19 May 1992 Income Tax Severed Letter 9214447 - Legal and Accounting Fees

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 Department. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

SUBJECT: LEGAL FEES SECTION: 40(1), 18(1)(a), 14(5)]

May 19, 1992

Audit Review Section HEAD OFFICE
TORONTO DISTRICT OFFICE Rulings Directorate
Business Enquiries Group Roberta Albert
(613) 957-2140
Attention: P. Keirstead
1213-148-1-6

• 7- 921444

XXX
Legal and Accounting Fees

We are writing in reply to your memorandum of May 1, 1992 wherein you requested our opinion with respect to a situation currently under audit involving the deductibility of legal and accounting fees incurred by in an unsuccessful attempt to dispose of a property.

Facts

XXX

XXX

District Office Position

As the taxpayer is not in the business of either selling, developing or long term leasing it is the auditor's opinion that the expenses claimed were not incurred for the purpose of earning income from business. It is the auditor's opinion that the legal expenses incurred of XXX be disallowed under paragraph 18(1)(a) of the Income Tax Act (the 'Act') in the years that the expenses were claimed. However, the auditor is also of the opinion that in order to be fair, the taxpayer should be entitled to either adjust the property and related assets by the amount of the legal fees or treat the amount expensed as an eligible capital expenditure ("ECE"). The preferred course of action would be to allow the amount paid to qualify as an ECE because the task of allocating the legal fees to separate assets would be too onerous.

You have asked for an opinion as to whether the expenses should be disallowed pursuant to paragraph 18(1)(a) and whether the taxpayer is entitled to any relief in the form of claiming the expenditure as an ECE.

Our comments

• 1. From Brooke Bond Foods Ltd v MNR [[1984] C.T.C. 115] 84 DTC 6144 (FCTD) "The fact the project was abondoned does not alter the nature of the expense, which remains an outlay on account of capital. As Thorson J. of the Exchequer Court wrote in Siscoe Gold Mines Ltd v MNR [[1945] C.T.C. 397] 2 DTC 749, at 753:
• "The fact that it was decided to abandon the option and not to acquire the (mining) claims cannot change the nature, the character of the disbursements. They were losses incurred in connection with a capital venture... I think it is clear that an expenditure incurred for the purpose of enabling a taxpayer to decide whether a capital asset should be acquired is an outlay or payment on account of capital..."
• In the Department's view, generally, expenditures should be accorded the same treatment that they would have been accorded had an acquisition attempt, or alternatively, a disposition attempt been successful.
• However, paragraph 13 of Interpretation Bulletin IT-99R4, Legal and Accounting Fees, states that "Pursuant to subsection 40(1), any outlay or expense (including legal or accounting fees) incurred for the purpose of making the disposition of a property is added to the adjusted cost base of the property in calculating the amount of the capital gain, capital loss, terminal loss or business investment loss, as the case may be, arising from the disposition."
• As the property was not actually disposed of, subsection 40(1) does not provide for the addition of the fees to adjusted cost base of the property and in our view the addition of the legal fees to the adjusted cost base of the property is not available to XXX.
• 2. Paragraph 14 of IT-99R4 states that "Legal and accounting fees that are "eligible capital expenditures" within the meaning of that term in paragraph 14(5)(b) are included in the cumulative eligible capital of the taxpayer in the manner provided in paragraph 14(5)(a) (see the current version of IT-143).'
• 3. Paragraph 2 of IT-143R2 states that "An eligible capital expenditure within the meaning of 14(5)(b) may be broadly defined as an outlay or expense made or incurred by a taxpayer (a) in respect of a business, (b) as a result of a transaction occurring after 1971, (c) on account of capital, and (d) for the purpose of gaining or producing income from the business.

... An outlay or expense made or incurred with respect to income from property (eg., non-business rental or investment income) or with respect to a capital gain or a capital loss will not be an eligible capital expenditure since it does not meet the purpose stated in (d) above.'

It is not clear from the facts, but it is likely that the legal fees were incurred with respect to a capital gain or a capital loss so that the purpose test in (d) above is not met and the legal fees could not be considered as an ECE.

