Legal and other Professional Fees

The taxpayer (Mobile), which was owned by a German family, sold its two Toronto properties in 2002 and 2003 for $7.3 million, with most of that sum being diverted by one of its directors (Black), without the authorization of the family, by lending it at 2% interest to his company, which was or became insolvent. 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 accounting 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 (TA, s. 129, similar to ITA s. 18(1)(b) – although TA s. 128, similar to ITA s. 18(1)(a), was also invoked).

In affirming the finding below that the professional fees were currently deductible, the Court stated (at paras.18-20, TaxInterpretations translation):

An expense to maintain a capital asset in good order will be deductible in computing business or property income as a current expense. In this case, the legal fees were incurred to recover the money misappropriated by Mr. Black, which capital existed long before the misappropriation. Therefore, these expenses did not increase the market value of the asset, replace a lost asset or create a new asset. As the judge stated, the fees had to be incurred to prevent the loss of the asset in order to make it grow. He decided that the primary purpose of the respondent was to generate income from its assets, which it could not have done but for the expense incurred to remedy the situation.

Since the settlement provided for interest to be recovered first (it provides for compound interest), the purpose of the professional fees was to generate income.

The judge committed no reviewable error when he stated that the non-recurring nature of the expense was not determinative.

The main source of income of the taxpayer and her husband until they separated in 2010 was dividends paid by two family corporations (“JEL” and “Holm”) to a family trust, and then distributed by it to them. However, shortly after the separation, her husband refused to consent to the payment of dividends, to him and the taxpayer. This left the taxpayer with no source of income other than her RRSP, and she commenced an action including a claim for spousal support and an oppression remedy. At issue was the deductibility of legal expenses identified by CRA as relating to the oppression litigation. This was settled with a settlement agreement pursuant to which the taxpayer “received a dividend payment of $1,533,469.16 as a result of her transferring 237 preferred shares of JEL to Mr. Richards” (para. 20).

After having noted (at para. 19) that, regarding the oppression action, the taxpayer “agreed on cross-examination that the main relief she sought was the redemption of her shares, McPhee J allowed the deduction of only about 25% of the legal expenses, on the grounds that the balance were capital expenditures, stating (at paras 38, 44-45):

Legal expenses incurred for the purpose of preserving capital assets are not deductible [citing Keating].

… [T]he fees incurred pursuing the Oppression litigation had as its dominant purpose, the intention to protect the Appellant’s interest in her shares in the corporations. Therefore, for the majority of the Oppression litigation expenses, I do find they were capital in nature, and therefore not deductible under paragraph 18(1)(b) of the Act.

But in this very particular fact situation, there is no question that professional fees were incurred seeking both the support and/or the payment of dividends by the corporations and the redemption of the Appellant’s shares. These costs were intermingled. Therefore, I have apportioned the fees in issue. … I will make an estimate that 25% of amount paid in the Oppression litigation was incurred in order to receive income.

The taxpayer, a Canadian public company listed on the TSX, NYSE and LSE, incurred fees (mostly of investment dealers, law firms, and a French lobbying and public relations firm (“Publicis”)) in connection with its decision to make a hostile bid for a French public company (“Pechiney”) and the subsequent making and completion of that bid late in 2003. In 2004, the taxpayer determined to effect a butterfly spin-off of a portion of its (laminated products) assets, held through subsidiaries, which resulted in the receipt by its shareholders of shares of a new public company (“Novelis”) in January 2005.

After quoting Bowater and Wacky Wheatley, and referring (at para. 72) to "fees for services that assist the board in the decision-making process and in the fulfilment of its oversight function" as “Oversight Expenses,” Hogan J stated (at para. 88):

Simply put, Oversight Expenses are current expenses because they relate to the management of a corporation’s income‑earning process. ... This is to be contrasted with expenses incurred as part of the implementation of a transaction leading to the acquisition of capital property.

Applying this principle, 35% of the $8.2 million fee paid to Lazard Frères related to work leading to advice to the taxpayers’ board of directors respecting whether, and on what terms, an offer should be made for the Pechiney shares and, therefore, was fully deductible under s. 9, whereas the balance, which related to the negotiation and revision of the offer, was a capital expenditure (which CRA accepted was part of the cost of the Pechiney shares). The same approach indicated that 65% of the $26 million fee paid to Morgan Stanley (including respecting a fairness opinion) was fully deductible, as relating to the work culminating in the advice to the board, as well as indicating that Novelis-related fees of Lazard Frères (to the extent allocable to the work on divestiture options incurred up to the time of board approval of the butterfly spin-off) were fully deductible - with the balance (relating to the Novelis-transaction implementation) being incurred on capital account.

All of the $19 million fee paid to Publicis was a capital expenditure (added to the Pechiney share cost) as its “underlying purpose ... was to facilitate a smooth implementation of the Pechiney takeover.” (para. 112). Various miscellaneous legal and other expenses also were on capital account given the absence of convincing evidence that they were for other than facilitating the acquisition.

The taxpayer incurred over $40,000 in legal expenses in an unsuccessful attempt to reduce child support payments made to his ex-wife. Masse DJ stated (at para. 20) that he agreed with the taxpayer "that it is not right that a parent who incurs legal expenses in order to obtain child support is entitled to deduct the legal expenses from income whereas the parent who incurs legal expenses in order to prevent child support from being established or increased or to decrease or terminate child support cannot deduct these legal expenses from income." However, as "the Tax Court of Canada is not a court of equity" (para. 21), the taxpayer's appeal seeking deduction of these expenses was dismissed.

The taxpayer owned 50% of the shares of a corporation ("DPX") which made heavily leveraged investments. The taxpayer's wife expected to receive $2.1M cash following their separation. Because of the risky nature of DPX's portfolio, borrowing this sum was infeasible. The taxpayer instead incurred legal fees in order to delay the process for reaching a final settlement (which took three and a half years).

Graham J accepted that "the predominant purpose for which Mr. Kondor incurred the legal fees was to protect the value of his shares in DPX" (para. 11). Therefore, the fees were incurred for the purpose of producing income from property.

Nevertheless, Graham J disallowed the taxpayer's deduction of the legal fees because they were incurred to preserve a capital asset, and were therefore on capital account.

The taxpayer incurred substantial legal fees to defend unsuccessfully against proceedings by the Alberta Securities Commission respecting false or misleading disclosure in the financial statements of a public company for which he was the CFO. He was fined by the ASC and prohibited from trading, and six years later the Alberta Institute of Chartered accountants rescinded his professional designation.

Campbell J found that the taxpayer (who at the time of the ASC investigation earned income from employment and also looked to earning gains from private placements) could not deduct the legal and professional fees in computing income from a business (namely, chartered accountancy as an alleged source of income), as the two were not substantially connected. She stated (at para. 54):

In both Leduc and in the appeals before me, the professional licenses were in no immediate risk at the time the expenses were incurred, despite the possibility that failure to defend the allegations could lead to future disciplinary action that had the potential of removing the professional designations.

And at para. 48:

[T]he Fees ... arose due to his conduct and actions in the capacity of President and director ... [and] were not incurred as a result of his business activities as an accountant.

The taxpayer was a shareholder in a corporation ("Canadevim"), and incurred legal fees contesting Canadevim's assignment in bankruptcy, a GST/QST assessment against Canadevim, and a personal tax appeal.

Bédard J found that the taxpayer could not deduct the fees as property expenses under s. 9. The fees could not have been for earning income from the Canadevim shares, as Canadevim was bankrupt. Moreover, they were capital in nature, and therefore not deductible as per s. 18(1)(b).

The taxpayer, a physician, sought retribution against an arbitrator who had ruled against her in a medical dispute. The arbitrator successfully sued the taxpayer for what amounted to a "vendetta" to sabotage his professional standing and have him criminally prosecuted, and he was awarded punitive damages.

Hogan J found that the taxpayer's legal fees incurred in the arbitrator's suit were not a business expense, as there was no connection between the relevant legal expenses and the business. He noted in particular that the expenses could not have been incurred to enable the taxpayer to continue her professional practice, given that her practice had continued even though the arbitrator's suit could not have turned out worse for her (para. 37).

The taxpayer sold his shares in a corporation for $300,000 but was only paid $25,000. In subsequent debt restructuring proceedings under the Bankruptcy and Insolvency Act, he personally paid $3000 to his bankruptcy trustee's counsel, who was charged with recovering the $275,000 in unpaid amounts for the shares.

Lamarre J. found that the $3000 payment was a capital outlay rather than a business expense. The payment had been made in order to recover proceeds of disposition of the shares, and those proceeds would have given rise to a capital gain.

The taxpayer's argued that he had a business purpose in incurring his expenses, given that his goal was to avoid bankruptcy and thereby keep his professional title (as a certified general accountant) and thereby preserve his source of income. In light of the above analysis, this argument was irrelevant to the conclusion that the payment was capital in nature.

Lamarre J. disallowed the taxpayer's deduction of legal fees connected with defending against an action to vary spousal support orders. Lammare J. found that it is "settled law" that legal fees incurred to prevent or reduce support payments are not made for the purpose of earning income (para. 8).

The taxpayer incurred legal and accounting fees in 1997 and 1998 of approximately $1.9 million in connection with a complicated reorganization of the manner in which it financed its investment in its US subsidiaries. The end result of the reorganization was that it financed that investment through a Luxembourg subsidiary so that cash flow paid out of the US subsidiaries was subject to US withholding tax of 5% and to Luxembourg income tax of 5% - whereas if it had continued to maintain its previous structure, such distributions would have been subject to a 30% US withholding tax rate due to an adverse change in the US tax regime.

In finding that these were capital expenses, Hershfield J noted (at para. 88) that they were paid in order to create an entirely different "pipeline" or structure for maintaining the after-tax cash flow of the taxpayer, noted (at para. 92) that in Imperial Tobacco (and similarly in Kaiser Petroleum) "that an outlay made in the course of a corporate reorganization to achieve an assurance that some end goal will be completed or achieved in a manner that will have value, will be on capital account," and that although the tax benefits of this new structure would last only three years due to impending changes in the US-Luxembourg treaty, this nonetheless represented an enduring benefit because more than the current period was benefited (para. 98).

The taxpayer incurred legal costs in the course of his 2006 divorce proceedings, which centered around custody of the couple's child. An interim court order on consent in 2001 gave the taxpayer sole interim custody and the spouse 50% access with supervision, and imposed an obligation on the taxpayer to pay $350 in monthly child support to the spouse. Nevertheless, the child in fact stayed with the taxpayer alone because appropriate supervision at the spouse's house was not available.

The Minister disallowed the taxpayer's deduction of legal costs incurred in the taxpayer's unsuccessful claim to receive child support payments, on the grounds that because of the 2001 order the taxpayer had no pre-existing right to child support. Woods J. disagreed at para. 23: "The legislative obligation to support children does not cease with a court order, and especially a court order providing for interim support only." The Minister also argued, but could not establish in evidence, that the taxpayer had abandoned his claim for child support.

Before going on to find that legal fees incurred by the taxpayer in successfully defending its president from criminal charges laid on the basis of an indecent act allegedly performed by him in the course of his employment were deductible, Lamarre Proulx J. stated (at para. 44):

"In the case of an alleged act that is not inherently linked to work activities, if the person is found guilty, the person has committed an act that is outside the sphere of work. A sexual act is necessarily outside an employee's sphere of activity."

After noting (at para. 25) the distinction "between fees incurred to affirm a right and those incurred to acquire a right", Angers J. found that legal fees incurred by the taxpayer in connection with recovering an amount equal to the value of her son's RRSP which was wrongfully paid to his estate rather than to her, plus interest thereon, were fully deductible given that these fees were incurred "in order for the appellant to have returned to her that which was rightfully hers after the passing of her son, and they were not incurred for the purpose of acquiring a right" (para. 26).

Legal fees incurred by the taxpayer in order to obtain a court order confirming that the taxpayer no longer was required to make child support payments were not deductible.

In finding that professional fees incurred by a corporation for the preparation of shareholder agreements were fully deductible with the exception of the portion acknowledged by the taxpayer to be eligible capital expenditures, McArthur J. found that the revised Shareholder Agreements gave rise to a corporate structure that made the business of the corporation more profitable and, respecting an argument that the expenditures were on capital account, indicated (at p. 2934) that he would "liken the redrafting of the Shareholder Agreements as the maintaining of an asset and (at p. 2935) the Shareholder Agreements were "amended to function as originally intended".

Legal fees incurred by the taxpayer in bringing an oppression action against her estranged husband and his companies for depleting her company of assets were incurred for the purpose of preserving a capital asset, and were not deductible.

The taxpayer, who was employed by an Indonesian firm for part of 1998 until his employment was terminated, was found to have remained a factual resident of Canada given the significant ties he maintained with Canada.

$140,000 in legal fees incurred by the taxpayer, a practising solicitor, to defend against sexual abuse charges, were found not to have been incurred for an income-producing purpose and to have their deduction denied by s. 18(1)(h). He would have incurred the expenses irrespective whether or not he was engaged in his profession, and it was not established that successful prosecution of him would have caused him to be disbarred.

After receiving an unsolicited hostile bid from another public company (BJ"), the taxpayer retained legal and accounting advisers (whose fees were admitted to be deductible) and financial advisers, and after it secured a higher bid from another public company ("GLCC"), the first bidder responded with a higher bid, which was accepted, with the result that ultimately all the shares of the taxpayer were acquired by BJ, which merged with it. In finding that the financial advisory fees, together with fees payable by the taxpayer to GLCC (including a "break" fee) were deductible, Campbell J. noted (at p. 2041) that these expenses "not only satisfied a need of the company but were necessitated in dealing with the practicalities of a takeover bid environment", that "it is a basic common sense approach to view maximizing share price as inexplicably interwoven with the business of any company, whether that be public or otherwise" (p. 2042) and that "given the circumstances, the expenses were part of the general overall costs, a corporation must incur to earn income, even though these expenses have no direct link to revenue generating activities but are related to shareholder interests"(p. 2043).

Professional fees incurred by the taxpayer in seeking to expand its distribution network by making acquisitions (typically through share acquisitions) in order to add franchised stores to its network or acquire corporate stores, were on capital account. In the case of successful acquisitions, the professional fees were added to the costs of acquisition. Where the projects instead were abandoned (including a contemplated takeover bid), the costs nonetheless were capital outlays (which the Minister had treated as eligible capital expenditures).

The taxpayer was the successor by amalgamation to a holding company ("SB Holdings") and its subsidiary ("SB Canada"). When a minority shareholder of SB Canada ("Candou") became bankrupt, SB Holdings purchased those shares from Candou for $6 million, and sold them six years later for $34 million.

The taxpayer incurred legal fees in successfully defending a frivolous action brought by a creditor of Candou alleging that the $6 million purchase price was fraudulently undervalued. In finding that the fees were deductible, McArthur T.C.J. indicated that in defending the suit the taxpayer was not acquiring or preserving an enduring benefit but was protecting its income (the creditor was after money that the taxpayer required to carry on its normal operations and the action had to be defended to protect its profitability and reputation) and that SB Holdings had not committed any deliberate delict.

A research program supervised by the taxpayer, who was associated with a Montreal hospital, was found to be a business in itself that was intended to produce exploitable intellectual property. Conversely, the taxpayer was not an employee of the hospital or an associated institute, notwithstanding that research grants were received by him from the institute. Accordingly, legal fees incurred by him when the institute terminated research grants were deductible.

The taxpayer, which held 32% of the outstanding common shares of another privately owned corporation ("Kruger") brought a statutory oppression remedy against Kruger as a result of Kruger ceasing to pay significant dividends on its shares. In addition to seeking the payment of the special dividend and a resumption of the ordinary dividends, alternative remedies were requested in order to bring additional pressure to bear on Kruger. The action was settled by Kruger agreeing to redeem the taxpayer's common shares for a substantial amount.

In finding that various legal and other fees incurred by the taxpayer in connection with the oppression remedy and various collateral actions were deductible, Archambault T.C.J. noted that the taxpayer's purpose was to receive more income for a relatively short period of time and that in applying for a remedy against oppression, the taxpayer was only exercising its right created by a statute rather than seeking the creation of a new right.

Legal fees incurred by the taxpayer in unsuccessfully defending narcotics charges were non-deductible as being of a personal nature (he was not seeking to justify the manner in which he carried on his business but, rather, to keep himself out of jail and to put the Crown to the proof that he carried on the business in question at all).

Professional fees incurred in connection with a share reorganization of the taxpayer in which its shareholders transferred their shares to a holding company were found not to be incurred in connection with any activities which formed part of the business by which the taxpayer earned income and were incurred in connection with its dealings with its own shareholders as shareholder. Accordingly such fees were for capital purposes and, as capital expenditures, were to be treated in accordance with a concession of the Minister, as eligible capital expenditures.

Professional fees relating to proposed acquisitions of other corporations that did not proceed also were outlays on capital account.

Legal and accounting fees paid by the taxpayer in connection with the preparation of management circulars, which were sent to shareholders in response to three take-over bids, were fully deductible. The circulars were required to be prepared by section 134 of the Securities Act (Quebec), whose purpose was to ensure that all shareholders were given equal access to adequate information in the course of a take-over bid, and "having to look after one's shareholders is part of the periodic administrative duties of a company doing business" (p. 171). In addition, respecting s. 18(1)(b), the expenditures did not give rise to an identifiable enduring benefit. However, in obiter dicta, Archambault T.C.J. indicated (at p. 174) that if, contrary to the facts in this case, the board had been hostile to the take-over bids and had incurred expenses in order to fight the bids and maintain the status quo, s. 18(1)(b) would have applied.

The taxpayer paid legal and accounting fees of $110,844 and $19,940, respectively, incurred by its principal shareholder as a result of his breach of an agreement with the other shareholder of the taxpayer. These amounts were non-deductible given the inability of the taxpayer to establish some connection between the earning of income and the payment of the fees.

Legal expenses incurred by the taxpayer in successfully defending against charges brought under s. 239 arising out of his failure to report commission income from a business of selling electrical generators for a U.S. corporation, were non-deductible. Such expenses could not be characterized as "money spent to defend a normal business activity carried out in the course of business operations or which had been carried out for the purpose of gaining or producing income" (p. 1491). Rather than defending his way of doing business, he was defending a personal decision not to declare the United States income.

Legal expenses incurred by the taxpayer in obtaining a court order which reduced the amount of alimony payments which he was required to make to his former wife, were non-deductible. "A spouse enforcing a right to obtain a court order for reducing alimony payments is not enforcing an income producing right, but is enforcing a right to sue to diminish the amount to be paid by virtue of an obligation to pay" (p. 1037).

Legal expenses incurred by an estate with an extensive portfolio of investments in connection with obtaining probate; determining the extent of the entitlement of various beneficiaries; managing and supervising the investments; devising and carrying out plans to minimize taxation of the estate, beneficiaries and companies within the group; and investing in liquid assets; were non-deductible.

