Citation: 2008 TCC 605
Date: 20081106
Docket: 2007-4874(IT)I
BETWEEN:
MARC BEGLEY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH
TRANSLATION]
REASONS FOR JUDGMENT
Lamarre J.
[1]
The Appellant is
appealing from an assessment established for the 2005 taxation year by the
Minister of National Revenue (the Minister) pursuant to the Income Tax Act
(the ITA). The Appellant declared legal fees of $10,163 when calculating his
income for his 2005 income tax report. In court, he produced a letter from his
lawyers detailing the fees he paid in 2005, for $12,424.19 (Exhibit A-2). In
any event, the Minister disallowed the entire claim for legal fees. They were
allegedly incurred by the Appellant to initiate proceedings against his insurer
to establish his right to the long-term disability benefits he had taken out
with the Canadian Dentists' Insurance Program.
Facts
[2]
The Appellant was a
dentist and had taken out group insurance in 1982, which included long-term
disability insurance for $3,000 a month to the age of 65. He never deducted the
premiums he paid for this insurance against his professional income in his tax
returns.
[3]
In 1994, he was
afflicted with a degenerative disease that forced him to end his career as a
dentist in 1998. He submitted a claim with his insurer and, after a medical
exam, it refused to pay the amount claimed. After the Appellant contested, the
insurer offered to pay him a lump-sum amount, equal to one third of the pension
the Appellant claimed under his insurance policy. The Appellant refused this
settlement. The proceedings against his insurer are still pending before the
Superior Court of Québec and a hearing has been set for March 2009.
[4]
The documentation
submitted to evidence shows that the long-term disability pension sought by the
Appellant is considered non-taxable, both by the insurer and the insured (see
letter from the Canadian Dental Association to the Appellant, dated July 4,
2007, Exhibit A-2), because insurance premiums paid by the Appellant were not deducted
from his income over the years. This is exactly why the Minister disallowed the
disability pension that is the subject of the proceedings brought by the
Appellant, because it is considered non-taxable.
[5]
The Respondent relies
on the principle of "revenue neutrality." An amount shall be
deductible for income tax purposes if it is incurred for the purpose of earning
taxable income.
[6]
The Appellant, to a
certain extent, relies on the substitution principle, the "surrogatum
principle." In his opinion, the disability pension he claims from his
insurer is to replace, in part, the professional income he no longer earns
because of his disability. Moreover, it seems that the insured amount would not
surpass his professional income.
Analysis
[7]
The substitution principle
was defined by Lord Diplock in London and Thames Haven Oil Wharves, Ltd. v.
Attwooll, [1967] 2 All E.R. 124 (C.A.)(Div. civ.), and recognized by the
Supreme Court of Canada in Tsiaprailis v. R., 2005 SCC 8, at
paragraphs 48 and 49:
48 …Damage and settlement payments
are inherently neutral for tax purposes and must therefore be classified to
determine whether they are taxable. This is the surrogatum
principle, as defined by Lord Diplock in London and Thames Haven Oil
Wharves, Ltd. v. Attwooll, [1967] 2 All E.R. 124 (C.A.) as follows:
Where, pursuant to a legal right, a trader receives from another
person compensation for the trader's failure to receive a sum of money which,
if it had been received, would have been credited to the amount of profits . .
. the compensation is to be treated for income tax purposes in the same way as
that sum of money would have been treated if it had been received instead of
the compensation. [p. 134]
49 When applying the surrogatum principle, the
question is what the damage or settlement payment is intended to replace: Canadian
National Railway Co. v. The Queen, [1988] 2 C.T.C. 111 (F.C.T.D.), at p.
114. It is a factual inquiry: Prince Rupert Hotel (1957) Ltd. v.
Canada, [1995] 2 C.T.C. 212 (F.C.A.), at pp. 216-17
[8]
In Tsiaprailis,
the taxpayer had brought proceedings against the insurance company to obtain a
judgment declaring that she had the right to disability benefits under an
insurance policy taken out for her by her employer. She finally settled out of
court by accepting a lump sum payment. Abella J. (dissenting) stated the
following at paragraph 54:
54 applying the surrogatum principle to this case, the
general nature of the settlement payment was to release the insurance company
from a claim that it was liable and, concurrently, to extinguish Ms.
Tsiaprailis's claim for entitlement under the disability insurance
policy.
[9]
Charron J., for the
majority, agreed with Abella J. on the principle of substitution in these
terms, at paragraph 7:
7 …the principle that awards of damages and settlement
payments are inherently neutral for tax purposes. My colleague takes no
issue with this principle. As she explains, in assessing whether the
monies will be taxable, we must look to the nature and purpose of the payment to
determine what it is intended to replace. The inquiry is a factual
one. The tax consequences of the damage or settlement payment is then
determined according to this characterization. In other words, the tax
treatment of the item will depend on what the amount is intended to
replace. This approach is known as the surrogatum principle.
As noted by Abella J., it was defined in London and Thames Haven Oil
Wharves, Ltd. v. Attwooll, [1967] 2 All E.R. 124 (C.A.), and subsequently
adopted in a number of Canadian cases: see P. W. Hogg, J. E. Magee and J.
Li, Principles of Canadian Income Tax Law (4th ed. 2002), at pp. 91-93;
and V. Krishna, The Fundamentals of Canadian Income Tax (8th ed. 2004),
at pp. 413-15.
[10]
In this case, the
Appellant is seeking to deduct legal fees incurred for his case against his
insurer to obtain a judgment granting him the entire disability benefit to
which he claims he is entitled under his insurance policy.
