ltd (hereinafter referred to as Jager Homes), the second appellant in these appeals (Exhibit A-2); again Mr William Jager was president and his wife Helen Jager was secretarytreasurer with the same allocation of shares.

Jager Holdings was the main company and was managed by Mr William Jager. The company’s business was that of land developer. It purchased land, subdivided it, serviced and sold it to building contractors among whom was its subsidiary, Jager Homes Ltd, which was managed by Mrs Helen Jager and which was in the business of constructing single and multifamily residential housing.

Matrimonial difficulties between Mr and Mrs Jager arose in 1972 and divorce proceedings were commenced in 1973. A restraining order was issued against Mr Jager and he no longer was allowed access to his wife and his child. Because of the restraining order which prohibited him from communicating with his wife, Mr Jager had difficulty in operating Jager Holdings which was closely associated with Jager Homes in which he had the majority of the shares but which was managed by his wife.

On September 26,1973, Mrs Jager filed a petition with the Supreme Court of Alberta for the winding up of Jager Holdings (Exhibit A-7), and Jager Homes (Exhibit A-8). Mr Jager was served within 24 hours with the related Court orders removing from him all authority in the administration of Jager Holdings and Jager Homes.

On September 27, 1973, Mr Jager retained the services of Mr Patrick J McCaffery, who looked after his interests during the pre-trial procedures and at the winding up trial.

Mr John W Halpin was appointed provisional liquidator and Mr James C Fowler, co-provisional liquidator of Jager Holdings and Jager Homes by court order dated September 26, 1973. The co-provisional liquidator appointed Mr William Jager as special manager for Jager Holdings (Exhibit A-7 and Exhibit A-8). The actual management of the companies was carried out by the co-provisional liquidator. The pre-trial period lasted some 6 months during which time it is alleged that 100 Jager Homes were selling at cost; examinations for discovery were held and an application was made to court with reference to Jager Holdings land which Mrs Jager allegedly disposed of during the pre-trial period.

Mr Jager stated that he did not wish to proceed with the trial which, if successful, would mean the winding up of what had been successful businesses and would lead to the inevitable sale of all the assets of the companies. He preferred to sell his shares in the companies rather than see the companies wound up and he made an offer to that effect.

The trial nevertheless was held before Mr Justice Moore on March 29, 1974, and lasted 5 days during which period 4 Zz were taken up in cross- examination of the only witness, Mrs Jager. Negotiations between the parties were entered into and a settlement reached whereby Mr Jager would purchase all of Mrs Jager’s shares in both Jager Holdings and Jager Homes for $1,000,000.

On April 9, 1974, by order of the court, the petition was dismissed and Jager Holdings and Jager Homes were to pay all solicitor’s and client’s accounts. (Exhibit A-7 and Exhibit A-8)

The statement of account for services rendered by the legal firm of McCaffery and Company was $56,179.03, (Exhibit R-1). By agreement between the parties, the legal fees attributable to the winding up proceedings were established at $36,800 for both Jager Holdings and Jager Homes. It is the deductibility or otherwise of this amount that is in issue and the question is whether we are dealing with capital or operational expenditures.

Submissions

Mr Patrick J McCaffery, on behalf of the appellants, contends that the appellants were forced to bring a defence against the petition for winding up both Jager Holdings and Jager Homes. Had the petition been granted and all the assets sold as a result of the liquidation, the business would have been destroyed and their abilities to earn income would have been completely lost. It was submitted that Mr Jager, in opposing the petition, successfully averted the winding up of the companies and permitted the companies to continue to earn income. He concludes that the $36,800 in legal fees is properly deductible since it is an operational expense directly related to the ability of the companies to earn income.

The respondent, represented by Mr W A Ruskin, contended that for the appellants to be successful in their appeals, they must meet conditions set out in paragraph 18(1)(a) and (b) and must establish that the expenditure falls with the exception of paragraph 18(1 )(a) and does not come within the meaning of paragraph 18(1 )(b) of the Income Tax Act, SC 1970-71-72, c 63, as amended.

The respondent submitted (a) that the legal expenses incurred in defence of the winding up procedures were not incurred for the purpose of earning income; and (b) that the same legal expenditures were capital in nature.

It is the respondent’s submissions that the purpose of the payment was to preserve the business as an entity, a going concern and to protect the capital structure of the “profit-making conglormerate” from being destroyed by liquidation of its assets that would inevitably have resulted, had the court decided to wind up the appellant’s business operations from which the appellants’ income was derived. The respondent further contended that legal expenses for its defence against a winding up action had no bearing on the appellants’ day to day operations and could not be considered as having been incurred for the purpose of producing income.

Counsel for the respondent, in a thorough study of the principles underlying the criteria used by the courts in distinguishing current or operation expenses from expenditures which are capital in nature, referred to cases decided according to the Tax Laws of Australia, New Zealand, the United Kingdom, as well as the principles evolved by Canadian Courts mostly on the wording of the Income War Tax Act, RSC 1927, c 92. Relatively few decisions on the point have been rendered by the courts on the basis of the wording of paragraphs 18(1)(a) and (b) of the Income Tax Act.

The pertinent section of the Income War Tax Act on which the Supreme Court of Canada decisions were largely based is paragraphs 6(a) and 6(b) which was the origin of the wording of paragraphs 12(1)(a) and (b) of the Income Tax Act RSC 1952, c 148. The difference in the wording of paragraphs 12(1 )(a) and (b) of the old Act and paragraphs 18(1 )(a) and (b) of the present Act is minimal.

Section 6 of the Income War Tax Act reads:

In computing the amount of the profits or gains to be assessed a deduction Shall not be allowed in respect of

(a) disbursements or expenses not wholly, exclusively and necessarily laid out or expended for the purpose of earning the income;

(b) any outlay, loss or replacement of capital or any payment on account of capital or any depreciation, depletion or obsolescence, except as otherwise provided in this Act.

Section 12 of the Income Tax Act of RSC 1962, c 148 reads:

(1) In computing income, no deduction shall be made in respect of

(a) an outlay or expense except to extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from property or a business of the taxpayer,

(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.

Paragraphs 18(1 )(a) and (b) reads:

(a) General limitation—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) Capital outlay or loss—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;

It is important, to note that the current Income Tax Act brought a significant change to the wording of paragraphs 6(a) and (b) of the Income War Tax Act which I believe, generally reflected the wording of the Income Tax Act of Australia, New Zealand and the United Kingdom at that time. The evolution which has taken place in the wording of the pertinent sections of the Income Tax Act, though perhaps not a decisive factor, is nevertheless indicative of a less narrow and restrictive approach to the concept of what constitutes expenses laid out for the purpose of earning income.

In attempting to determine whether or not legal fees paid in defence of a winding up action was laid out for the purpose of earning income, it seems evident that the ultimate purpose of the expenses was to gain or produce income from the business, which in my opinion, is within the meaning of paragraph 18(1)(a). The nature of those expenses is however another matter and constitutes, in my view, the principal issue in these appeals.

In reviewing the case law relied on by counsel for the appellants, the pertinent conclusions therein can be summarized as follows:

1. Legal fees paid in the defence of an aborted winding up action are operational

expenses because the proceedings did not affect or threaten the company’s assets or capital structure. They did not add anything or take anything away from the companies’ assets.

#355 v MNR, 15 Tax ABC 452.

2. Legal fees incurred in making representations to a commissioner appointed under the Combines Investigation Act were held to be deductible by the Supreme Court of Canada pursuant to Section 6(1)(a) of the Income War Tax Act because the fees paid were necessities of the company’s practices of earning income and held to be working expenses as opposed to expenses “to preserve a capital asset in a capital aspect.”

MNR v The L D Caulk Co of Canada Limited and Goldsmith Bros Smelting and Refining Co Limited, [1954] CTC 28; 56 DTC 449.

3. Legal expenses incurred in defending action for infringement of rights of a trade mark were held by the Exchequer Court to have been operation expenses because the expenses were not “once and for all” nor did they bring into existence an advantage for the enduring benefit of the appellants’ trade since no material benefit resulted in the trade other than a judicial affirmation of an advantage already in existence and engaged by the appellants.

Some importance was attached to the fact that Kellogg had not voluntarily made Specific disbursements in relation to the trade but the disbursements were imposed on the taxpayers.

The Supreme Court of Canada, confirming the Exchequer Court’s decision, held that legal expenditures incurred fell in the general rule enunciated by the Supreme Court in Dominion Natural Gas Company Limited ie “that in the ordinary course legal expenses are simply current expenses.”

