Damages

The taxpayer (Mobile), which was owned by the Waibel family in Europe, sold its two Toronto properties in 2002 and 2003 for $7.3 million, with $7.258 million of that sum being diverted by one of its directors (Black) without the authorization of the family. After this was discovered in 2004, an action was commenced against Black and the other director (Black’s mother), with the action being settled in 2012 by the payment by Black of a sum plus interest thereon at 5%. The ARQ reassessed to deny the deduction by Mobile of legal and other professional fees incurred by it in investigating the disappearance of the sales proceeds and in relation to the Superior Court action, primarily on the basis that they were capital expenditures.

In finding that the legal expenses were deductible, Cameron JCQ stated (paras. 77, 82, TaxInterpretations translation):

The outcome of the dispute, as far as the Waibel family is concerned, is the confirmation, by a settlement agreement that is as valid as a judgment and that has been implemented, of Mobile's right in the capital, a right that Mobile also had as soon as the funds were misappropriated, and the establishment of an interest rate of 5% on this capital, all secured by real estate guarantees. The result: the receipt of amounts, as interest, that was not a capital transaction, and that was income arising from property, the property being Black's obligation arising from the misappropriation, as confirmed by the legally binding effect of a settlement. …

The analogy with the Kellogg and Evans cases is not perfect, because the former involved a business and the latter involved income from a trust, but it is sufficient to convince us that an expense is not capital in nature simply because the expense is not recurring or extraordinary.

Due to an insufficiency of funds of Mobile, some of the expenses in question were funded by a limited partnership (KG) of the Waibel family, with the KG subsequently reimbursed by Mobile. Cameron JCQ found that this manner of funding the expenses did not detract from expenses in such amount having been incurred by Mobile.

The taxpayer was permitted to deduct as a business loss amounts paid by her in settlement of claims brought by a franchisor against her bankrupt husband, who had personally guaranteed franchise obligations of companies in which they had invested. McArthur J. noted (at para. 18) that in determining the potential deductibility of damages "it is appropriate to focus on the origin of the claim" and found that the origin of the claim was a franchise agreement which was entered into by the two companies for the purpose of earning income from a hotel business. He went on to find that if the purpose of making the settlement was instead relevant, that purpose was to allow the taxpayer and her husband "to continue carrying business in the motel industry" (para. 23) and that although the settlement also preserved the assets to the corporations, this was a secondary purpose.