6 May 1998 Internal T.I. 9810067 - DEDUCTIBILITY OF LEGAL 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.

Principal Issues:

Deductibility of legal fees incurred to defend against a lawsuit filed after business sold and taxpayer no longer carrying on business.

Position:		Question of fact.

Reasons:

Have to determine whether the lawsuit relates to the ownership and operation of the business or whether it arises from the contract of sale of the business and have to determine whether or not the outlays are on account of capital.

May 6, 1998

	XXXXXXXXXX  Tax Services Office	Resource Industries
	Business Enquiries	  Section
	Client Assistance	A. Seidel
(613) 957-8974
	Attention:  XXXXXXXXXX
	981006

Deductibility of Legal Fees

This is in reply to your facsimile dated April 20, 1998 in which you requested our views on the deductibility of legal fees in the following situation:

1. A taxpayer sold a gas service station seven or eight years ago.

2. 5 years later it was discovered that the gas tanks had been leaking and contaminated the ground around the tanks.

3. The purchaser filed a lawsuit against, amongst others, the vendor.

4. The vendor retained legal representation to protect his interests and incurred legal fees in the amount of several thousands of dollars.

5. The vendor is no longer in the gas service station business at the time of the lawsuit.

Issue

Are the legal fees incurred by the vendor deductible in any manner whatsoever?

Our Comments

While we do not have sufficient information to provide you with a definitive opinion in this case, we hope that the following general comments will assist you.

Except as otherwise prohibited by a provision in the Income Tax Act (the “Act”), legal fees would generally be deductible if they:

1. are incurred for the purpose of gaining or producing income from a business or property, and

2. are not outlays of a capital nature.

One of the issues that was dealt with in Attorney General of Canada v. Jean-Camille Poulin, 96 DTC 6477, FCA, was whether an expense could be deductible by a taxpayer after the taxpayer had ceased to carry on business. The FCA confirmed the tax court Judge’s view that the taxpayer, although no longer actively in business, was still occupied with the results of the activities which had previously been carried on by him such that this did not preclude the taxpayer from complying with the provisions of paragraph 18(1)(a) of the Act relating to permissible deductions from income.

The above case also addressed the issue of when an expense is deductible under paragraph 18(1)(a) of the Act. Marceau, J. disagreed with the tax court judge’s conclusion that

“the appropriate way to interpret paragraph 18(1)(a) in the case of the discharge of an obligation or debt requires one to ask whether that obligation or debt is related to the operation of a business or property or falls within the context of that operation. If the answer to that question is yes, the outlay or expense is deductible”.

In Ben Matthews & Associates Limited v. The Minister of National Revenue, 88 DTC 1262, (TCC), Rip, T.C.J. made the following comment in determining that the legal fees in question were deductible:

"Where a business carries out activities in the normal course of its operations, and the cost of those activities is deductible in computing the income of the business, any expense incurred to defend those activities is a direct result of the activities themselves and is permitted by paragraph 18(1)(a) to be deducted:"

and concluded that :

"The legal expenses in the case at bar were incurred to defend a prosecution against the appellant which arose directly from the practice of preparing financial statements in the normal course of business."

In this case, if on the particular facts, the legal fees are expenses incurred to defend against a prosecution which arose directly from owning and operating the gas service station, the legal fees could be considered to be incurred for the purpose of gaining or producing income from a business. Query whether the “prosecution” in this case arises directly from the contract for sale instead of directly from ownership and operation of the gas station by the vendor.

On the other hand, it is quite possible that the legal fees are on account of capital as you suggest. As this determination would depend on the circumstances of the lawsuit, it would be prudent to examine, among other things, the statement of claim filed by the purchaser, the taxpayer’s statement of defense and any other documentation relevant to the lawsuit such as the purchase and sale agreement between the two parties when the gas service station was sold which may contain provisions as to any on-going liability of the vendor. It may also be relevant whether or not the taxpayer was subject to any provincial legislation with respect to the leaked gas tanks and the clean-up thereof.

If you wish to refer any documentation or other information in connection with this enquiry in order that we may provide an interpretation of the Act in the circumstances of this case, or if we can be of any further assistance, please contact the writer.

John Chan, B.Comm., CA
Manager
Resource Industries Section
Resources, Partnerships and
Trusts Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
- 2 -