2 May 2013 Internal T.I. 2013-0477561I7 - Carrying Charges

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: Deductibility of carrying charges on T1 final return and T3 trust return.

Position: General Comments provided.

May 2, 2013

Audit Division - Estates and Trusts Headquarters
VITSO – 1415 Vancouver Street, Income Tax Rulings
Victoria, BC V8V 3W4 Directorate
V. Srikanth
(613) 952-9853

Attention: Darlene Hildebrand 2013-047756

Deductibility of Carrying Charges

This is in response to your correspondence dated February 6, 2013, wherein you requested our views on the deductibility of carrying charges with respect to an individual's T1 final return and a T3 trust return. Specifically, you have asked us to comment on the deductibility of legal and accounting expenses in those instances. Please note that the question of whether an amount is deductible is a question of fact and can only be determined on a case-by-case basis. However, we can provide you with our following general views on this matter.

Subsection 9(1) of the Income Tax Act (the "Act") provides that a taxpayer's income from a business or property is the profit from that business or property subject to the rules in Part I of the Act. Section 18 of the Act contains several limitations concerning the deductions permitted. In general, paragraph 18(1)(a) of the Act provides that no outlay or expense is deductible in computing the income of a taxpayer from a business or property, unless it was made or incurred for the purpose of gaining or producing income. Although this provision is very broad, the Act goes on to identify various refinements to what is or is not deductible. Further, the deduction for specific outlays and expenses is discussed in various other provisions of the Act. For example, paragraph 8(1)(b) of the Act allows the deduction of legal expenses incurred by a taxpayer to collect or establish a right to salary or wages owed to the taxpayer by the taxpayer's employer or former employer. Finally, section 67 of the Act limits an otherwise deductible amount to an amount that is reasonable in the circumstances.

Whether an expense is incurred for the purpose of earning income from business or property is entirely a question of fact and has to be addressed on a case by case basis. As commented by the Court in (SCC) Symes v The Queen et al 94 DTC 6001:

"The well accepted principles of business practice encompassed by s. 9(1) of the Income Tax Act, under which a taxpayer's income from business is the taxpayer's profit therefrom for the year, would generally operate to prohibit the deduction of expenses which lack an income-earning purpose, or which are personal expenses, just as much as ss. 18(1)(a ) and (h ) operate expressly to prohibit such deductions... The current wording of s. 18(1)(a ) indicates that Parliament amended its predecessor section so as to broaden the scope for business expense deductibility. The language of the section itself provides the most appropriate test: were the expenses incurred for the purpose of gaining or producing income from a business? Courts will look for objective manifestations of purpose, and purpose is ultimately a question of fact to be decided with due regard for all the circumstances. It may be relevant to consider whether a particular deduction is ordinarily allowed as a business expense by accountants, whether the expense is one normally incurred by others involved in the taxpayer's business, and whether it would have been incurred if the taxpayer was not engaged in the pursuit of business income."

Accordingly, legal and accounting fees are deductible provided the taxpayer can establish that they were incurred for the purpose of earning income from business or property [paragraph 18(1)(a)], and were not on account of capital [paragraph 18(1)(b)], or a personal expense [paragraph 18(1)(h)]. The term executor or trustee fee applies to an amount paid to a legal representative for administering a trust or estate of a deceased person. In the case of an estate, the legal representative's main function is to gather and distribute all of the deceased's assets, determine and settle all the debts including taxes, and carry out the terms of the will. The executor may also temporarily manage the assets of the trust until such time that they are disposed.

In our view, generally, fees paid to gather, distribute and settle assets and debts are on account of capital and therefore, non-deductible for tax purposes. Any accounting fees that relate to these functions are also not deductible. The onus is on the taxpayer to establish that the fee was incurred for the purpose of earning income from business or property. Wherever necessary, the taxpayer may be requested to provide details of the services performed to establish the reasonableness of the expenses claimed. In the case of Waxman Estate v The Queen 94 DTC 1216, Lamarre Proulx, J. made the following comments with respect to the issue of onus of providing evidence to claim certain legal expenses by the taxpayer:

"However, the costs of these services were not apportioned in the invoice. At the hearing, although the lawyer produced exhibits A-16 and A-19 showing the vacations respecting the estate and the time allotted to each vacation, there was no regrouping of the expenses. Thus, it is difficult to determine even by approximation, the time the lawyer spent on the contentious issues and on the preparation of the income tax returns. That burden of proof is on the taxpayer…

I want to reemphasize that it is incumbent on the taxpayer to provide the information so that the Minister may exercise his statutory duty… I would like to point out that the Minister's agents must be provided with the information necessary so that they may determine whether or not the legal fees were incurred by the appellant for the purpose of earning income from property…"

The following comments were made by the Canada Revenue Agency (the "CRA") with respect to deductibility of trustee fees, at the 1981 CTF conference:

"Trustee fees chargeable against income account are allowable where they meet the usual criteria necessary for deduction in the computation of income from business or property, viz., "made or incurred for the purpose of gaining or producing income from the business or property" paragraph 18(1)(a); "not an outlay...on account of capital" paragraph 18(1)(b); "reasonable in the circumstances" section 67.

Paragraph 20(1)(bb) requires consideration in the case of those fees charged to capital account and fees charged to income account that were not laid out to gain or produce income but were outlays on account of capital. Where the requirements of paragraph 20(1)(bb) are met all such fees are deductible.

It is not [the CRA's] policy that fees paid to individuals can never be categorized as amounts paid to a person whose principal business is advising on the purchasing or selling of securities or for services with respect to administration and management of shares of securities. However, paragraph 20(1)(bb) is applied strictly."

With respect to expenses incurred related to the disposition of a capital property, please refer to our comments in the recent CRA document – 2012-045790.

Some of the case law that you may consider in making your determination of deductibility of trustee fees are:

1. AW Bardsley Trust, 82 DTC 1659:

In this case, two of the trustees had assumed the main burden of managing the investment portfolio of the trust. Their activities included reviewing the trust property periodically during the year, analysing the stock market, making decisions on the purchase and sale of shares and securities and collecting and distributing the revenue. These two trustees had extensive personal experience in the field of investment management; however, they were not in the investment business as such. The trust made remuneration payments to the trustees for their management services and claimed a portion of the remuneration (corresponding to 5% of the income) as a deduction from business income. The Tax Review Board found that providing investment advice was not the principal business of the trustees and, therefore, the deduction of the fees was not within the scope of paragraphs 18(1)(a) or 20(1)(bb) of the Act.

2. The Estate of the Late Kelly Waxman, 94 DTC 6229:

Here, the trustee deducted legal fees alleging that he had allowed a reasonable amount of legal fees for each taxation year in dispute, based on fees charged by financial institutions in comparable situations of estate administration. The Minister disallowed the deductions being sought by the estate in respect of its 1987 and 1988 taxation years. The estate was comprised of shares of public companies, Guaranteed Investment Certificates, bonds and cash. The estate's appeal to the Tax Court of Canada was dismissed (94 DTC 1216) on the ground that there was no evidence to demonstrate that the legal fees in issue had been incurred by the estate for the purpose of earning income from property. Conversely, they appeared to have been incurred to administer the estate and to distribute its assets to the heirs. The estate applied to the Federal Court of Appeal for a judicial review of the Tax Court's findings. The estate's application was dismissed. The Tax Court had made no reviewable error and, therefore, there was no reason to disturb its findings. In addition, the Tax Court in The Estate of the Late Kelly Waxman also noted that in The Estate of Stevens Pappas, 90 DTC 1646, the judge concluded that legal fees incurred for the administration of an estate are not deductible unless they are related to the income earning process.

3. Walmsley Estate v The Queen 99 DTC 594:

In this case, the executor of the estate claimed fees for professional investment advice, which were calculated based on the total value of assets administered. The appellant, however, did not provide a breakdown of the fees to show, for example, what portion related to amounts spent on income matters, capital, administrative or other matters. The Minister disallowed the expense pursuant to paragraph 18(1)(b), section 67 and subparagraph 20(1)(bb)(iii) of the Act. The appellant argued that in the investment advisor industry, fees are charged based on certain percentage of the value of the financial assets administered. The Tax Court dismissed the appeal on the ground that while the appellant performed a mixture of duties, only some of them related to income earning purposes. However, the appellant failed to provide a breakdown of the fees charged for activities performed related to income earning purposes.

With respect to the specific example that you have described in your correspondence dated February 6, 2013, please note that while we are in agreement with your observation and conclusion to disallow certain expenses in that particular instance, such conclusions cannot be generalized. As stated earlier, deductibility of an expense is fact specific and can only be determined on a case-by-case basis.

For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the CRA'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 taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity. Requests for this latter version should be made by you to Mrs. Celine Charbonneau at (613) 952-1361. In such cases, a copy will be sent to you for delivery to the taxpayer.

We trust our comments will be of assistance to you.

Yours truly,

Phil Kohnen
For Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch