Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: Several questions about the deductibility of legal expense under paragraph 8(1)(b) of the Act.
Position: See response.
Reasons: See response.
Author: McCarthy, Kathryn
Section: 8(1)(b), 6(1)(a)
April 11, 2018
Re: Deduction of legal expense
We are writing in response to your correspondence dated April 13, May 14, and June 22, 2017, and our subsequent conversations (Underhill/ XXXXXXXXXX and McCarthy/XXXXXXXXXX). We apologize for the delay in our response.
Legislative references are to provisions of the Income Tax Act (“Act”).
You had several questions about the deductibility of a taxpayer’s legal expense, from employment income, under paragraph 8(1)(b) of the Act. The determination of the income tax treatment of the legal fees described in your letter involves questions of fact that can only be determined after reviewing all of the relevant facts and documentation. Based on the information available to us, we are prepared to offer the following general comments.
This technical interpretation provides general comments about the provisions of the Act. It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of a particular transaction proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R7, Advance Income Tax Rulings and Technical Interpretations.
If a legal expense is incurred by a taxpayer in a prior tax year to collect, or establish a right to collect an amount that will be included in the taxpayer’s employment income in a subsequent tax year, in which tax year is the legal expense deductible for the taxpayer?
It is always a question of fact whether a particular legal expense is deductible under paragraph 8(1)(b) of the Act for a particular taxpayer. Paragraph 8(1)(b) of the Act generally provides a deduction from employment income for legal expenses paid by the taxpayer in the year. The expense must not only be paid, it must also be incurred by the taxpayer to collect (or to establish a right to collect) an amount owed to the taxpayer that, if received by the taxpayer, would be required to be included in the taxpayer’s employment income. For the purposes of paragraph 8(1)(b), employment income includes amounts that would be required to be included in computing a taxpayer’s income under subdivision a, of Division B of the Act. Subdivision a, of Division B of the Act contains sections 5 through 8 of the Act.
Can a taxpayer request an amendment to a previous tax year individual Income Tax and Benefit Return (“T1 Return”), to claim a deduction for legal expenses under paragraph 8(1)(b) of the Act, that was paid in that year, if the established employment income is not paid until a subsequent tax year?
If the conditions to claim a deduction under paragraph 8(1)(b) of the Act are met, a taxpayer may request an adjustment to a T1 Return for the legal expenses that were paid in the previous tax year (generally within 3 years).
Is a deduction for legal expenses under paragraph 8(1)(b) of the Act only allowed when the claim is well founded in law, or is likely to succeed?
Paragraph 23 of Archived Interpretation Bulletin IT-99R5 (IT-99R5), Legal and Accounting Fees, states that a deduction for legal fees is only allowed in respect of an amount owed by an employer. IT-99R5 also states that if a taxpayer is unsuccessful in court and fails to establish that an amount is owed, then no deduction is allowed. However, those comments are no longer accurate based on the decision in John Loo v. the Queen (2004 DTC 6540). In that case, the Federal Court of Appeal ruled that a taxpayer’s legal action need not be successful in order to deduct an amount under paragraph 8(1)(b) of the Act. The CRA has since published technical interpretations to state its position, based on the Loo case, to no longer tie the deduction of the expenses to the successful outcome of the case.
However, it is still necessary to examine the nature of the action against the employer to establish whether the order sought by the taxpayer is for an amount owed to the taxpayer that would be included in income under subdivision a of Division B. Cases involving the deductibility of legal fees paid to establish a right to a promotion or a raise or where the claimant is seeking financial compensation in connection with allegations of unlawful or wrongful acts by an employer remain distinguishable.
For the purposes of paragraph 8(1)(b) of the Act, how is it determined if the taxpayer has collected or established a right to collect an amount owed?
For the purposes of paragraph 8(1)(b) of the Act, the taxpayer needs to look at the purpose of incurring the legal expense to determine if the purpose was to collect or establish a right to collect an amount owed. This approach is consistent with the Loo case, where the FCA states that “Paragraph 8(1)b) requires a determination as to the purpose for which legal expenses were incurred. If the legal expenses were incurred in pursuing a claim that falls within the words of paragraph 8(1)(b), the expenses are deductible.”
Are legal expenses paid by an individual (to reinstate the individual’s former employment position), deductible under paragraph 8(1)(b) of the Act when employment is reinstated without retroactive pay?
The legal expense incurred for the purposes of paragraph 8(1)(b) of the Act must be incurred by the taxpayer to collect, or to establish a right to, an amount owed. In Loo, the FCA referred to the New Oxford Dictionary of English (1998, Clarendon Press, Oxford) definition of the word “owe” as “an obligation to pay or repay (something, especially money) in return for something received.”
While the legal expenses paid may have facilitated the reinstatement of the individual’s employment, the legal expenses were not incurred to collect (or establish a right to collect) an amount that was owed and required to be included in employment income under subdivision a of Division B. As such, the legal expenses incurred would not be deductible under paragraph 8(1)(b) of the Act.
We trust our comments will be of assistance to you.
Shiri Trop CPA, CA, MTax
Business and Employment Income Section
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without the prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5.
© Her Majesty the Queen in Right of Canada, 2018
Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.
© Sa Majesté la Reine du Chef du Canada, 2018