Helene Gelinas v. Minister of National Revenue, [1989] 1 CTC 2163, 89 DTC 117

Tremblay, T.C.J. [Translation]:—These appeals were heard in the city of Montreal, Quebec, on January 13, 1988.

1. Point at issue

The question is whether the appellant was correct in deducting the amounts of $12,000 and $4,000 respectively as legal fees in computing her income for 1984 and 1985.

In the respondent's submission, the legal fees resulted from the filing by the appellant of an application for declaratory relief in the Superior Court of Quebec for the probate of a will, an injunction and so on, and such an expense was not incurred for the purpose of gaining income within the meaning of paragraph 18(1)(a) of the Income Tax Act.

2. Burden of proof

2.01 The appellant has the burden of showing that the respondent's assessments are incorrect. This burden of proof results from several judicial decisions, including a judgment of the Supreme Court of Canada in Johnston v. M.N.R., [1948] S.C.R. 486; [1948] C.T.C. 195; 3 D.T.C. 1182.

2.02 In the same judgment, the Court held that the facts presumed by the respondent in support of these assessments or reassessments are also assumed to be true until the contrary is shown. In the instant case the facts relating to the notice of assessment issued for the 1985 taxation year are the same as those for the 1984 taxation year, as indicated below, except that for 1985 the legal fees amount to $4,000. The facts are described in paragraph 6(a) to (d) of the reply to the notice of appeal, and read as follows:

6. In assessing the appellant for her 1984 taxation year the respondent Minister of National Revenue relied, inter alia, on the following presumptions of fact:

(a) the appellant filed an application for declaratory relief in the Superior

Court (case No. 500-05-014236-838), in which she asked the Court for:

(i) the probate of a will;

(ii) a declaration of validity of a will and partial invalidity of two wills;

(iii) an injunction;

(iv) an accounting;

(b) in 1984 the appellant spent $12,000.00 on legal fees to establish the existence of a codicil or holograph will by Roger Juneau in her favour, in which he bequeathed her a number of shares;

(c) this holograph will was in the form of an envelope on which was written:

"Property of Mrs. H. Gélinas” and in which there were a number of shares;

(d) during the 1984 taxation year the sum of $12,000.00 spent by the appellant was not incurred for the purpose of gaining or producing income from a business or property within the meaning of s. 18(1)(a) of the Act . . .

3. Facts

3.01 The appellant was employed from 1956 to December 1984 by Estampages R.J. Cie Inc., of which Mr. Roger Juneau was president.

3.02 Mr. Juneau died on May 10, 1979, leaving the appellant an envelope with a handwritten inscription: "Property of Mrs. H. Gelinas [signed] Roger Juneau”. A photocopy of this envelope was filed as Exhibit A-1. This envelope contained inter alia all the shares of the company Canadian Electronic Door Operators Ltd. (C.E.D.O. Inc.), a company affiliated with Estampages R.J. Cie Inc. and, according to the appellant, with a turnover of over a million dollars per annum.

3.03 Photocopies of shares included in the envelope were also filed as part of Exhibit A-1. They were broken down as follows:

3.04 The photocopy of a cheque in the amount of $100 (front and back) made to the order of Roger Juneau and signed by Hélène Gélinas was also part of Exhibit A-1. On the back of the said cheque appears the signature of Mr. Juneau below the following typed information:

Payment on account for purchase of 14 ordinary shares of FINE METAL STAMPINGS COMPANY, shares received this day.

3.05 The comparative financial statements of C.E.D.O. Inc. at July 31, 1980 and July 31, 1983 were filed as Exhibit A-2.

3.06 The appellant considered the envelope to be a codicil to the will already made by Mr. Juneau. This will appointed the appellant executor with four other persons, namely Messrs. Monroe Abbey, Richard Juneau, Pierre Juneau and Oscar Strawczynski. The latter, who were all heirs and legatees under Mr. Juneau's will, refused to regard the envelope as a codicil.

3.07 On June 10, 1981 an agreement was signed between Messrs. Pierre Juneau and Richard Juneau (Exhibit A-3) concerning Mrs. Hélène Gélinas that she should be given an opportunity to withdraw her claim in the C.E.D.O. case or to settle it by mutual agreement, otherwise she would have to be transferred from her position to another branch and, after a six-month period, would have to leave her employment.

3.08 Finally, therefore, the appellant filed an application for declaratory relief in the Superior Court of Quebec as described in paragraph 9(a) of the presumed facts and cited in paragraph 2.02 of this judgment.

