Citation: 2008TCC243
Date: 20080425
Docket: 2005-3862(IT)G
BETWEEN:
ALLAN FENWICK,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Woods J.
[1] This appeal
concerns the deduction provided in paragraph 8(1)(b) of the Income
Tax Act for legal expenses incurred by an employee to collect or to
establish a right to salary or wages owed.
[2] The appellant,
Allan Fenwick, claimed a deduction in computing employment income in an amount
of $636,949.80 pursuant to this provision. The deduction, which was for the
2000 taxation year, was disallowed by the Minister of National Revenue
in its entirety and the appellant appeals in respect of that decision.
Background
[3] During the
relevant period, the appellant was the sole director, president, secretary and
chief executive officer of 372116 Ontario Limited (“Hemispheres”), which
operated under the trade name of Hemispheres International Manufacturing
Company. The principal business of the corporation was the manufacture and
distribution of automotive brake pads.
[4] The original
founders of the business were the appellant’s father and uncle. Eventually the
business was given to the appellant and his two sisters, with the appellant
having 40 percent of the equity of Hemispheres by way of voting shares, and the
two sisters each having 30 percent of the equity by way of non-voting shares.
[5] The appellant
was given all the voting shares in Hemispheres because it was anticipated that
he would actively manage the business and the sisters would be passive
shareholders only.
[6] During the
relevant period, the appellant’s interest in Hemispheres was owned by Fenfam
Holdings Inc., a holding company for the appellant’s wife and children.
[7] The appellant
and his sisters have a long history of acrimonious dealings. In regard to
Hemispheres, the sisters were first concerned about the lack of financial
disclosure that was provided to them. It appears that the more the sisters
learned about the financial state of Hemispheres, the angrier they became with
the extent to which the appellant and his family had benefited.
[8] Inevitably
litigation was threatened by the sisters against their brother, which included
a proposed derivative action in the name of Hemispheres. The legal expenses at
issue were incurred to defend this proposed action.
[9] The seriousness
of the matter is evident by the large amount of legal fees paid by the
appellant during the taxation year at issue. During this period, the sisters
sought leave of the Ontario Superior Court of Justice to commence an action in
the name of Hemispheres, leave was granted, and a statement of claim in the
name of Hemispheres and the sisters was filed.
[10] The appellant was
the main defendant in the action, but several other persons were named who
allegedly benefited from, or participated in, improper acts by the appellant.
[11] The essence of
the claim against the appellant was alleged harm that was done to Hemispheres
by the appellant’s conduct over a number of years in breach of his duty as
officer and director to act in the corporation’s best interest. This conduct,
it was alleged, resulted in significant financial detriment to Hemispheres, and
to the sisters as shareholders. Damages in the amount of $100,000,000 were
claimed, as well as an accounting and equitable tracing of property received as
a result of the breaches.
[12] In 2002, the dispute
was resolved in principle in a court-mediated settlement and formal settlement
agreements were executed in due course. The parties have agreed to keep the
terms of the agreements confidential and there is no need for me to describe
them in detail in these reasons.
[13] The statement of
claim that was filed in 2000 was 93 pages long, and it set out a large number
of alleged improper actions by the appellant.
[14] Central to this
appeal are just two of these: that the appellant paid excessive remuneration to
himself from Hemispheres; and that the appellant diverted a corporate
opportunity away from Hemispheres by commencing a complimentary business in a
corporation called Fenwix Friction Ltd.
[15] These are just
two of several allegations. I accept that the potential damages that could have
been awarded to Hemispheres from these allegations are very significant, but
there is not sufficient evidence for me to conclude that the other allegations
were not also significant.
[16] The statement of
claim describes the relief that was sought by Hemispheres against the appellant
as follows:
1. THE
PLAINTIFF, 372116 Ontario Limited c.o.b. Hemispheres International
Manufacturing Company (“Hemispheres”), claims as against Allan Fenwick
(“Fenwick”):
a. a declaration that Fenwick holds the property, business
assets, profits, or other benefits received by him, either directly or
indirectly, as a result of the breaches of his duties owed to Hemispheres and
the misappropriation of Hemispheres’ corporate opportunities (the “Hemispheres
Constructive Trust Property”), in trust for Hemispheres;
b. an accounting of the Hemispheres Constructive Trust Property;
c. an equitable tracing of the Hemispheres Constructive Trust
Property;
d. an Order requiring Fenwick to return the Hemispheres
Constructive Trust Property to Hemispheres;
e. damages in the amount of $100,000,000 for:
i. Fenwick’s breaches of his statutory and fiduciary duties owed
to Hemispheres, including his duty to act honestly and in good faith in the
best interests of Hemispheres and his duty of confidence to Hemispheres;
ii. Fenwick’s misappropriation of Hemispheres’ corporate
opportunities; and
iii.
