17 December 1997 Internal T.I. 9732546 - LEGAL FEES - TAXPAYER NOT SUCCESSFUL IN COURT

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.

Principal Issues:

Whether legal fees incurred while trying to establish an amount owed to the taxpayer further to his loss of employment is deductible per 8(1)(b), when the taxpayer drops his law suit in the course of the proceedings.

Position:

No.

Reasons:

Paragraph 20 of IT-99R4 is clear in that the taxpayer must be successful in his attempt to establish his right to the amount owed. Finance agrees with our position XXXXXXXXXX

			December 17, 1997

	HEADQUARTERS	HEADQUARTERS
	Client Services Directorate	P.-A. Sarrazin
	Ministerial Correspondence Division		(613) 957-2058

	Attention:  Richard Gendron
	            Manager
					7-973254

Legal fees - taxpayer not successful in court

This is in response to your memorandum dated December 9, 1997 wherein you requested our comments on whether legal fees, incurred by a taxpayer while trying to establish his right to salary or wages from his employer, were allowable as a deduction under paragraph 8(1)(b). You mention that this taxpayer dropped the law suit due to a lack of financial resources required to pay his lawyer.

Our Comments

The deductibility of legal expenses, as they relate to an employee's salary or wages, is provided for in paragraph 8(1)(b), which reads:

Section 8: Deductions allowed.

(1)In computing a taxpayer's income for a taxation year from an office or employment, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:

(b) Legal expenses of employee

amounts paid by the taxpayer in the year as or on account of legal expenses incurred by the taxpayer to collect or establish a right to salary or wages owed to the taxpayer by the employer or former employer of the taxpayer;

The Department's views on paragraph 8(1)(b) are reflected in IT-99R4. Paragraph 20 of this IT bulletin is clear and states: "A deduction under paragraph 8(1)(b) is allowed only in respect of an amount "owed" by an employer. If the taxpayer is not successful in court or otherwise fails to establish that some amount is owed, no deduction for expenses is allowed." XXXXXXXXXX

The reason why a taxpayer must be successful in an action is twofold. First and foremost, if a taxpayer is unsuccessful or does not pursue an action until a judgment is rendered or an out-of-court settlement is reached, it is impossible to determine if any amount was indeed owed by the employer.

Second, the amount of legal fees that would be deductible is determined in two different ways, depending whether they are incurred to collect or establish a right to (1) an amount owed as salary or wages, or (2) a retiring allowance. In the case of salary or wages, there is no limit on the amount of legal expenses deductible, other than the fact that they must reasonably be regarded as applicable to a source of income. In the case of a retiring allowance, however, the deduction is limited to the amount included in income (see subclause 60(o.1)(ii)(A)(III)). Unless the action is pursued until a judgment is rendered or an out-of-court settlement is reached, the Department is unable to determine the nature of the amount, if any, that would have been owed to, or collected by, the taxpayer. It is therefore impossible for the Department to determine under which provision any deduction could be claimed (i.e. paragraph 8(1)(b) if salary or wages were owed, or paragraph 60 (o.1) if a retiring allowance was owed) and whether such deduction should be limited to any amount included in income.

In this case, by dropping the law suit, we are of the view that the taxpayer has otherwise failed to establish that some amount was owed to him. In addition, it may be that the taxpayer was only entitled to damages the nature of which was a retiring allowance, in which case the legal fees would have been limited to the amount of retiring allowance included in income. It may also be that the taxpayer would have been awarded an amount the nature of which was salary or wages, but in this case we will never know if indeed the employer "owed" him any amount since the law suit was dropped. The taxpayer has no new source of income to apply this expense to, and therefore is not entitled to a deduction.

The taxpayer's accountant refers to the case of Fernando v. Her Majesty The Queen, 93 DTC 5412 which, in our view, can be distinguished from that of his client on the basis that Mr. Fernando was successful in his law suit. It was therefore open to the Court to conclude that Mr. Fernando had indeed incurred the expense to establish a right to an amount and that the expense was wholly applicable to that source of income.

The accountant also refers to the change in the wording of paragraph 8(1)(b) made in 1990 whereby the words "or establish a right to salary" were added. He argues this change was to allow clients like his to claim legal expenses incurred while attempting to establish a right to salary. However, this change to the wording was only made by Finance to conform with the language in new paragraph 60(o.1).

XXXXXXXXXX In no way does this wording include incomplete or unsuccessful attempts by the taxpayer to do so. The process of establishing a right to an amount normally precedes the process of collecting the said amount. In this context, the Income Tax Act admits that legal fees can be incurred to either collect an amount or to have a Court declare, by judgment, that an amount is owed by the employer and collectible by the employee. Therefore, "establish" does not refer to an attempt to collect an amount as the taxpayer's accountant argues, but it refers to a process by which one seeks the Court's recognition that an amount is owed.

This difference is further outlined by comparing paragraphs 18(1)(a) and 8(1)(b). Under paragraph 18(1)(a), expenses "for the purposes of" earning income are deductible as long as the intent of earning income is there. Conversely, in paragraph 8(1)(b), the words "for the purposes of" are not used, suggesting that the mere intent of being successful is not sufficient. It follows that while the attempt to earn income may be sufficient to justify a paragraph 18(1)(a) deduction, success in collecting or establishing a right to salary is required for a paragraph 8(1)(b) deduction. This interpretation is in line with the preamble of subsection 8(1) which only allows as a deduction an expense applicable to a source of income.

Roberta Albert, CA
for Director
Business and General Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch