9 September 2010 Internal T.I. 2010-0374081I7 - Deduction 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.

Principal Issues: Whether legal fees incurred in an action to have income exempted may be deducted from other sources of income.

Position: Yes, if they otherwise qualify.

Reasons: The deductions in section 60 reduce Part I income and need not be related to a particular source of income.

September 9, 2010

WINNIPEG TAX CENTRE					HEADQUARTERS
Individual & Benefit Services Division		Income Tax Rulings
		    							Directorate
Attention:  Cyndi Martin-Conway			Rita Ferguson
								519-645-5261

								2010-037408

		
Deduction of Legal Fees	

We are writing in response to your request for a Technical Interpretation on the matter of expenses deductible under paragraph 60(o) of the Income Tax Act (the "Act").

Your file involves employees at a XXXXXXXXXX in Manitoba (the "Employees"). The Employees are status Indians whose income from employment at the XXXXXXXXXX was exempt from income tax by virtue of the combined operation of section 87 of the Indian Act, R.S.C. 1985, c. I-5, and paragraph 81(1)(a) of the Act. XXXXXXXXXX . T1 returns for each of the Employees for the years from XXXXXXXXXX to XXXXXXXXXX were, or are, being reassessed to reduce taxable income by the amount of the exempt employment income that had been previously included. The Employees have requested that their XXXXXXXXXX T1 returns also be reassessed to allow them to claim deductions for the expenses they incurred for representation in these proceedings. You wish to know if the provisions of paragraph 60(o) of the Act allow a taxpayer to deduct legal and/or professional costs incurred in an action whose result is to exempt the subject income from tax. You have also asked whether it is necessary for a taxpayer to file a Notice of Objection to qualify for a deduction under paragraph 60(o) and whether a deduction allowed by 60(o) can be used to reduce interest income from a refund of income tax.

Our Comments

Paragraph 60(o) of the Act allows a taxpayer to deduct "amounts paid by the taxpayer in the year in respect of fees or expenses incurred in preparing, instituting or prosecuting an objection to, or an appeal in relation to, (i) an assessment of tax, interest or penalties under this Act..."

Section 60 of the Act allows deductions "in computing a taxpayer's income for a taxation year" for any amounts described in that section that may be applicable to the taxpayer. The deductions allowed by section 60 reduce any income subject to Part I tax, notwithstanding that the amounts may not relate to a particular source of income. This is confirmed by both the wording in the preamble of section 60 and by the rules of calculation provided by section 3 of the Act. Paragraph 3(a) requires a taxpayer to determine the amount of each income for the year "from a source", including income from each office, employment, business and property. The income from each source to be included in the total for paragraph 3(a) is the "net" income from that source as calculated under the more specific rules found in subdivision a of the Act (for income from an office or employment) and/or subdivision b (for income from business or property) and/or subdivision d (for other sources of income). Paragraph 3(c) then provides that the total of the net incomes calculated under paragraph 3(a), plus the net taxable capital gain calculated under paragraph 3(b), be reduced by the deductions permitted in subdivision e of the Act (encompassing sections 60 to 66.8), except to the extent that the applicable deductions have already been taken into account in determining any of the net incomes from a source included in paragraph 3(a). The deductions allowed by paragraph 3(c), including the deduction in paragraph 60(o), are therefore not restricted by the rules which are applicable to particular sources of income. For example, although paragraph 18(1)(c) states that, in computing income from a business or property, expenses incurred to produce exempt income are not deductible, this restriction will not be applicable to legal fees allowed under paragraph 60(o). Paragraph 60(o) of the Act will therefore allow the Employees, who otherwise qualify, to deduct such legal and other costs even though the result of their representations was to exempt their employment income. The deduction may be used to reduce any source of income, including interest income from a refund of income tax.

Interpretation Bulletin IT-99R5 "Legal and Accounting Fees" explains at paragraph 7 that the expenses allowed by paragraph 60(o) may be deducted even where no objection or appeal is ultimately filed:

"A taxpayer may deduct amounts expended in connection with legal and accounting fees incurred for advice and assistance in making representations after having been informed that the taxpayer's income or tax for a taxation year is to be reviewed, whether or not a formal notice of objection or appeal is subsequently filed."

The view above was also clarified in response to a question at the 1992 Prairie Provinces Tax Conference as documented in Technical Interpretation E9211210:

"Does Revenue Canada consider that legal and accounting expenses incurred in responding to a proposal letter from Revenue Canada, prior to an assessment, are deductible pursuant to paragraph 60(o)?"

"As stated in paragraph 6 of IT99R4, it is the Department's practice to allow a taxpayer to deduct amounts expended in connection with legal and accounting fees incurred for advice and assistance in making representations after having been informed that the taxpayer's income or tax for a taxation year is to be revised, whether or not a formal notice of objection or appeal is subsequently filed."

Whether Employees who did not file a Notice of Objection but who sought legal advice concerning the tax treatment of their employment income would qualify for a deduction under paragraph 60(o) will depend on the facts of each particular situation. Although there is no requirement that an appeal or objection be ultimately filed, the provision requires that the costs be in relation to the preparation of an objection or an appeal. Where a taxpayer merely seeks advice on a matter of tax concern before filing a tax return, the costs of such advice would not be deductible under paragraph 60(o). However, where the advice was sought in connection with a reassessment, or potential reassessment, of that Employee's tax return, the costs may be deductible.

We trust that these comments will be of assistance.

For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity. Requests for this latter version should be made by you to Mrs. Celine Charbonneau at (613) 957-2137. In such cases, a copy will be sent to you for delivery to the taxpayer.

Renée Shields
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch