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Citation: 2004TCC520
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Date: 20040723
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Docket: 2003-2261(IT)I
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BETWEEN:
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PIERRE LEPAGE,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
Lamarre
Proulx J.
[1] These are appeals under the Informal
Procedure for the 1997 and 1998 taxation years.
[2] The issue is to determine if the legal fees
incurred with respect to rental properties were on account of income or on
account of capital.
[3] The Appellant testified. He acquired three
rental properties having six units each from 1985 to 1987. The lender was
Fiducie Desjardins Inc. (Fiducie Desjardins). In 1993, the Appellant had difficulty
renting his units, which led to difficulty in paying the property taxes.
Towards the end of 1994, an agreement was reached with the lender regarding an
increase in the amounts payable on the hypothec loans. This did not seem to
suffice.
[4] On April 28, 1995, a Notice of Withdrawal
of Authorization to Collect Rents was served on the landlords and the tenants
(Exhibit A-2). On June 16, 1995, a prior notice of the exercise of the
hypothecary right to take possession for purposes of administration (article
2757 et seq. of the Civil Code of Québec) (Exhibit A-1) was
served. On August 1, 1995, there was a prior notice of the exercise of the
hypothecary right to take in payment (article 2757 et seq. of the Civil
Code of Québec) (Exhibit A-4). On June 22, 1995, a judgment was issued
ordering the immediate surrender to take temporary possession to administer the
property until final judgment on this application (Exhibit A-5). On October
19, 1995, there was an application for forced surrender and taking in payment
(article 795 of the Code of Civil Procedure) (Exhibit A-3). This
application was so that the Court could declare Fiducie Desjardins the sole
owner retroactively to the registration of the prior notice on August 10, 1995.
[5] The various documents in Exhibit A-6 are
letters from April 22, 1996, to September 11, 1997, between the Appellant’s
counsel and Fiducie Desjardins’s counsel. They are about the possibility of
restructuring the loans.
[6] The Appellant said that for each year at
issue, Fiducie Desjardins had him send a statement of rental income that he
included in his income tax return. He remained the owner during those years.
According to him, a lawyer’s services were required to contest the
administration of the units by Fiducie Desjardins. He also said that in 1999,
he and his spouse decided to transfer the properties to Fiducie Desjardins
because contesting it was too costly.
[7] The Notice of Objection was attached to the
Notice of Appeal and explained the Appellant’s position during the hearing. I
will cite the relevant passage:
[TRANSLATION]
...
A – Immeubles Plessis, Cartier and Dorion
(1997 and 1998):
1. Legal fees:
In August 1995, the hypothecary creditor
presented some documents to the Superior Court of Quebec in order to obtain the
right to administer the aforementioned buildings. The taxpayers objected to
such a presentation of facts and brought an action against the hypothecary
creditor. During these years, the taxpayers remained the building owners, as
evidenced by their personal income tax returns, indicating the rental income
and losses based on the information provided by the hypothecary creditor,
“Fiducie Desjardins”. Each year, Fiducie Desjardins provided the taxpayers
with all the particulars of the income and expenses with respect to their
management of the buildings.
The taxpayers claimed the fees of counsel
that they had mandated to contest the seizing of the administration of the
buildings by Fiducie Desjardins. In addition, in the building administration
fees of Fiducie Desjardins, there were the Fiducie’s legal fees for objecting
to the contestation by the taxpayers of the building administration by Fiducie.
These legal fees were disallowed by the
Department and added (or capitalized) to the cost base of each building,
pro-rated in accordance with their gross rental income.
The taxpayers object to this disallowance
for the following reasons:
Their legal fees are deductible for each of
the years as they are fees related to normal operations for the purpose of
gaining rental income. Often, landlords experience difficulties with
hypothecary creditors or others;
The action or contestation concerns the
undue seizing of control of the administration of the buildings and not the
repossession of the buildings that were seized. The expense is not related to
seized capital property but to operating and administrative expenses;
...
[8] The reasons relied
on in the Notice of Appeal are the following:
[TRANSLATION]
...
The taxpayers object to
this disallowance for the following reasons:
Their legal fees are deductible for each of
the years as they are fees related to normal operations for the purpose of
gaining rental income. Often, landlords experience difficulties with
hypothecary creditors or others;
The action or contestation concerns the
undue seizing of control of the administration of the buildings and not the
repossession of the buildings that were seized. The expense is not related to
seized capital property but to operating and administrative expenses.
...
[9] Counsel for the Appellant contended that
the legal fees may be deducted as current expenses. They were expenses related
to rental administration.
[10] Counsel for the
Respondent contended that the fees incurred were on account of capital and
could not be deducted pursuant to paragraph 18(1)(b) of the Income
Tax Act (the Act).
[11] He referred to the Federal Court of Appeal’s
decision in Her Majesty the Queen v. Jager Homes Ltd., A‑792-83, January
28, 1988 (F.C.A.), specifically to the comments of the Mr. Justice Urie at
pages 16 and 17 of the decision:
From all of the evidence it is reasonable
to conclude that the real objective of the plaintiff in the actions was to use
the threat engendered by the petitions for winding up to obtain a settlement of
her financial claim in her divorce action or, if no settlement were achieved
and the petitions were granted, as a consequence of the winding up, to receive
her ratable share in the distribution of the assets. The defence was clearly instituted
to prevent the latter occurrence. That was the primary purpose of the defence
in the litigation. The indirect and ultimate result of succeeding in that
defence would be that the income earning capacity for each company would
continue. To use the words of Dixon J. in the Sun Newspapers case, supra,
'The expenditure in question is a large non-recurrent unusual expenditure made
for the purpose of obtaining an advantage for the enduring benefit of the
appellants' trade .[nb].[nb].' In other words, the payments for legal fees were
made to preserve the business entity, structure or organization not as the
kinds of expenditures which are made to earn profits from the operation of such
business entities.
[12] Counsel for the Appellant remarked, in
reply that the motion in Jager Homes (supra) concerning an application
for a winding-up order, and that it was mentioned on page 3 of this judgment
that:
... All incidental legal fees
incurred in the day-to-day operations of the Respondents, during the period of
the winding up actions, were allowed as current deductions from income by the
Minister of National Revenue.
Conclusion
[13] Paragraphs 18(1)(a)
and 18(1)(b) of the Act read as follows:
General
limitations
18(1) In
computing the income of a taxpayer from a business or property no deduction
shall be made in respect of
General
limitation
(a) 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;
Capital
outlay or loss
(b) an outlay, loss
or replacement of capital, a payment on account of capital or an allowance in
respect of depreciation, obsolescence or depletion except as expressly
permitted by this Part;
[14] I refer to the
Supreme Court of Canada decision in Farmers Mutual Petroleums v. M.N.R., [1967] C.T.C. 396 and to Mr. Justice
Martland’s comments on page 400:
In
my opinion, this proposition is not valid, because it is directly contrary to
the intent of paras. (a) and (b) of s. 12 when read together. To be deductible
for tax purposes an outlay must satisfy at least two basic tests:
(1)
It must be made for the purpose of gaining or producing income (s. 12(1)(a)).
(2)
It must not be a payment on account of capital (S.12(1)(b)).
Both
of these tests must be satisfied concurrently to justify deductibility. In
British Columbia Electric Railway Company v. Minister of National Revenue[4],
Abbott J. said at p. 137:
Since
the main purpose of every business undertaking is presumably to make a profit,
any expenditure made “for the purpose of gaining or producing income” comes
within the terms of s. 12(1) (a) whether it be classified as an income expense
or a capital outlay.
Once
it is determined that a particular expenditure is one made for the purpose of
gaining or producing income, in order to compute income tax liability it must
next be determined whether such disbursement is an income expense or a capital
outlay.
[15] In the case at
bar, there is no question that the legal fees in question were incurred to gain
or produce income from a business or property pursuant to paragraph 18(1)(a)
of the Act. What must be determined is whether it is an outlay of capital
pursuant to paragraph 18(1)(b) of the Act and therefore not deductible
in the computation of income (except as expressly permitted by this Part).
[16] I wish to refer
back to Jager Homes (supra), cited by counsel for the Respondent.
In this case, it had to be determined if the legal fees incurred by the
taxpayers to contest a winding-up action were incurred for the purpose of
gaining income or if they were outlays or payments on account of capital. It
was concluded that the payments were on account of capital as they were
expenses incurred to obtain an advantage for the long-term benefit of the
taxpayer. The payment of legal fees was for the purposes of preserving the
business entity, structure or organization and not for the purpose of making a
profit from running the business entity.
[17] From Jager Homes (supra), I cite an
excerpt from page 9:
...
And then at page 359 he made the
following comment which was referred to with approval by Jackett P. (as he then
was) in Canada Starch Company Limited v. M.N.R. (68 DTC 5320 at 5323):
The distinction between
expenditure and outgoings on revenue account and on capital account corresponds
with the distinction between the business entity, structure, or organization
set up or established for the earning of profit and the process by which such
an organization operates to obtain regular returns by means of regular outlay,
the difference between the outlay and returns representing profit or loss.
[18] Were the legal
fees incurred in regard to the operation of the business or in regard to its
structure? I now refer back to the proceedings undertaken at the source of the
fees in question.
[19] The documents,
submitted as Exhibits A-1 through A-5, are proceedings undertaken for the
purpose of exercising hypothecary rights during 1995. The documents in Exhibit
A-6 are dated 1996 and 1997. They are proposals and replies for the purpose of
seeking means to resolve the failing commercial structure of the rental
properties. The legal fees claimed are for 1997 and 1998. The receipts were
not submitted.
[20] These
proceedings and this correspondence did not concern disputes regarding the
daily or ongoing administration of the rental properties as claimed by the
Appellant. The case at bar was about ownership of the rental properties and
the correspondence concerned the restructuring of the hypothecary loans.
[21] I can only conclude,
based on the evidence submitted, that the legal fees were incurred to preserve
ownership of the rental properties and for the reorganization of the commercial
structure. They were not incurred to operate the business entity.
[22] As a result, the
appeals must be dismissed.
Signed at Ottawa,
Canada, this 23rd day of July 204.
Lamarre
Proulx J.
Translation certified
true
on this 31stday of
March 2009.
Bella Lewkowicz, Translator
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