2019-0824081E5 Deductibility of legal fees

Principal Issues: Whether legal fees deductible under paragraph 60(o) can be carried forward to a future year and deducted as a non-capital loss.

Position: No.

Reasons: Legal fees deducted under the circumstances provided are not related to a source of income, and therefore cannot be carried forward to a future taxation year in accordance with paragraph 60(o) and 3(c) of the Act.

Author: Clarkson, Julia
Section: Paragraph 60(o) and section 3

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                                                                                                                            2019-082408
                                                                                                                            Julia Clarkson

March 13, 2020

Dear XXXXXXXXXX:

Re: Carry forward of legal fees to future taxation years

We are writing in reply to your request of September 20, 2019, in which you requested our comments on how to deduct legal fees in a future taxation year. We also acknowledge our discussions of November 12 and December 5 and 10, 2019 (Clarkson / XXXXXXXXXX).

You have informed us that your client, an individual that is not a trust, has been objecting to taxable employment income assessed in XXXXXXXXXX. He has been objecting to this assessment for XXXXXXXXXX years. During the course of those XXXXXXXXXX years, your client has incurred legal fees that were in excess of his personal taxable income. Aside from the reassessed employment income, the taxpayer had no taxable income in those years that could be reduced by the legal fees. The legal fees were not related to a source of income. Specifically, they were not incurred to collect, or establish a right to, employment income. You have informed us that you consider the legal expenses to be deductible under paragraph 60(o) of the Income Tax Act (“the Act”).

Issue

You have requested our opinion on how to claim these excess amounts on your client’s T1 form in future taxation years, as the form, specifically line 232, does not provide for a way to create a carry forward of a non-capital loss of an individual.

Our comments

This technical interpretation provides general comments about the provisions of the Income Tax Act and related legislation (where referenced). 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 particular transactions 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 70-6R9, Advance Income Tax Rulings and Technical Interpretations.

Paragraph 60(o) of the Act allows a taxpayer to deduct “amounts paid by the taxpayer in the year in respect of fees or expenses incurred in preparing, instituting or prosecuting an objection to, or an appeal in relation to, (i) an assessment of tax, interest or penalties under this Act...” Based on the facts provided, this appears to be the section of the Income Tax Act that would authorize the deduction of the legal fees incurred by the taxpayer.

Internal interpretations 2010-0374081I7 and 2001-0114917, which were provided to you on XXXXXXXXXX, provide a good summary of how legal expenses deductible under section 60 of the Act impact a taxpayer’s taxable income for the taxation year.

To summarize those interpretations, the deductions allowed by section 60 reduce any income subject to Part I tax, notwithstanding that the amounts may not relate to a particular source of income.  This is confirmed by both the wording in the preamble of section 60, as well as by the calculation provided by section 3 and subsections 4(2) and (3) of the Act.

Paragraph 3(a) requires a taxpayer to determine the amount of each (net) income for the year "from a source", including income from each office, employment, business and property. Legal fees deductible under paragraph 60(o) are not deductible in determining income or loss from a source, and therefore are included in this calculation in accordance with subsections 4(2) and (3). For the same reason, such legal fees are not included in the calculation of a non-capital loss, as described in subsection 111(8) of the Act.

As they are not covered by paragraph 3(a), legal fees deductible under paragraph 60(o) are considered in the calculation described in paragraph 3(c). The result of a paragraph 3(c) calculation cannot be negative. This is supported by the wording of paragraph 3(c): “the amount, if any, by which the total determined under paragraph (a)...exceeds the total of deductions permitted...”

Based on this calculation, and the calculation of non-capital loss described in subsection 111(8), no non-capital loss can be created by legal fees described in paragraph 60(o).

As a result, the amounts cannot be carried forward to future taxation years. Unfortunately this means that, in effect, the excess legal fees are lost.

We trust these comments will be of assistance.

Yours truly,

Terry Young CPA CA
Section Manager
for Division Director
Administrative Law
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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