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.
Principal Issues: Whether a shareholder's legal fees are deductible as a current expense, allowable business investment loss or a capital loss.
Position: No
Reasons: They were not incurred for the purpose of gaining or producing income from a business or property, they were not incurred to a guarantee of the debt of a corporation, nor were they incurred for the purpose of making a disposition of a capital property.
Robert Ferrari
XXXXXXXXXX 2005-012254
(613) 957-2138
September 13, 2005
Dear XXXXXXXXXX:
Re: Legal Fees
This is in reply to your letter of March 22, 2005 with respect to the above noted matter.
In the situation you have described, a small business corporation became bankrupt and as a result, the corporation's bank filed a lawsuit against the sole shareholder for the corporation's debts. The shareholder had not guaranteed these debts and incurred legal fees in defence of the lawsuit. You have asked whether the legal fees represent a deductible current expense, an allowable business investment loss or capital loss of the shareholder.
As indicated in paragraph 1 of Interpretation Bulletin IT-99R5, legal fees are deductible only to the extent they were incurred for the purpose of gaining or producing income from a business or property and are not outlays of a capital nature. Generally, legal fees are deductible where they are incurred in connection with normal activities, transactions or contracts incidental or necessary to the earning of income from a business or property. In the circumstances described, the legal fees were incurred in connection to the lawsuit filed against the shareholder on the premise there was fraud and breach of fiduciary duty and in our view, do not represent a deductible current expense to the shareholder.
Subject to certain conditions, subsection 39(12) of the Income Tax Act (the "Act") provides that a payment made by a taxpayer to an arm's length person under a guarantee of the debts of a corporation is deemed to be a debt owing to the taxpayer by a small business corporation. Where all the conditions of subsection 39(12) of the Act have been met, the taxpayer may be eligible to claim a business investment loss. However, in this case, the shareholder did not pay an amount in respect of a debt of the corporation under an arrangement under which the debts were guaranteed as required by subsection 39(12) of the Act.
As indicated in paragraph 14 of IT-99R5, legal fees incurred for the purpose of making the disposition of a property may be added to the adjusted cost base of the property in calculating the capital gain or capital loss, as the case may be. However, the shareholder's legal fees were not incurred for the purpose of making a disposition of property as required by subparagraph 40(1)(a)(i) of the Act and would therefore not form a part of the capital loss on the shares.
In summary, in our view, no part of the fees would be allowable as a current expenditure, an allowable business investment loss or as an expense on the disposition of property of the shareholder.
Yours truly,
Phil Jolie
Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Planning Branch
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