• 4. Paragraph 14 of IT-99R4 states that "Legal and accounting costs incurred to fight a bid to take over control of a corporation are not deductible as current expenses or as eligible capital expenditures. Such costs relate to the ownership of the shares themselves (ie., the capital structure of the corporation) and are not laid out for the purpose of gaining or producing income from the business. Legal and accounting costs incurred in successful corporate acquisitions will generally be capital expenditures which may be added to the cost base of the shares acquired. The treatment of legal and accounting fees in the case of abortive attempts to acquires shares is discussed in the current version of IT-143.'

This paragraph supports the result that some legal costs are not deductible as current expenses, may not be ECE and may be true 'nothings' for tax purposes.

• 5. It is possible that it could be argued that XXX was undertaking to start up a new business. The business could have been one of a developer had they sold 50% of the property to the other developer and the joint venture proceeded as noted in paragraph 4(i)(a) above. Alternatively. the business could have been one of leasing property had the option noted in paragraph 4(i)(b) above proceeded.

Paragraph I of IT-364, Commencement of Business Operations, states that 'For an amount to be deductible on the grounds that it was an expense incurred for the purpose of gaining or producing income from a business, the taxpayer must have been carrying on business in the fiscal period in which the expense was incurred. Therefore, where a taxpayer proposes to undertake a business and makes some initial expenditures with that purpose in mind, it is necessary to establish whether they preceded the commencement of the business or whether the business had in fact commenced and they were expenses incurred during preliminary steps leading to the start of normal operations.'

Paragraph 2 of the same IT states that "Where an activity consists merely of a review of various business possibilities in the expectation or hope that information will be obtained to justify going into business of some kind, such an activity does not represent the commencement of a business." It also states that "it is the Department's view that a business commences whenever some significant activity is undertaken that is a regular part of the income-earning process in that type of business or is an essential preliminary to normal operations."

Based on the facts above, a new business has not commenced. From paragraph 6 of IT-364 "Expenses in respect of a proposed business that are incurred prior to commencement of the business do not constitute a business loss or a non-capital loss and thus cannot be applied against income in the year the expenses were incurred, and cannot be carried back to be applied against income of the preceding year or forward to be applied against income of any subsequent year." Again, based on this analysis, the legal fees in question would be 'nothings' for tax purposes.

• 6. Paragraph 23 of IT-143R2, Meaning of Eligible Capital Expenditure, states that "Since an outlay or expense is only an eligible capital expenditure if it is incurred for the purpose of gaining or producing income from a business, legal and accounting fees incurred in an abortive attempt to acquire shares of a corporation would normally not qualify. Where, however, the taxpayer can demonstrate that he proposed to make the business of the corporation part of a similar business which the taxpayer already operated, the fees may qualify as eligible capital expenditures.

For the Department's interpretation of "similar business" see IT-259R2." Paragraph 20 of IT-259R2, Exchanges of Property, states that "Where there is a question of whether two businesses in a service industry or in any other industry... are "similar businesses", the determination will have to be made on the facts of the case. For such cases, the Department will interpret 'similar business' in a reasonably broad manner."

• The taxpayer is currently in the business of 'renting or leasing income producing properties" and obviously the option of developing the property in a joint venture would not have been a similar business. However, it is possible that the entering into of the long term lease could be a similar business to that of renting or leasing 4 income producing properties. If the facts support that XXX proposed to make the long term lease part of its current business, which would have to be a similar business, then the legal fees from the unsuccessful attempt to enter into the long term lease could qualify as an ECE. The possible treatment to be accorded to legal fees on the abortive share acquisition attempt from IT-143R2 provides some support for this treatment.

From the above, it appears that the legal expenses could be considered ECEs only if the entering into of the long term lease could be considered to be a similar business to the current business of XXX. This would be a question of fact. However, given the unique nature of the failed transaction, the fact that leasing was only one of the options considered and the very long term of the proposed lease, it appears to us that these are not similar businesses. As a result the legal fees would be disallowed by virtue of paragraph 18(1)(a) of the Act and would be 'nothings' for tax purposes.

We trust that our comments will be of assistance.

E. Wheeler
for Director
Business and General Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch