Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.
Principal Issues:
Are legal fees incurred by a taxpayer to defend himself in connection with a prosecution under section 239 (income not reported) deductible?
Position:
The legal fees are not deductible.
Reasons:
The taxpayer did not incur the legal fees for the purpose of gaining or producing income from a business or property. The legal fees are not related to the defence of practices which arise in the normal course of the taxpayer's income-earning activities. Furthermore, paragraph 60(o) does not apply.
May 14, 2003
Shawinigan-Sud Taxation Centre HEADQUARTERS
Mrs. Danielle Gélinas Sylvie Labarre, CA
Client Services (613) 957-8953
541-3-1
2003-001017
Legal fees
We are writing in response to your memorandum dated March 24, 2003 wherein you requested our views on the deductibility of the legal fees incurred by XXXXXXXXXX (the "Taxpayer") in his XXXXXXXXXX tax return.
The Taxpayer incurred legal fees of $XXXXXXXXXX in XXXXXXXXXX. The fees were paid for services rendered to the Taxpayer by barristers-at-law with regard to the defence of one charge of tax evasion, contrary to paragraph 239(1)(d) of the Income Tax Act (the "Act") and XXXXXXXXXX counts of filing false returns, contrary to paragraph 239(1)(a) of the Act.
According to the Reasons for Judgment included with the request, the Taxpayer was prosecuted under section 239 of the Act because an amount of income was missing from a tax return.
Except where there is a specific provision in the Act, such as paragraphs 8(1)(b), 60(o) or 60(o.1), legal fees are deductible only to the extent that they:
(a) are incurred for the purpose of gaining or producing income from a business or property, and
(b) are not outlays of a capital nature.
According to the Reasons for Judgment included with the Taxpayer's request, the Taxpayer was earning income from a business. It is not clear from that judgment that the income not reported was income from that business. It may have been income from property. To claim a deduction under the general rule for computing income from a business or property, the Taxpayer has to show that the legal fees were incurred to earn income from the business or the property.
Our general position, as mentioned in paragraph 33 of Interpretation Bulletin IT-99R5, is that legal fees incurred in connection with a prosecution under section 239 (tax evasion) are not allowable expenses since they are not laid out to earn income. However, in limited circumstances, we consider that legal fees may be allowable deductions where they can be shown to relate to the defence of practices which arise in the normal course of the taxpayer's income-earning activities, provided that there has been full disclosure of information by the taxpayer.
In Kenneth Sommers v. Her Majesty the Queen (93 DTC 1489) and in Mario Cormier v. The Minister of National Revenue (89 DTC 44), the taxpayers were charged with failing to report amounts of income. They incurred legal fees in connection with that prosecution. The Tax Court of Canada had to establish whether or not the legal fees incurred by the taxpayers were deductible in computing the income from their business. In these two cases, the Tax Court of Canada ruled that the legal fees were not deductible because they were not made for the purpose of gaining or producing income.
In Sommers, Judge Teskey mentioned that Sommers'success in having the charges dismissed was not a relevant consideration. He found that the expenses were not monies 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 and that the reporting or non-reporting of this income was not an integral part of his business. The income had been gained or produced, it simply was not reported.
In Cormier, Judge Kempo found that the failing to report income could not 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, that it lacked commerciality and simply did not fit within the jurisprudential phraseology of incurring legal expenses to defend a way of doing business or to preserve a system under which a business operates.
In our view, as in the Sommers and Cormier decisions, in the present situation the Taxpayer did not incur the legal fees to defend himself from a prosecution under section 239 of the Act for the purpose of gaining or producing income from a business or property. Our view is that the legal fees are not related to the defence of practices which arise in the normal course of the Taxpayer's income-earning activities. Therefore, the legal fees are not deductible in computing income from business or property. The next question to address is whether the legal fees are deductible under a specific provision of the Act.
Under paragraph 60(o), all taxpayers, including those persons who report income from sources other than business or property (such as salary or capital gains), may deduct fees or expenses incurred and paid for advice or assistance in preparing, instituting or prosecuting an objection or appeal in respect of an assessment of tax, interest or penalties under the Act or a similar provincial law. As stated in paragraph 33 of Interpretation Bulletin IT-99R5, the legal fees incurred in connection with a prosecution under section 239 are not deductible under paragraph 60(o) inasmuch as the information laid with respect to the charge is not an assessment within the meaning of that paragraph.
This interpretation is consistent with the decision in Cormier where the Tax Court of Canada found that legal fees incurred by the taxpayer in respect of defending himself under section 239 criminal tax evasion charges laid by information or complaint were not envisaged in the paragraph 60(o) phraseology of assessments of tax, interest or penalties made under the Act and were not deductible under that paragraph.
There is no other specific provision in the Act that would allow a deduction for the legal fees incurred by the Taxpayer. Therefore, the Taxpayer cannot claim a deduction from his XXXXXXXXXX income.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and place in the Canada Customs and Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should the client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (819) 994-2898.
We trust our comments will be of some assistance.
Ghislaine Landry, CGA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
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