The petitioner, whose shares were traded on the NYSE, incurred legal fees of $490,000 and a fee of $2.2 million from Morgan Stanley (primarily for a fairness opinion) in connection with the friendly take-over bid of the petitioner by the Unilever Group pursuant to which shareholders of the petitioner had a choice between receiving cash or exchanging their shares on a rollover basis for shares of a Unilever company. These, and related fees, did not qualify for deduction under s. 162(a) of the Code as being "ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business":

"Petitioner's directors determined that it would be in petitioner's long-term interest to shift ownership of the corporate stock to Unilever. The expenditures in issue were incurred incident to that shift in ownership and, accordingly, lead to a benefit 'which could be expected to produce returns for many years in the future.' E.I. Du Pont De Nemours and Co. v. United States, 432 F. 2d 1052, 1059 (3d), Cir. 1970. An expenditure which results in such a benefit is capital in nature."

Legal and accounting fees which the individual taxpayer incurred in the enforcement of his rights under a shareholders' agreement, which culminated in the receipt by him of deemed dividends on the purchase for cancellation by the corporation of his common shares, were "like expenses incurred to collect rents, royalties or other income from property," and were fully deductible.

Professional fees which were incurred for the purpose of a bond issue which did not take place, and which issue would have been the means of acquiring the assets of a company similar to the taxpayer, were non-deductible. Because the professional fees were to have assisted in acquiring the total assets of another company, they were not operating expenses and instead were paid on account of capital.

The day-to-day conduct of the business of the taxpayer was significantly hampered by its 1773 charter, which limited its borrowing powers to £25,000, and contained restrictions on the transfer of shares coupled with stringent qualifications for voting that effectively precluded the management of the company by a salaried official with a status equivalent to that of a managing director. In order to obtain a supplementary royal charter which removed these restrictions on profitable trading, the company first had to pay £88,000 to two of its shareholders in settlement of their opposition to such a change, and then obtained the supplementary charter itself at a cost of £3,107.

The expenditures were deductible. In finding that the expenditures were incurred on income account, Lord Reid stated (p. 68):

"This money was spent to remove antiquated restrictions which were preventing profits from being earned. It created no new asset ... 'The benefit was essentially of a revenue character because the Company became able more easily to finance its day-to-day transactions, and more efficiently to carry on its day-to-day manufacture.'"

A company engaged in a sugar refining business was entitled to deduct expenses of propaganda campaign directed against the nationalization of the sugar refining business, on the basis that such expenses were "wholly and exclusively laid out or expended for the purposes of the trade" within the meaning of rule 3(a) of the Rules applicable to Schedule D, Cases I and II. Lord Morton stated (p. 39):

"If the assets are seized, the company can no longer carry on the trade which has been carried on by the use of these assets. Thus the money is spent to preserve the very existence of the company's trade."

It was also noted (by Lord Reid at p. 55) that if the proposed nationalization had entailed an acquisition of the shares of the company rather than its assets, the expenditures would have been non-deductible.

The taxpayer reorganized its affairs in order to commence manufacturing and selling a superior type of refridgerator upon the expiry of the patent for that refridgerator that had been granted to the competitor. In finding that legal fees incurred by the taxpayer in opposing a petition by the competitor to extend the life of the patent were deductible, Latham C.J. stated (at p. 191):

"A right enjoyed in common with all persons is not a capital asset of any single person ... . [E]xpenditure in the defence of a right enjoyed in common with all His Majesty's subjects is not expenditure incurred in obtaining anything. It is an outgoing of the business incurred in keeping the business going on the same basis as in the past, without any change in the constituent elements of the profit-yielding structure."

A company, which after a history of losses had become profitable, was precluded from paying dividends because of a substantial deficit. In order to permit the company to resume the payment of dividends, it incurred legal and other expenses in accomplishing a reduction of the capital of its issued shares. These expenses were found to have not been "made for the purposes of the trade of this Company, but for the purposes of distributing the profits of its trade, after these profits have been earned" (p. 162). Accordingly, the expenses were non-deductible.