Fenwick’s unjust enrichment;
to compensate
Hemispheres for its loss of the Hemispheres Constructive Trust Property;
Analysis
[17] Paragraph 8(1)(b)
of the Act provides:
8. (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) 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;
[18] The appellant
submits that the expenses at issue are deductible under this provision because
they were incurred to establish his right to retain remuneration received from
Hemispheres and Fenwix.
[19] For the reasons
below, I do not agree.
[20] Paragraph 8(1)(b)
provides a deduction in computing employment income for legal expenses incurred
by an employee in limited circumstances.
[21] The elements of
the section that are particularly relevant in this appeal are: (1) that the
deduction is for the purpose of computing income from an office or employment;
(2) that the expenses must be incurred by an employee (including an officer);
and (3) that the expenses must be incurred for the purpose of either collecting
or establishing salary or wages owed.
[22] I would first
comment about the word “owed” in s. 8(1)(b). The respondent submits that
the use of this word suggests that Parliament had in mind legal disputes
concerning unpaid remuneration. If this interpretation is correct, it would be
fatal to this appeal because the Hemispheres’ lawsuit had nothing to do with
unpaid remuneration.
[23] In support of
this position, the respondent referred to the decision of the Federal Court of
Appeal in Loo v. The Queen, 2004 D.T.C. 6540. According to Loo,
it is suggested, the taxpayer must satisfy two conditions in order to qualify
for the deduction in s. 8(1)(b). These are referred in Loo as
“branches” of the section and they are described in paragraphs 7 and 8 of the
decision as follows:
[7] Paragraph 8(1)(b)
has two branches. The first branch permits a deduction for legal expenses
incurred in an action to collect salary or wages owed. It contemplates
litigation resulting from the failure of an employer to pay the salary or wages
due to an employee. In such a case, there may be no dispute as to the amount of
salary or wages that the employee is entitled to be paid for the services the
employee has performed, but there may be a factual dispute as to how much of
the salary or wages remains unpaid.
[8] The second branch of paragraph 8(1)(b)
contemplates a situation in which the matter in controversy is the legal
entitlement to the salary claimed. The second branch applies if, for example,
an individual incurs legal expenses in litigating a factual dispute as to
whether he or she has actually performed the services required by the contract
of employment, or a dispute as to the rate of salary payable for services
performed. That would include, for example, a dispute as to the term and
conditions of employment.
[24] I would comment
briefly that I do not interpret Loo as suggested by the respondent that
both branches must be satisfied in order to qualify for the deduction. Such an
interpretation would be contrary to the words of the statutory provision, which
clearly permits a deduction for two different situations – legal expenses to
“collect” and legal expenses to “establish a right.”
[25] I have trouble
with the limited interpretation of the word “owed” suggested by the respondent
because it is difficult to see why Parliament would want to make a distinction
based on whether the remuneration has been paid or not. It seems to make more
sense in this context to interpret the word “owed” as equivalent to “earned.”
[26] It is not
necessary that I reach a conclusion on this, however, because in my opinion the
expenses incurred by the appellant do not qualify for the deduction for other
reasons.
[27] The essential
question to be decided in this case is whether the appellant incurred legal
fees to establish a right to salary or wages. I have concluded that this was
not the case, essentially because there is no evidence that the threatened
lawsuit would impact the appellant’s right to salary or wages paid to him by
Hemispheres or Fenwix.
[28] I will first
consider the application of s. 8(1)(b) as it relates to remuneration
paid from Fenwix.
[29] Fenwix was incorporated
by the appellant and carried on a business involving the manufacture and
distribution of automotive brake plates. The shares of Fenwix were owned
entirely by the appellant’s family during the relevant period.
[30] Over the years,
Fenwix paid very significant bonuses to the appellant. However, the wrongdoing
that Hemispheres complains of in the statement of claim is not that these
bonuses were excessive.
[31] The alleged
improper conduct of the appellant in reference to Fenwix is set out in
paragraphs 76 to 88 of the statement of claim. In general, Hemispheres and the
sisters assert that the appellant diverted a significant business opportunity
away from Hemispheres and that resources of Hemispheres were improperly used by
Fenwix.
[32] The statement of
claim refers to the remuneration paid out of Fenwix but it does so in the
context of alleging that Fenwix improperly used Hemispheres’ resources, that
is, the services of the appellant. In essence it is suggested in the statement
of claim that the appellant must have spent considerable time working for
Fenwix, as evidenced by his large remuneration, and that this time should have
been spent working for Hemispheres.
[33] I note the
following excerpt from paragraph 84 of the statement of claim:
84. Fenwix
operated as a profitable enterprise from its inception. It was able to do so,
in part, because it was improperly using the property, business assets, profits
and other benefits of Hemispheres, including but not limited to the following:
[…]
(b) Fenwick devoted a significant amount of his time and energy to
starting and operating Fenwix. Fenwick drew direct compensation from Fenwix for
the period from 1987 to 1996 totalling at least $32,107,000, at the same time
that he was taking millions of dollars in compensation as the top executive of
Hemispheres.
[34] I do not see any
basis for concluding that the legal fees at issue were incurred to collect or
establish a right to remuneration from Fenwix. It may be that the
reasonableness of the remuneration paid by Fenwix would be relevant in
determining the amount of damages incurred by Hemispheres from having the brake
plate business carried on outside Hemispheres, but this has nothing to do with
the entitlement of the appellant, as an employee of Fenwix, to retain
remuneration received from Fenwix.
[35] I turn now to the
remuneration received by the appellant from Hemispheres. Paragraph 60(h)(i)
of the statement of claim alleges that the appellant wrongly took excessive
bonuses and salary from Hemispheres. Accordingly, unlike the allegations made
in respect to Fenwix, the reasonableness of the remuneration from Hemispheres
was a specific allegation.
[36] The problem that
I have with the appellant’s argument in relation to the remuneration from
Hemispheres is that the appellant’s right to retain this remuneration, in his
capacity as an employee, was not at issue.
[37] Hemispheres was
not making a complaint against an employee for accepting remuneration that
Hemispheres itself paid out. The complaint by Hemispheres was that an officer
and director acted improperly by directing that such a payment be made. If the
claim were successful, an award of damages would be against the appellant in
his latter capacity, not the former.
[38] It is enticing to
reach a conclusion that there is no substantive difference between an
allegation against the person who directed a payment to be made and an
allegation against the person who received the payment where the persons are
one and the same. However, I think that the distinction is important.
[39] Like all
provisions of the Act, paragraph 8(1)(b) should be construed, if
possible, in a manner that provides harmonious results for similar
circumstances. The interpretation suggested by the appellant would not achieve
this.
[40] If, for example,
a director of a corporation arranged for the corporation to pay excessive
salary to the director’s spouse, and the director was sued by the corporation
for such action, the legal fees incurred by the director clearly would not
qualify for deduction under s. 8(1)(b). It makes no sense to interpret
s. 8(1)(b) to provide for a deduction in this case simply because the
appellant was wearing two hats. To do so would lead to an inequitable
application of the section to taxpayers in similar circumstances.
[41] I note that in
addition to the claim for damages, Hemispheres also asked for an equitable
tracing of assets that were allegedly wrongfully transferred out of the
corporation. Although it was not raised at the hearing, it could perhaps be
argued that this remedy focuses on the beneficiaries of the wrongful actions,
including the appellant as an employee who received some of the assets.
[42] Even if I were to
agree with this approach, there is not sufficient evidence to enable me to
conclude that the appellant was at risk in handing over remuneration received
under an equitable tracing theory. If the appellant was not at risk, it is
difficult to link the legal expenses to it.
[43] In this regard,
the statement of claim alleges, at paragraph 152, that most or all of the funds
inappropriately paid out were received by the appellant’s spouse. It would not
be surprising if all the funds were given to the spouse because the appellant
testified that he personally had very significant legal exposure as a result of
the nature of Hemispheres’ business operations.
[44] Accordingly,
there is no factual foundation for suggesting that the legal expenses were
incurred by the appellant to defend an equitable tracing of the remuneration
received by him.
[45] For these
reasons, I conclude that none of the legal fees at issue qualify for deduction
under s. 8(1)(b). The appeal will be dismissed, with costs.
[46] As a final
matter, the appellant requested that an order be made to seal the confidential
settlement agreements that were entered into evidence. I have concluded that it
would be appropriate to issue a direction to the Registry to place these
documents in a sealed envelope, which envelope is not to be provided to any
third party without leave of a judge of this Court. I will include this
direction as part of the judgment.
Signed at Toronto, Ontario this 25th day of April, 2008.
“J. Woods”
Email this Content