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.
SYDNEY DISTRICT OFFICE
HEAD OFFICE Specialty Rulings Directorate R. B. Day (613) 957-2136 J. Sutherland Enquiries & Office Examination Section
Deductibility of Legal Fees incurred to earn General Damages for Wrongful Dismissal
We are writing in response to your memorandum of June 25, 1986 wherein you requested our assistance in determining the deductibility of legal fees in cases where awards are made by an order of a competent tribunal. We apologize for the unavoidable delay in replying to your enquiry.
The fact situations, as we understand them, are summarized below and our responses to questions posed are set out in the order in which they appear in your memorandum.
Situation A
A dismissed employee filed a statement of claim against his former employer for general damages for wrongful dismissal, pre-judgement interest from the date of dismissal to the date of judgement, costs of the action and any other relief the court saw fit to award.
The decision of the court was that the employee was to receive $10,000 to cover general damages, special damages, interest and costs. An additional amount of $2,000 was awarded to cover the employee's legal fees.
Response
We have recently taken the position that any reimbursement for necessary legal expenses in wrongful dismissal cases will not be included in a taxpayer's income as part of a retiring allowance to the extent they were actually incurred by the taxpayer.
For example if, in the above situation, the taxpayer's actual legal expenses were $1,500 rather than the $2,000 awarded by the Court, that $1,500 would be excluded from the taxpayer's income. The remaining $500, along with the balance of the court award, would be included in the taxpayer's income by virtue of paragraph 248(1)(b) "Retiring Allowance" and subparagraph 56(1)(a)(ii).
Generally, legal expenses incurred to establish a taxpayer's right to a retiring allowance are not deductible under paragraph 8(1)(b) (see paragraph 15 of IT-99R3 ).
Where an award includes "prejudgment interest" we have, for the 1984 and 1985 taxation years, taken the position that such interest would not be included in a taxpayer's income. This issue is still under review in respect of pre-judgement interest received in the 1986 and subsequent taxation years. However, in the situation described above, there is no indication as to the amount of prejudgement interest included in the lump sum figure of $10,000, and if there is such an amount, on what basis was it computed.
Usually, prejudgement interest is computed, on the principal amount of the settlement at an agreed rate of interest, from the date of commencement of the legal action up to the date of settlement or judgement. In the absence of such a calculation, it is our view that no portion of the $10,000 awarded would relate to prejudgment interest.
For T4A reporting purposes, it is our opinion that the $10,000 award would be included along with the amount, if any, representing legal fee reimbursements for which there was no corresponding expense (i.e. in our example $10,000 + 500 = $10,500).
Situation B
The facts are the same as in A above except that the court orders the former employer to pay the dismissed employee $10,000 as general damages for wrongful dismissal.
Response
It is our opinion that the legal costs incurred would not be deductible because they were incurred to establish the taxpayer's right to receive a retiring allowance as defined in subsection 248(1) (please refer to paragraph 15 of IT-99R3 ).
Situation C
A dismissed employee files a claim against a former employer regarding general damages for wrongful dismissal.
The former employer is ordered to pay to the dismissed employee general damages for wrongful dismissal.
Response
Same as for Situation B.
Situation D
The facts are the same as Situation C except the former employer is ordered to pay to the dismissed employee $10,000 for wrongful dismissal inclusive of costs. An additional $2,000 is paid as reimbursement for legal fees.
Response
As previously stated in A above, to the extent that the $2,000 represents reimbursement of necessary legal expenses actually incurred by the taxpayer with respect to his wrongful dismissal, such amounts will not be included in the taxpayer's income as a retiring allowance. Legal fees incurred would not, otherwise, be deductible as previously discussed.
The T4A reporting would be the same as in A above.
for Director Small Business and General Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch
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