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 legal fees incurred in respect of an unsettled lawsuit against an employer for general damages and performance pay owed are deductible in the year incurred.
Position: 1. A portion of the legal fees relating to the performance pay can be deducted under s. 8(1)(b) before the resolution of the lawsuit since this is a claim for salary and wages for services already rendered. 2. The deductibility of the rest of the legal fees cannot be determined prior to the resolution of the case.
Reasons: 1. Legal fees incurred to collect or establish a right to an amount owed that would be required to be included in income under Subdivision a of Division B of the Act are deductible under s. 8(1)(b), regardless if the taxpayer is successful in the legal action. 2. If the taxpayer is successful in being reinstated to his or her former position and receives retroactive pay to the date of dismissal, this amount will be salary or wages owed and therefore the legal fees incurred will be deductible in the year incurred. If the taxpayer is not reinstated but receives compensation in the form of damages, the amount may be considered a retiring allowance and the applicable legal fees would be deductible under s. 60(o.1), up to the amount received and included in income. However, if the taxpayer is not successful, the expenses will not be deductible since it could not be said that they were incurred to collect or establish a right to salary or wages owed.
November 19, 2012
XXXXXXXXXX Tax Centre Income Tax Rulings Directorate
Reorganizations Division
Bonnie Ruttan-Morillo
Attention: XXXXXXXXXX
2012-043320
Deduction of legal fees
This is in reply to the email received from XXXXXXXXXX dated January 13, 2012, and subsequent discussions (Ruttan-Morillo/XXXXXXXXXX) regarding the deductibility of an individual's legal fees. These fees have been incurred in a legal action taken against the individual's former employer in an attempt to be reinstated to his or her job with retroactive pay, and to receive performance pay and other damages.
Unless otherwise stated, all statutory references in this letter are to the Income Tax Act.
Paragraph 60(o.1) allows the deduction of legal fees paid to collect or establish a right to collect a retiring allowance or pension benefit. A retiring allowance includes an amount received as a result of a wrongful dismissal suit as per the definition in subsection 248(1). Therefore, legal fees incurred in a wrongful dismissal suit can be deducted under paragraph 60(o.1), however, the deduction in any given year is limited to the amount of retiring allowance received in that year. Under proposed legislation applicable to amounts paid in the 2001 and subsequent taxation years, paragraph 8(1)(b) permits a deduction from employment income for legal fees paid by a taxpayer in the year to collect or establish a right to "
an amount owed to the taxpayer that, if received by the taxpayer, would be required by this subdivision to be included in computing the taxpayer's income;". Subdivision a of Division B contains sections 5 through 8 inclusive. Since subsection 5(1) requires salary, wages and other remuneration to be included in income, legal fees incurred to collect or establish a right to salary or wages owed to the taxpayer are deductible under paragraph 8(1)(b). "Salary or wages" is defined in subsection 248(1) and does not include any amounts that are a retiring allowance.
Paragraph 23 of IT-99R5, Legal and Accounting Fees, states that a deduction for legal fees is only allowed in respect of an amount owed by an employer. IT-99R5 goes on to state that if a taxpayer is unsuccessful in court and fails to establish that an amount is owed, then no deduction is allowed. However, those comments are no longer accurate based on the decision in John Loo v. the Queen (2004 DTC 6540). In that case, the Federal Court of Appeal ruled that a taxpayer's legal action need not be successful in order to deduct an amount under paragraph 8(1)(b). Rulings has revised its position, based on the Loo case, to no longer tie the deduction of the expenses to the successful outcome of the case. However, it is still necessary to examine the nature of the action against the employer to establish whether the order sought by the taxpayer is for an amount owed to the taxpayer that would be included in income under subdivision a of Division B. Cases involving the deductibility of legal fees incurred to establish a right to a promotion or a raise or where the claimant is seeking financial compensation in connection with allegations of unlawful or wrongful acts by an employer remain distinguishable.
Jurisprudence has confirmed that legal fees are not deductible in an action to secure future wages, as per the Tax Court of Canada's decision in Mathieu L'Ecuyer v. the Queen (95 DTC 241). Also, legal fees incurred to dispute a promotion not received are not deductible. In the case of Karen L. Turner-Lienaux v. the Queen (97 DTC 5294), the taxpayer was denied a deduction for legal expenses incurred to seek an amount she claimed was owed to her as a result of a flawed competition for a job promotion. The Federal Court of Appeal confirmed the Tax Court of Canada's decision that the expenses incurred did not relate to salary or wages owed to her, but rather, to an amount "in lieu of the salary or wages" that she would have earned had the competition been fair. The Tax Court stated:
This Court has some difficulty in concluding that a person is "owed" a salary or "wages" if he did not do the work or occupy the position that required the salary or wages to be paid. Further it has difficulty in concluding that a person could be found to have incurred legal expenses to establish a right to salary or wages when two Courts of competent jurisdiction actually found that the Appellant did not have the "right" that she was seeking to enforce the legal action.
Where a taxpayer takes legal action against the employer and seeks reinstatement and retroactive pay to the date of dismissal, the legal fees will be deductible if the taxpayer is successful. This was the case in Fernando v. the Queen (93 DTC 5412) where the taxpayer was reinstated to his position with retroactive pay. The court found that the amount could not be a retiring allowance since he did not retire, nor was there a loss of employment, since he was reinstated to his job as of the date of his dismissal. The court ruled that the amount received was salary or wages owed to the taxpayer and thus the legal fees were deductible under paragraph 8(1)(b).
In a previous interpretation, document 9306657, Rulings stated that where a taxpayer is not reinstated to his job, but receives a cash award, the amount would be a retiring allowance rather than salary or wages. The legal fees would be deductible under paragraph 60(o.1), to the extent of the amount received and included in income.
In the current situation, the taxpayer is seeking damages relating to several issues. These issues should be examined independently to determine if any of the related legal fees were incurred to collect or establish a right to an amount owed that would be included in income under subdivision a of Division B. The taxpayer must be able to allocate the legal fees on a reasonable basis.
With respect to the legal fees incurred for reinstatement of employment and the associated retroactive pay, we do not believe they are currently deductible. It is true that if the individual is ultimately successful in his or her lawsuit, the applicable legal fees may be deductible. If reinstated with retroactive salary to the date of dismissal, the amount would be considered salary or wages owed and the expenses would be deductible under paragraph 8(1)(b). This is similar to the position taken in document 9306657. The banked leave would also be considered salary or wages owed. Should the taxpayer receive an amount in respect of lost promotional opportunities, this amount would be salary and wages as well. However, if not successful, it cannot be said that an amount was owed as the court found in Turner-Lienaux, and no deduction would be allowed for the legal fees incurred.
If the taxpayer is not reinstated to his or her job, but receives a cash award, the amount would be considered damages that would likely fall under the definition of retiring allowance. The applicable legal fees would be deductible under paragraph 60(o.1), to the extent of the retiring allowance included in income and not transferred to the individual's RPP or RRSP.
Generally, damages received for pain and suffering are non-taxable and therefore, any legal fees associated with this amount will not be deductible.
The taxpayer is also seeking performance pay for XXXXXXXXXX years of past employment. Any amount received would be salary or wages owed since it relates to services rendered during employment. Therefore, a reasonable portion of the legal fees associated with this issue would be deductible under paragraph 8(1)(b) in the year incurred regardless of the success of the action.
Conclusion
The only legal fees deductible at the present time is the portion that relates to the performance pay. The taxpayer is seeking an amount that would be considered salary or wages for services already rendered in the course of employment, and the success of the case is not relevant to the deduction of the corresponding legal fees.
As stated above, the remaining legal fees are not necessarily for amounts that can be regarded as amounts owed. Therefore, the deductibility cannot be determined until the results of the legal action are known. Since the amounts deductible under paragraph 8(1)(b) are only deductible in the year incurred, the taxpayer will have to file an amended return for the previous year(s) in which the fees were actually incurred. Where it is likely that the year may be statute-barred before the resolution of the case, the taxpayer should file a waiver.
We trust our comments will be of assistance to you.
Yours truly,
Nerill Thomas-Wilkinson
Manager,
For Director
Reorganizations Division
Income Tax Rulings Directorate
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