Kellogg Company of Canada Limited v MNR, [1942] CTC 51; 54 DTC 601. (Italics mine)

The respondent’s Book of Authorities contained the Supreme Court’s decision in MNR v Dominion Natural Gas Company, Limited, [1940-41] CTC 155; 40 DTC 449-133, cited in Kellogg Company of Canada Limited v MNR, [1943] CTC 1; 2 DTC 601. Dominion Natural Gas Company, Limited is one of the leading cases on the point at issue; the Supreme Court reversed the decision of the Exchequer Court which had allowed as current legal expenses incurred in the taxpayers’ defence against an attack on its franchise for the sale of gas in the city of Hamilton, Ontario.

The Supreme Court, in holding that the legal expenses incurred in Dominion Natural Gas Company, Limited (supra) were capital in nature, based its decision on the wording of paragraph 6(a) of the Income War Tax Act and referred to and cited from decisions rendered in other countries, most of which were also referred to by the respondent in his Book of Authorities.

The Chief Justice of the Supreme Court, in his decision in Dominion Natural Gas Company, Limited (supra), cited the following passage in Ward and Company, Limited v Commissioner of Taxes, [1923] AC 145 at 149:

We find it quite impossible to hold that the expenditure was incurred exclusively, or at all, in the production of the assessable income. It was incurred not for the production of income, but for the purpose of preventing the extinction of the business from which the income was derived, which is quite a different thing.

It is most important to relate that statement with the issue which was then being decided. Ward and Company, Limited (supra), a brewery, voluntarily incurred expenses in an anti-prohibition campaign. The pertinent section of the New Zealand Tax Act reads as follows:

86(1) In calculating the assessable income derived by any person from any source no deduction shall be made in respect of any of the following sums or matters:

(a) Expenditure or loss of any kind not exclusively incurred in the production of the assessable income derived from that source . . .

The issue in that case was whether funds laid out for an anti-production campaign were exclusively incurred in the production of the assessable income. It is relatively easy to conclude that such expenses were not exclusively operating expenses. The question that arises is, if such expenses were not current expenses exclusively laid out to produce income are they automatically a capital expenditure, or could they be something else?

I believe that the learned Chief Justice of the Supreme Court gave an important clue to the answer to that question in Dominion Natural Gas Company, Limited (supra) at 161 [499-135] where he stated:

In the ordinary course, it is true, legal expenses are simply current expenditure and deductible as such; but that is not necessarily so.

Legal expenses incurred in and related to the creation or preservation of a specific capital asset or the collectivity of capital assets such as the case in the legal expenses laid out for the preservation of a franchise in Dominion Natural Gas Company, Limited (supra), are logically seen to be capital in nature.

For the purposes of this appeal, Mr Justice Kerwin in the Dominion Natural Gas Company, Limited (supra) has also, I believe, contributed in clarifying the basis on which paragraph 18(1)(a) should be interpreted when he stated at 164 [499-136]:

The cases referred to on the argument deal with expressions used in other statutes and certainly, so far as clause (a) is concerned, I have been unable to derive any assistance from them. Ward and Company, Limited v Commissioner of Taxes (1923), AC 145, was determined on the wording of the New Zealand Act there in question “in the production of the assessable income”. In view of the fact that that wording is less liberal and comprehensive than the wording in our statute “laid out or expended for the purpose of earning the income”, the decision is, I think, inapplicable.

The learned Justice was commenting on paragraph 6(a) of the Income War Tax Act and his remarks are applicable a fortiori to paragraph 18(1 )(a) of the current Act whose wording is even less restrictive and more comprehensive than was paragraph 6(a) of the Income War Tax Act. Without yet deciding whether or not the legal fees incurred in the instant appeal are Capital in nature, I refer to the above statement of Mr Justice Kerwin in holding that they were laid out for the purpose of earning income and meet the requirement of paragraph 18(1)(a) of the Income Tax Act.

In attempting to determine whether the legal fees incurred in this instance in opposing a winding up action is or is not capital in nature, I reviewed all the case law submitted by the respondent. A close examination of the facts of Dominion Natural Gas Company, Limited and all the other cases listed in the respondent’s Book of Authorities will disclose that they all have one thing in common, viz that the expenditures were incurred in relation to the creation of, the preservation of, or the elimination of a possible danger to a specific capital asset or assets.

In Dominion Natural Gas Company, Limited, expenses were incurred to defend an oil franchise;

In Ward and Company, Limited (supra), a brewery incurred expenses in anti-prohibition propaganda;

In British Insulated and Helsby Cables, Limited v Atherton, [1926] AC 205, the expenditures went toward a pension fund;

In Sun Newspapers Limited v The Federal Commissioner of Taxation (1938), 61 CLR 337, monies were paid to prevent the publication of a competitive newspaper;

In Morgan v Tate & Lyle Limited, [1955] AC 21, a sugar refinery incurred expenses in a propaganda campaign opposing nationalization;

In John Fairfax and Sons Proprietary Limited v Federal Commissioner of Taxation (1958-1959), 101 CLR 30 monies were expended by a company to gain control of another company;

In British Columbia Power Corporation Limited v MNR, [1966] CTC 451; 67 DTC 5258, the legal expenses were incurred to recover expropriated shares and to obtain adequate compensation;

In Hallstroms Proprietary Limited v Federal Commissioner of Taxation (1946), 72 CLR 634 (H C Austr), legal costs were paid to oppose a petition made by a rival company relative to an extension of certain of its letters patent.

In Farmers Mutual Petroleums Limited v MNR, [1967] CTC 396; 67 DTC 5277, legal expenses were incurred in resisting lawsuits instituted by some landowners relative to leases and mineral rights acquired by the taxpayers, The Supreme Court, in holding that the expenses were of a capital nature, through Mr Justice Martland, stated at 401 [5280]:

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 CLR 634 at 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 s 12(1)(a), but in relation to s 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, s 12(1)(b) prevents its deduction.

In the instant appeal the legal expenses were not incurred relative to any specific capital asset or assets of the taxpayers; they did not affect any or all of the taxpayers’ capital assets; they did not bring into existence or add to the assets any advantage of an enduring benefit and, in my view, are not necessarily an expenditure made once and for all.

In my opinion, the legal fees paid in their defence of a winding up action were involuntarily incurred by the appellants to protect their legal rights to operate their businesses and to continue to earn income therefrom. The words of Mr Justice Maclean of the Exchequer Court in the Kellogg Company of Canada Limited (supra) are most pertinent and applicable to the facts of the present issue:

Here, the expenditure brought no such permanent advantage into existence for the taxpayer’s trade. I do not think it can be said that the expenditure in question here brought into existence any asset that could possibly appear as such in any balance sheet, or that it procured an enduring advantage for the taxpayer’s trade which must pre-suppose that something was acquired which had no prior existence. No “material” or “positive” advantage or benefit resulted to the trade of Kellogg from the litigation except perhaps a judicial affirmation of an advantage already in existence and enjoyed by Kellogg.

In confirming the Exchequer Court’s decision, the Chief Justice of the Supreme Court in MNR v Kellogg Company of Canada Limited, (supra) stated at 3 [601]:

The right upon which the respondents relied was not a a right of property, or an exclusive right of any description, but the right (in common with all other members of the public) to describe their goods in the manner in which they were describing them.

In these instant appeals, even more clearly than in the Kellogg case, the appellants incurred legal expenses, not to preserve property rights or exclusive rights, but to obtain “a judicial affirmation” of their fundamental legal rights to operate their businesses and to earn income therefrom.

The winding up action did not affect “the appellants’ capital assets in its capital aspect,” it was aimed at the appellants’ freedom to operate the businesses. In my view, this is a valid instance where the principle enunciated by Sir Lyman Duff, “that in the ordinary course, legal expenses are simply current expenditures and deductible as such” must be applied.

From the case law cited, it would appear that legal fees directly related to and expended for the creation or the preservation of a specific capital asset or assets, are generally considered to be capital in nature. Those legal expenditures incurred in relation to and affecting the actual operation of a business in earning income, have been held to be current expenses. The general principles already established by the courts lead me to conclude that the legal fees which the appellants were forced to pay in order to reaffirm and protect the existing fundamental legal right of the corporate entities to operate their businesses in the ordinary course, whatever else they may be, are not capital in nature.

I hold, therefore, that the legal fees paid by the appellants were incurred for the purposes of producing income and fall within the exception of paragraph 18(1)(a) of the Income Tax Act and that they were not outlays or payments on account of capital within the meaning of paragraph 18(1)(b). The appellants have met both conditions set in paragraphs 18(1)(a) and (b).

The appeals are allowed and the matter referred back to the Minister for reassessment according to the above reasons.

Appeal allowed.