[11]
For these expenses to
be deductible, the Appellant must establish that they were incurred for the
purpose of earning revenue from a business or property and that it was not a
personal expense. This must be done in accordance with subsection 9(1) and
paragraphs 18(1)(a) and 18(1)(h) of the ITA (see, among others,
an analysis on this by the Supreme Court of Canada in Symes v. R.,
[1993] 4 S.C.R. 695, paragraphs 38 and 40). These provisions state:
SECTION 9: Income
(1) Subject to this Part, a taxpayer's income for a
taxation year from a business or property is the taxpayer's profit from that
business or property for the year.
SECTION 18: General Limitations
(1) In computing the income of a taxpayer from a
business or property no deduction shall be made in respect of:
(a) General limitation – an
outlay or expense except to the extent that it was made or incurred by the
taxpayer for the purpose of gaining or producing income from the business or
property;
...
(h) Personal and living expenses
– personal or living expenses of the taxpayer, other than travel expenses
incurred by the taxpayer while away from home in the course of carrying on the
taxpayer's business;
…
[12]
It is to resolve this
issue that the principle of substitution becomes important. If the disability
pension the Appellant is claiming were to substitute his professional income,
the legal fees incurred to obtain it would become expenses for the purpose of
gaining income to replace business income (in this case the dentist's
professional income). As a result, these legal fees would be deductible for tax
purposes, but the disability pension would then be taxable. In this way, the
principle according to which an amount granted as a benefit is inherently
neutral for tax purposes is conserved. On this, I rely on a very recent
decision by our Court, Goff Construction Ltd. v. R., 2008 TCC 322, in
which Miller J. stated the following at paragraphs 14 and 16:
14 …The tax consequences of a settlement payment depend on
the tax treatment of the item for which the payment is intended to substitute.
Where, as here, the amount is recovery of expenditures, as opposed to lost
profits, one must look to the tax treatment of those expenditures. In this
case, those expenditures were properly deducted for tax purposes and
consequently, applying the surrogatum principle, the settlement amount
should fall into income…
15 This conclusion is not a conclusion that the settlement
amount was compensation for current expenses; it is a conclusion that the
settlement amount was compensation for deductible capital expenditures.
16 …The surrogatum principle should apply to assist in
reaching a tax result in accordance with the tax legislation, not to encourage
a result of either windfall at one end of the spectrum, or double taxation at
the other end. The surrogatum principle should apply to maintain tax neutrality
of damages.
[13]
If the opposite were
true, that the disability pension was not to replace the actual professional
income but rather paid on a personal level to compensate the now disabled
taxpayer, then it would likely not be taxable. It would not be a benefit
received or to be received instead of money that would have been calculated in
the business profits.
[14]
If this is the
conclusion reached, the legal fess would therefore not have been incurred for
the purpose of gaining business income (from the dentistry profession), but for
personal reasons and would therefore not be deductible for tax purposes.
[15]
In the Appellant's
case, he stated that the premiums he paid for his insurance policy were not
used as deductions against his professional income. This is a sign that the
purpose of the Appellant's insurance policy was not to reduce the loss of his
professional income. On this, counsel for the Respondent relied on a decision
by the Federal Court of Appeal, Canada v. MacIntyre, [1975] F.C.J. No.
501 (QL), from paragraph 6:
6 My reason for concluding that the premium in question is
not an expenditure to earn the income of the "business" is that it is
paid as consideration for an insurance policy pursuant to which the respondent
is entitled to receive certain fixed weekly amounts for each week that he is
"totally disabled and is thereby prevented from working for remuneration
or profit" by reason of "disability due to accidental bodily
injury", or by reason of "disability due to sickness", and to
have such insurance coverage he must be a member of an organization that
bargains on behalf of television and radio artists. From this it appears clear
that the premiums are in no way laid out to earn the fees paid for the
respondent's services (which are the gross revenues of his business); that he
must be "totally disabled and ... thereby prevented from working for
remuneration or profit" in any week in respect of which he receives the
insurance benefit so that, during any such week, he must have suspended or
terminated his "business", which consists exclusively in the
rendering of his own personal services; and the insurance is not insurance
against loss of earnings from the "business"2 but an assurance of
payments in respect of a period of disability whether or not the
"business" continues in existence.
[16]
Similarly in this case,
the disability pension is not an insurance against a loss of professional
income, but is related to guaranteed payments for the entire period of
disability regardless of the Appellant's professional activities. Moreover,
even if the reference for setting the amount of the pension is the Appellant's
professional income, according to the terms of the insurance policy, this is
not a determining factor in itself. As mentioned above, the taxability of the
pension depends on its nature and purpose, and what it is intended to replace
(see Tsiaprailis, supra, at paragraphs 7 and 13).
[17]
The disability pension
the Appellant is claiming is not a result of his work as a dentist but rather
his disability, against which he personally protected himself by taking out an
insurance policy. The disability pension is therefore of personal nature and
not intended to replace an amount that would have been accounted for as profit
from his professional practice.
[18]
As a result, the legal
fees incurred for this disability pension are not expenses for the purpose of
gaining business income or property, and therefore are not deductible under
sections 9(1), 18(1)(a) and 18(1)(h) of the ITA.
[19]
The appeal is
dismissed.
Signed at Montreal, Quebec, this 6th day
of November 2008.
"Lucie Lamarre"
Translation
certified true
on this 4th day
of December 2008.
Elizabeth Tan,
Translator
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