3.09 On August 3, 1984 judgment was rendered by Paul Reeves, J. and filed as Exhibit I-1. This judgment denied the application, although the judge believed the testimony of Mrs. Hélène Gélinas. The reason given was that as there was no date on the envelope it was impossible to know at what time the codicil was made. Its validity depended on whether it was made before or after 1974, because of the content of Mr. Juneau's two wills. This ambiguity made Exhibit A-1 uncertain and so invalid.

Mrs. Hélène Gélinas was therefore not found to be the owner of the shares included in the envelope, and in particular those of C.E.D.O. Inc.

3.10 According to the uncontradicted testimony of the appellant, in December 1984 Estampages R.J. Inc. went into bankruptcy and C.E.D.O. Inc. discontinued its operations. The president of these two companies is now the president of Bizek Industries, a management company operating under the name Cedomatic, in the same premises as the old company, C.E.D.O. Inc., with the same employees and the same manager.

4. Act—Case law—Analysis

4.01 Act

The principal provisions of the Income Tax Act involved in the instant appeal are paragraphs 18(1)(a) and (b). They read as follows:

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 . . .

4.02 Case law

The case law cited by the respondent is the following:

1. BP Oil Limited v. The Queen, [1979] C.T.C. 174; 79 D.T.C. 5121 (F.C.T.D.).

In his judgment Dubé, J. of the Federal Court-Trial Division referred to eight leading cases on the same point. They are as follows:

1. Farmers Mutual Petroleums Limited v. M.N.R., [1968] S.C.R. 59; [1967] C.T.C. 396: 67 D.T.C. 5277;

2. M.N.R. v. Dominion Natural Gas Company Limited, [1941] S.C.R. 19, [1940-41] C.T.C. 155; 1 D.T.C. 499-113;

3. M.N.R. v. The Kellogg Company of Canada Limited, [1943] S.C.R. 58, [1943] C.T.C. 1; 2 D.T.C. 601;

4. M.N.R. v. Goldsmith Bros. Smelting & Refining Company Limited, [1954] S.C.R. 58, [1954] C.T.C. 28; 54 D.T.C. 1011;

5. Canada Starch Company Limited v. M.N.R., [1969] Ex. C.R. 96, [1968] C.T.C. 466; 68 D.T.C. 5320;

6. Sun Newspapers Ltd. et al. v. Fed. Com. of Taxation (1938), 61 C.L.R. 337;

7. British Columbia Electric Railway Company Limited v. M.N.R., [1958] S.C.R. 133, [1958] C.T.C. 21; 58 D.T.C. 1022;

8. Van Den Berghs Limited v. Clark, [1935] A.C. 431;

2. BP Oil Limited v. Her Majesty The Queen, [1980] C.T.C. 408 (F.C.A.);80 D.T.C. 6252;

3. Brault v. M.N.R., [1988] 2 C.T.C. 2316; 88 D.T.C. 1735.

4.03 Analysis

4.03.1 Principles at issue

4.03.1(1) For a proper understanding of the principles at issue reference must be made to BP Oil Limited (para. 4.02(2)), where the principles are well explained in relation to the facts.

4.03.1(2) The facts in BP Oil Limited (para. 4.02(2)) are well summarized by Pratte, J. of the Federal Court of Appeal at 408 (D.T.C. 6252), and read as follows:

Appellant is the tenant of a building in Beloeil, in which it operated a service station. In 1973, a neighbour sued it asking the Superior Court to issue an injunction prohibiting operation of this service station. The neighbour alleged that the property occupied by appellant was subject to a servitude which prohibited its being used for the business of selling gas. The Superior Court granted the injunction requested. Appellant nonetheless continued to operate the service station. Because of this, it had on three occasions to defend itself against charges of contempt of court. In May 1974, after being convicted of contempt of court twice, appellant closed its service station.

It is legal fees incurred in connection with these proceedings, relating to the injunction and contempt of court, which appellant claims to be able to deduct in computing its income.

The Federal Court of Appeal affirmed the decision of Dubé, J. of the Federal Court Trial Division.

4.03.1(3) After citing the provisions of paragraphs 18(1)(a) and (b) of the Income Tax Act, Dubé, J. examined the principles and the case law. The cases cited in his judgment are those described [sic] in paragraph 4.02 of the instant case and numbered 1 to 8. This analysis is cited at [sic] 176-7 (D.T.C. 5122-3) and reads as follows:

For an expense to be deductible it must have been incurred in order to produce income (18(1)(a)) and not have been made on capital account (18(1)(b) ) (see Farmers Mutual Petroleums Limited v. M.N.R., [1968] S.C.R. 59; [1967] C.T.C. 396; 67 D.T.C. 5277). Clearly, the objective of a commercial undertaking is to obtain a profit and any expense is generally incurred with this in view, but the requisition for tax purposes is whether the expense was incurred to earn income or on capital account.

In the case at bar, the legal costs incurred by plaintiff undoubtedly were incurred, directly or indirectly, to protect either its source of income, or that income itself. What the Court must decide is whether the costs in question are connected with defending the structure, the assets, the very existence of the company, or whether those costs actually related to operation of the business and the production of income.

As Martland, J. of the Supreme Court of Canada observed in the aforementioned Farmers case, legal costs incurred in order to protect "an asset of advantage for the enduring benefit” of the business are capital costs and nondeductible.

In M.N.R. v. Dominion Natural Gas Company Limited, [1941] S.C.R. 19; [1940-41] C. T.C. 155; 1 D.T.C. 499-133, legal costs were held to be intended to defend the capital assets, and non-deductible. Duff C.J. found that an expenditure made “once and for all” for the purpose of obtaining "the advantage of an enduring benefit" for the company is an expenditure on capital account. The company was defending its right to distribute its product to the residents of Hamilton.

On the other hand, Maclean J. of the Exchequer Court concluded in M.N.R. v. The Kellogg Company of Canada Limited, [1943] S.C.R. 58; [1943] C.T.C. 1; 2 D.T.C. 601 that legal costs to defend a trademark related to operation of the business and were therefore deductible. He found that these outlays were "involuntary" and were not incurred “once and for all or for the enduring benefit of the business”.

In M.N.R. v. Goldsmith, Bros. Smelting and Refining Company Limited, [1954] S.C.R. 58; [1954] C.T.C. 28; 54D.T.C. 1011, legal costs incurred to defend the company against the charge of participating in an unlawful combine were also held to be deductible.

Jackett, P. of the Exchequer Court (now Chief Justice of the Federal Court) attempted in Canada Starch Company Limited, [1969] Ex.C.R. 96; [1968] C.T.C. 466; 68 DT.C. 5320, to define what constitutes an expenditure on capital account. First, he referred to a guideline laid down by Dixon, J. in Sun Newspapers et al. v. Fed. Com. of Taxation (1938), 61 C.L.R. 337, which reads as follows:

The distinction between expenditure . . . on revenue account and on capital account corresponds with the distinction between the business entity, the structure or organization . . . established for the earning of profit and the process by which such an organization operates to obtain regular returns.

From this Jackett P. derived his own twofold distinction, at page 102:

(a) on the one hand, an expenditure for the acquisition or creation of a business entity, structure or organization, for the earning of profit, or for an addition to such an entity, structure or organization, is an expenditure on account of capital, and

(b) on the other hand, an expenditure in the process of operation of a profit-making entity, structure or organization is an expenditure on revenue account.

The learned judge applied this distinction in Canada Starch, cited above, concluding that the legal costs incurred in defense of the trademark "Viva" were expenses related to operation of the business and so deductible.

Abbott, J. had already added a further clarification of the guideline in British Columbia Electric Railway Company Limited v. M.N.R., [1958] S.C.R. 133; [1958] C.T.C. 21; 58 D.T.C. 1022. In his view, the principle underlying the distinction between a capital expenditure and an income expenditure is that for tax purposes income is determined on an annual basis, therefore an expense in order to earn income during the current year is deductible in that year. At the same time, an expense on capital account is an eligible deduction as a capital cost allowance over a period of several years.

In Van Den Berghs Limited v. Clark, [1935] A.C. 431, an English company and a Dutch company went to arbitration after a series of agreements and disputes, and the second company had to pay £450,000 in damages to the first. The Privy Council held that this sum was a payment on capital account and therefore not deductible. Lord McMillan concluded that the agreements were not ordinary commercial agreements in the normal course of business. There was no question of there being, in his opinion, contracts for the sale of goods, for the hiring of representatives, or for the distribution of profits. Rather, he observed, at page 442 :

On the contrary the cancelled agreements related to the whole structure of the appellants’ profit-making apparatus. They regulated the appellants' activities, defined what they might and what they might not do, and affected the whole conduct of their business. I have difficulty in seeing how money laid out to secure, or money received for the cancellation of, so fundamental an organization of a trader's activities can be regarded as an income disbursement or an income receipt.

The case law on the point, then, is abundant and often cited; it must be applied to the facts of the case at bar.

4.03.2 In the instant case the appellant brought an action which for all practical purposes was intended to have her declared owner of the shares of C.E.D.O. Inc., which was then a thriving company.

To do this she incurred legal costs. To begin with, it should be pointed out that the fact the appellant lost her case in the Superior Court is of no relevance in the instant appeal and can in no way affect the decision.

The question that arises, in accordance with the principles explained above, is the following: is the expenditure made in keeping with the structure of the organization established, to make a profit, or is it in keeping with "the process by which such an organization operates to obtain regular returns", in the words of Jackett, P.?

4.03.3 In Brault (paragraph 4.02(2)), a decision by Couture, C.J. of the Tax Court of Canada, a matter similar to the instant case was decided. A wife had brought an action against her husband, one Russo, inter alia to be declared owner of 50 per cent of the shares of a company known as Rideau Construction Ltée ("Rideau"), in which she alleged that they each owned 50 per cent of the issued shares. Three actions in the Superior Court were involved. I cite Couture, C.J.T.C. 2316-17 (D.T.C. 1736) of his judgment:

This company operated successfully until 1972, when its letters patent were revoked. She also alleges that she was the owner of a building located at 444 Ogilvy in Montreal, which contained 23 apartments and from which she collected revenues.

As a result of the couple’s domestic situation, Russo sued the appellant in 1971 for $91,000, the cost of the land and the construction of the building in question, and had a writ issued for seizure before judgment in order to intercept the rental payments from the building.

In 1975 the appellant sued Russo claiming ownership of 50 per cent of the shares in Rideau, since he claimed he was the beneficial owner of the shares and that his wife was listed on the company's records only as a dummy for him.

Finally, a second action was commenced by the appellant against Russo for $181,409.12, which represented 50 per cent of the amount she alleged he had appropriated from the company. The appellant was represented by the same counsel in all three actions, in which three judgments were rendered on October 2, 1980 in favour of the appellant.

In the action against Russo, the Court granted a release of the seizure following its ruling that the building belonged to the appellant and dismissing Russo's claim.

In a second judgment the Court declared that the appellant was entitled to half of the net assets of the company and ordered that a sequestrator be appointed to administer and proceed with the division of the assets.

In the third judgment the court ordered the defendant Russo to pay the appellant $129,411.74, which was half the assets deemed to have been appropriated by Russo from the company.

For all of the services relating to the aforementioned judicial proceedings, her solicitor submitted an account for fees of $10,636 covering his services to the date of billing.

Further, after citing paragraphs 18(1)(a) and (b) [sic], Couture, C.J.T.C. made the following comments and drew his conclusions:

The three judgments of the Quebec Superior Court in favour of the appellant seemed to indicate clearly that the appellant's claims are invalid in view of the requirements of paragraph 18(1)(a).

In the action commenced by Russo in 1971, the Court had to determine who was the owner of the building at 444 Ogilvy. Bernard Flynn, J. concluded that the building was the property of the appellant and in his judgment he said:

When looked at in the context of a partnership between the spouses, the Court can conclude that the defendant Russo (the appellant) is the owner of the building in question . . . To some degree it represented her particular share of the property that the business was rapidly accumulating.

The effect of this judgment was to uphold the appellant's right of ownership to the building, and, as such, to protect a source of income. This source of income represented a Capital asset for her, and not a gain in income. The order of release simply disposed of a procedure ancillary to the main action.

The second action commenced by the appellant against Russo involved only the division of the net assets of the company, which had operated and existed until 1972, and thus, in this case as well, a claim by the appellant to a share in a capital property.

As to the third action commenced in 1975, it likewise involved recovering her share of the assets deemed to have been appropriated by Russo from the Rideau properties. Again, the appellant was claiming ownership in a capital property.

It seems evident, therefore, from the situation as described, that the fees paid to her counsel were not incurred by the appellant for the purpose of gaining income from property but rather for recovering assets that she claimed belonged to her.

For these reasons the appeal is dismissed.

4.03.4 In the instant case, the appellant is seeking to be declared owner of the shares of C.E.D.O. Inc. and as in Brault to reclaim ownership of a capital property. It is this capital the operation of which will produce income; but the expenditure on legal fees was in no way part of operation of the undertaking of C.E.D.O. Inc.

The appellant pointed out that in recovering the C.E.D.O. Inc. shares, she was recovering employment and that this was in part the reason for her effort. The employment connected with the disputed shares was also part of the capital she was trying to recover and would also produce income for her.

The actions was not brought by the appellant as an employee to recover salary owed by C.E.D.O. Inc. Only in such a case would the legal fees have been deductible under paragraph 8(1)(b) of the Income Tax Act.

4.03.5 The respondent's assessments must therefore be upheld.

5. Conclusion

For all these reasons, the appeals of the appellant must be dismissed.

Appeal dismissed.