Peter De Verteuil and Reni De Verteuil v. Her Majesty the Queen (Informal Procedure), [1993] 1 CTC 2669

Mogan, T.C.CJ.:—Mr. Peter De Verteuil and his wife Mrs. Reni De Verteuil commenced appeals in this Court concerning the deduction of legal expenses which they incurred in the taxation years 1987 and 1988. These appeals were heard on common evidence. The appellants have elected the informal procedure.

In 1987 and 1988, the appellants expended $39,532 on legal fees defending themselves against certain criminal charges which I will refer to later. They deducted these fees in the computation of income and, upon reassessment, the Minister of National Revenue disallowed in total the deduction of the fees. The only issue in these appeals is whether the legal fees expended by the appellants in the amount of $39,532 are deductible in computing income. The fees were apportioned on a 50/50 basis so that each appellant is claiming one- half of this amount.

During the years in question, Peter De Verteuil was a successful car salesman. He worked in St. Catharines, Ontario, for Henley Motors in 1987 and the first half of 1988. In the latter half of 1988, he worked for an Ontario numbered corporation carrying on business as Sudbury Mazda, and he owned a 50 per cent interest in the Ontario numbered corporation.

The other appellant, Reni De Verteuil, worked as an employee of St. David’s Youth Residence Inc., which I shall refer to as "St. David's", a non-profit, nonshare capital corporation which was involved in housing young offenders in open custody. Mr. and Mrs. De Verteuil had been instrumental in setting up St. David's. They had submitted to the Ontario government an application to operate a youth custody facility under the Young Offenders Act, and an agreement was reached between the Ontario Ministry of Corrections and St. David’s under which the Ministry was to fund two open custody facilities. Mr. and Mrs. De Verteuil received rental income from two houses which they owned and leased to St. David's for the purpose of operating the group homes for young offenders.

In 1987, the Niagara Regional Police conducted an investigation and, as a result, certain criminal charges were laid against Peter De Verteuil, Reni De Verteuil and the St. David's corporation. Those charges related to fraud, theft, conspiracy to commit fraud and assault. The fraud and theft charges apparently related to certain allegations as to whether funds earmarked for or paid to St. David's for the operation of the two group homes had been or may have been diverted to the private use of the appellants. In any event, the charges were laid and the legal fees in question were incurred by the appellants for the sole purpose of defending themselves and St. David's against those charges.

When the appellants filed their income tax returns for 1987 and 1988, there was a schedule in the returns reporting income from real property and, on that schedule, they showed the rents they derived as owners of the two houses which were leased to St. David's. The schedule also showed certain expenses connected with owning the houses: the usual expenses like municipal taxes and mortgage interest. But the appellants included as expenses on the schedule of rental income the legal fees in issue. Therefore, at first blush, if one were to take their income tax returns as filed, one would have thought that they were deducting the legal fees in issue as expenses incurred in connection with the earning of rental income.

At the hearing of the appeals, however, this was not the position that was taken by the appellants. In fact they did not press that position at all. The appellants maintained that the amounts in issue were expended to protect their good name and reputation; in particular, the reputation of Peter De Verteuil who testified at length that he was required to hold a licence as a car salesman, the licence being issued by the Ontario Ministry of Consumer and Corporate Affairs. He stated in evidence that, if the criminal charges against him in connection with alleged fraud and alleged theft had been sustained, he was informed by officials of the Ontario Ministry of Consumer and Corporate Affairs that his licence would have been cancelled. Similarly, as a successful car salesman, he had the natural hope and ambition to be a car dealer one day and, in that capacity, he would also require a licence from the Ontario Ministry of Consumer and Corporate Affairs to operate a car dealership either as a proprietorship or through a company that he would control. Again, he was informed that if the criminal charges were sustained against him, he would have no hope of obtaining such a licence. Therefore, according to Peter De Verteuil's evidence, it was necessary for him to defend the criminal charges to preserve his job of selling cars as a car salesman and his hope of becoming the owner of a car dealership.

In the presentation of the appeals, the appellants shifted ground (as they were entitled to do) and did not identify the legal expenses as being incurred in connection with the earning of rental income but really in connection with the earning or the potential earning of income from selling cars. It is this change which makes it necessary to consider whether the amounts in issue are deductible in computing income from employment or business.

In determining the deductibility of any expense, one must consider the scheme of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") which provides for the computation of income derived from different sources. There are provisions in section 8 which deal with deductions permitted in computing income from office or employment; and there are other provisions in section 18 which deal with deductions permitted in computing income from business or property. The important provisions in section 18 are:

18(1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(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;

(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;

Under paragraph 18(1)(a), a deduction is permitted if the taxpayer operates a business and has incurred expenses for the purposes of producing or gaining income from that business. As a general rule, legal expenses may be deducted in computing income from a business if the expenses were incurred in defending a criminal charge where the conduct resulting in the charge was performed in the normal operation of the business. The leading cases on the deductibility of legal fees are M.N.R. v. L.D. Caulk Co., [1954] S.C.R. 55, [1954] C.T.C. 28, 54 D.T.C. 1011; and Rolland Paper Co. v. M.N.R., [1960] C.T.C. 158, 60 D.T.C. 1095 (Exch. Ct.).

In Rolland Paper, supra, the legal expenses were incurred defending against the criminal charge of operating a combine. The Exchequer Court held that those expenses were deductible whether or not the corporation was found guilty; the legality or illegality of the corporate conduct was not relevant because the conduct itself was for the purpose of earning income from business. The legal expenses were incurred to defend the taxpayer's way of doing business, even if it was an illegal way. Presumably, participating in a combine would enhance the profits of each participant. On that theory, the legal expenses were held to be deductible. In other words, the deductibility of legal expenses did not depend upon any moral judgment of the way a corporate taxpayer conducted its business.

In the appeals before me, the facts do not indicate that either appellant carried on any business at all. The business of operating the group home for young offenders was carried on by the St. David's corporation; not by either appellant. Reni De Verteuil was an employee of St. David's. Peter De Verteuil was employed as a car salesman. The appellants’ conduct which resulted in the laying of criminal charges and the incurring of legal expenses was not connected in any way with the selling of cars, but was connected with the appellants’ involvement in the operation of St. David's.

I shall consider first the appeal of Peter De Verteuil. As stated earlier, he was involved in selling cars but at all times he was an employee. He was never the proprietor of a car dealership. He earned a very generous income from the selling of cars but that income was derived as commission income working as a car salesman for a corporation that carried on the business of a car dealership. During 1987 and the first half of 1988, his employer was Henley Motors in St. Catharines, Ontario. During the last half of 1988, his employer was the Ontario numbered company that he worked for and sold cars for, even though he had a 50 per cent ownership in it. Throughout 1987 and 1988, Peter De Verteuil had only employment income and no business income; and he was not engaged in any business that would permit him to claim the deduction of these legal expenses as expenses incurred for the purpose of gaining and producing income from a business.

Turning to the appeal of Reni De Verteuil, she also sought to deduct legal expenses in computing either business income or rental income. Her position is less clear because she did not testify, nor did she make any submissions to the Court. It was agreed at the commencement of the hearing that her husband would act as her agent and he did not call her as a witness. In presenting the summation on behalf of the appellants, he did not make a separate submission concerning the deductibility of her portion of the legal expenses. In the years under appeal, her only income was derived from employment because she was apparently the administrator of St. David's, the operator of the group homes. She was paid a salary by St. David's for administering its business. Therefore, she had no business income; and could not rely on the provisions of paragraph 18(1)(a) which might otherwise have permitted the deduction of legal expenses if they were incurred for the purpose of earning income from business.

The question therefore comes down to whether either appellant could deduct in the computation of employment income the legal expenses in issue? In my opinion these legal expenses are not deductible in computing income for two reasons, quite independent of each other. Firstly, they were incurred to preserve the good name and reputation of the appellants. The preservation of a person's good name is the preservation of capital asset. If it had been possible to find that either one of the appellants was engaged in business, I would have held that the legal expenses were an outlay of capital within the meaning of paragraph 18(1)(b) to preserve the good name of the appellants.

And secondly, the deduction of legal expenses by a person whose only income is from employment is permitted under paragraph 8(1)(b) of the Income Tax Act. It is a narrow provision which states:

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 him in collecting salary or wages owed to him by his employer or former employer;

These expenses were clearly not paid to collect any salary or wages for either appellant. Therefore, they do not qualify as a deduction under paragraph 8(1)(b).

Lastly, although it was not raised in argument, I will consider whether these legal expenses can be characterized as expenses incurred for the purpose of earning rental income as reported in the appellants' returns. Certainly, the expenses were not incurred for the purpose of gaining and producing rents from the two properties which were leased to St. David's, nor were they expenses incurred in connection with owning the properties, like municipal taxes. The actions which resulted in the legal expenses were not those of the appellants as owners of property but as operators of St. David's in their administrative capacity.

It came out in evidence that the criminal charges did not go to trial because an agreement was reached with the Crown Attorney under which the charges against Peter De Verteuil were dropped (he indicated quite frankly that it was part of the arrangement that he wanted to preserve his good name for purposes of the car business) but his wife and St. David's pleaded guilty either to lesser charges or to a certain number of the charges which had been laid.

For the reasons set out above, the appeals will be dismissed.

Appeals dismissed.