Her Majesty the Queen v. Jager Holdings (Calgary) LTD and Jager Homes LTD, [1983] CTC 225, 83 DTC 5256

Jerome, ACJ:—These actions brought by way of appeals from decisions of the Tax Review Board came on for trial at Calgary, Alberta, on September 21, 1982. The proceedings before the Tax Review Board were conducted in Calgary on February 25, 1980. The facts are not in dispute and prior to trial in this Court, upon the consent of the parties, an order was made to permit the transcript of the proceedings before the Tax Review Board to be filed and to serve as an agreed statement of facts for the purpose of this trial. In this respect, the issue and the facts as set out before the Tax Review Board may be conveniently set out as follows:

Issue:

The sole issue to be determined in these appeals is the nature of the payments made by the appellants, as legal fees incurred in the defence of a petition commenced in the Supreme Court of Alberta, to have the appellant companies wound up pursuant to provisions of the Companies Act (Alberta).

By agreement with the Department of National Revenue the said legal fees in issue are in the amounts of $36,800 viz, $19,404 and $17,396 paid by Jager Holdings (Calgary) Ltd and by Jager Homes Ltd, respectively.

Facts:

The facts are not in dispute. Mr Jager, who has lived in Calgary since 1946, was in the business of building houses and incorporated his first company in 1949. Several construction companies were subsequently incorporated by Mr Jager.

On July 24, 1958, a company known as Jager Holdings (Calgary) Ltd (hereinafter referred to as Jager Holdings), one of the appellants, was incorporated, Mr William Jager holding 51% shares of the company and Mrs Helen Jager, his wife, holding 49% shares. Both were directors of the wholly owned company, Mr Jager acting as president and Mrs Jager acting as sec reta ry-t reas u re r.

On February 28, 1962, five companies were amalgamated as one company under the name of Jager Homes Ltd (hereinafter referred to as Jager Homes), the second appellant in these appeals; again, Mr William Jager was president and his wife Helen Jager was secretary-treasurer with the same allocation of shares.

Jager Holdings was the main company and was managed by Mr William Jager. The company’s business was that of land developer. It purchased land, subdivided it, serviced and sold it to building contractors among whom was its subsidiary, Jager Homes, which was managed by Mrs Helen Jager and which was in the business of constructing single and multi-family residential housing.

Matrimonial difficulties between Mr and Mrs Jager arose in 1972 and divorce proceedings were commenced in 1973. A restraining order was issued against Mr Jager and he no longer was allowed access to his wife and his child. Because of the restraining order which prohibited him from communicating with his wife, Mr Jager had difficulty in operating Jager Holdings which was closely associated with Jager Homes in which he had the majority of the shares but which was managed by his wife.

On September 26, 1973, Mrs Jager filed a petition with the Supreme Court of Alberta for the winding up of Jager Holdings and Jager Homes. Mr Jager was served within 24 hours with the related Court orders removing from him all authority in the administration of Jager Holdings and Jager Homes.

On September 27, 1973, Mr Jager retained the services of Mr Patrick J McCaffery, who looked after his interests during the pre-trial procedures and at the winding-up trial.

Mr John W Halpin was appointed provisional liquidator and Mr James C Fowler, co-provisional liquidator of Jager Holdings and Jager Homes by Court order dated September 26, 1973. The co-provisional liquidator appointed Mr William Jager as special manager for Jager Holdings. The actual management of the companies was carried out by the co-provisional liquidator. The pre-trial period lasted some 6 months during which time it is alleged that 100 Jager Homes were selling at cost; examinations for discovery were held and an application was made to court with reference to Jager Holdings land which Mrs Jager allegedly disposed of during the pre-trial period.

Mr Jager stated that he did not wish to proceed with the trial which, if successful, would mean the winding up of what had been successful businesses and would lead to the inevitable sale of all the assets of the companies. He preferred to sell his shares in the companies rather than see the companies wound up and he made an offer to that effect.

The trial nevertheless was held before Mr Justice Moore on March 29, 1974, and lasted five days during which period four and a half were taken up in cross-examination of the only witness, Mrs Jager. Negotiations between the parties were entered into and a settlement reached whereby Mr Jager would purchase all of Mrs Jager’s shares in both Jager Holdings and Jager Homes for $1,000,000.

On April 9, 1974, by order of the Court, the petition was dismissed and Jager Holdings and Jager Homes were to pay all solicitor’s and client’s accounts.

The statement of account for services rendered by the legal firm of Mc- Caffery and Company was $56,179.03. By agreement between the parties, the legal fees attributable to the winding-up proceedings were established at $36,800 for both Jager Holdings and Jager Homes. It is the deductibility or otherwise of this amount that is in issue and the question is whether we are dealing with capital or operational expenditures.

It is clear, therefore, that the sums in issue were expenses actually incurred by these two corporate taxpayers to defend an action brought for the purpose of dissolution of the two companies. The problem is particularly troublesome because on the one hand, legal fees are normally related to company operations and accordingly are deductible as operating expenses, while disputes over dissolution normally relate to the division of the assets rather than to operational expenses. Once a corporation is in existence and carries on business, almost every capital acquisition assists in the production of income and every improvement in the ability to earn income should produce an increased value in shares which are, of course, capital assets. Rarely, therefore, are the differences between expenses for capital and income account precise and clear, and the distinction becomes even more blurred when it relates not to the company activity itself, but to legal expenses incidental to it.

I have been greatly assisted by the very extensive review of the relevant jurisprudence in the decision of my colleague, Dube, J, in BP Oil Limited v The Queen, [1979] CTC 174; 79 DTC 5121. There is a significant distinction in the facts of these two cases which leads me to a different conclusion than that reached by my learned colleague, but his analysis of the law provides an excellent outline of the principles applicable to this case. In the cases at issue here, the two companies, Jager Homes and Jager Holdings, incurred legal expenses to defend a lawsuit which threatened to bring operations to a halt. The companies were driven to take this step as a consequence of the appointment of interim receivers or managers and because by virtue of the initial orders of the Court, officers of the companies were denied access to the premises and were prevented from carrying on meetings or otherwise managing the companies. The effect was an injunction restraining the companies from carrying on business. It is true that an order for dissolution would also affect the corporate shell which, of course, is a capital asset, but surely the far more dramatic consequence was to cause both companies to cease to operate. It was this result that was resisted; it was in resisting this very dire consequence that the legal expenses were incurred.

In the BP Oil Limited v The Queen, supra, decision, my brother, Dube, J, came to the conclusion that legal expense, to resist an injunction related to the right to operate, is properly classified as an expense incurred for the purpose of producing income pursuant to paragraph 18(1)(a) and therefore properly deductible unless it was related to the preservation of a capital asset, as contemplated in paragraph 18(1 )(b), which in the particular circumstances of that case he determined it to be. In the cases before me, the same test applies, except that in the last and most significant determination, I find as a fact that preservation of the corporate shell as a capital asset was incidental to the lawsuit and that the main purpose of the lawsuit was to safeguard the operations of the company.

I concur entirely with the conclusion reached by the learned Chairman of the Tax Review Board that, in the circumstances, the matter should be re- ferred back to the Minister for reassessment on the basis that the legal expenses incurred in the lawsuit in issue here for the purpose of producing income are found within the exception in paragraph 18(1 )(a) and were not outlays or payments on account of capital within the meaning of paragraph 18(1)(b).

The actions are therefore dismissed with costs.