2 July 1993 External T.I. 9306465 F - Legal Fees Incurred by a Trust and Beneficiaries

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.

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Attention:  XXXXXXXXXX

Dear Sirs:

We are writing in reply to your letter of March 2, 1993, wherein you requested our comments on whether certain legal fees incurred by a trust or by beneficiaries of a trust are deductible for income tax purposes. We apologize for the delay in responding to your letter.

Our Comments:

Your request appears to relate to completed transactions involving specific taxpayers. As indicated in paragraph 21 of Information Circular 70-6R2 dated September 28, 1990 (the "Circular"), requests for written opinions on completed transactions are generally considered by the taxpayer's local District Taxation Office. While we are unable to provide any opinion in response to the situation outlined in your letter, we are prepared to offer the following general comments.

As indicated in paragraph 1 of Interpretation Bulletin IT-99R4, legal and accounting fees are deductible only to the extent that they

a)     are incurred for the purpose of gaining or producing income from a business or property (as per paragraph 18(1)(a) of the Income Tax Act (the "Act")), and

b)     are not outlays of a capital nature (as per paragraph 18(1)(b) of the Act).

In the Tax Court of Canada case of Estate of Steven Pappas v. MNR (90 DTC 1646), the Court upheld the disallowance of certain legal expenses incurred by the executors in administering the estate. The Court itemized the legal expenses incurred into five categories including: i) the cost of securing probate and locating and gathering the assets and ii) the cost of determining the extent of the entitlement of the various beneficiaries both under the will and estate plan and of taking the necessary steps to ensure that each beneficiary received his/her due course. The Court stated that:

     "The taking of possession of the property of the deceased, the obtaining of probate... and the distribution of the property of a deceased to persons beneficially entitled are actions quite unrelated to the earning of income from a business or property. Such operations are not commercial in nature. They do not involve the generation of fees or other revenues payable to the estate and therefore are not carried on with a view to earning a profit."

Therefore, the Court held that paragraph 18(1)(a) of the Act would prohibit the estate from deducting the legal expenses in question because they were not made or incurred for the purpose of gaining or producing income from a business or property.

As indicated in the court case William Bannerman v. MNR (1959 DTC 1126) S.C.C. and confirmed in the 1981 Conference Report of the Canadian Tax Foundation - Revenue Canada Round Table question 40, legal expenses incurred to wind up a company are not laid out to earn income and therefore, are not deductible pursuant to paragraph 18(1)(a) of the Act. This position would also be applicable to the winding up of a trust. In addition, the courts have held that legal expenses incurred for the purpose of bringing a capital property (e.g., a capital interest in a trust) into existence or for preserving and protecting capital property are expenditures on account of capital.

Legal expenses incurred to establish a right to income (including whether other persons are or are not income beneficiaries under a trust) are considered to be non-deductible capital expenditures in accordance with the reasoning in the court case The Queen v. Dr. Beverley A. Burgess (1981 DTC 5192) F.C.T.D. Where a beneficiary's right and share of entitlement to a specific amount of income derived from the will of a deceased is not the issue (since the beneficiary is at all relevant times entitled to the income), but the beneficiary incurs legal fees in order to enforce and obtain payment of that income, those legal fees will be deductible to the beneficiary based on the reasoning in the court case Gladys (Geraldine) Evans v. MNR (1960 DTC 1047) S.C.C.

Based on the above comments, it is our opinion that legal expenses incurred by a trust:

i)     to apply to the court for acceleration of the winding up of a trust;

ii)     to determine a person's status as an income beneficiary under a trust before the trust is wound up;

iii)     to transfer title of the assets from a trust to its capital beneficiaries upon the winding up of the trust; or

iv)     to determine the rights of the grandchildren of a settlor with respect to their capital interest in a trust that is being wound up

are not deductible expenses to a trust because they are not incurred for the purpose of gaining or producing income from a business or property.

It is our opinion that legal expenses described in ii) above incurred by income beneficiaries of a trust to establish their income interest in the trust will be on account of capital for which no deduction is permitted. This response will remain the same regardless of whether or not the beneficiaries receive any income from the trust.

In addition, it is our opinion that legal expenses described in iv) above incurred by capital beneficiaries of a trust to establish their capital interest in the trust's property upon the winding up of the trust will be on account of capital. However, as indicated in paragraph 13 of IT-99R4 and paragraph 1 of IT-174R, those legal costs incurred by a beneficiary in respect of capital property received from a trust may, depending on the circumstances, be included as part of the capital cost of the property acquired.

These comments represent our opinion of the law as it applies generally. As indicated in paragraph 21 of the Circular, this opinion is not a ruling and accordingly, it is not binding on Revenue Canada, Customs, Excise and Taxation.

We trust that these comments will be of assistance.

Yours truly,

for Director Manufacturing Industries, Partnerships and Trusts DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch