Tax Court of Canada Judgments

Date: 20000501

Docket: 98-2260-IT-G

BETWEEN:

MELVYN L. SOLMON,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Sarchuk, J.T.C.C.

[1] This is an appeal by Melvyn L. Solmon from an assessment of tax with respect to his 1994, 1995 and 1996 taxation years. In computing his income for those taxation years, the Appellant deducted legal fees of $21,000, $43,317 and $38,648, respectively. The Minister of National Revenue (the Minister) reassessed the taxation years in issue to disallow the deduction of the legal fees claimed.

[2] In assessing as he did, the Minister assumed that:

(a) the Appellant's business is the practice of law;

(b) the Appellant incurred legal fees of $21,000 in 1994, $43,317 in 1995 and $38,648 in 1996 for the purpose of obtaining a judicial determination of several issues relating to his ongoing support obligations; and

(c) the Appellant did not incur the legal fees for the purpose of gaining or producing income from business or property.

[3] The Appellant is a barrister whose practice for the most part is commercial litigation. He was married to Richelle Gordon (Richelle) in June 1975 and there are two children from that marriage, Kerah and Tasha (now 20 and 15, respectively). In February 1987, they separated, matrimonial proceedings were commenced and an interim support order was made by Master Cork in July 1987.[1] The Appellant and Richelle were divorced in April 1988. According to the Appellant, from the outset the dispute was decidedly acrimonious and every issue: custody, access, support payments, the method of making payments, etc. were, and in some aspects continue to be, hotly contested. On July 5, 1989, following a 12-day trial a judgment for support order was pronounced by Sutherland J.[2]

[4] The Appellant says that pursuant to the Order of Sutherland J., he was to provide, inter alia, spousal support to Richelle and that in turn she was required to make certain payments out of the funds so provided to her. The Appellant says that she failed to make a number of required payments including such items as the mortgage payments with respect to the matrimonial home[3] and payments to the children's scholarship trust fund. He also says that she improperly claimed payments of monies for support to which she was not entitled and in particular, he asserts that Richelle presented a budget to the Court which was accepted but then treated the Appellant's child support obligation as open-ended.

[5] According to the Appellant, the legal expenses incurred related to his attempts to enforce compliance by Richelle of the "rights" granted to him by virtue of the various Orders of the Ontario Courts. These he categorized as follows:

(a) Claim Related to Mortgage Payments: Both the interim support Order of Master Cork and the Order of Sutherland J. required that the carrying costs associated with the matrimonial home be paid by Richelle which costs included the mortgage payments. According to the Appellant, Richelle stopped making the required payments on November 1, 1988. He attempted to have these payments enforced at the trial of the matrimonial proceedings, however, the trial judge declined to do so since the issue also involved the mortgagee which was not a party to the proceedings. The Appellant subsequently commenced a separate action in which he was successful in obtaining an Order requiring Richelle to repay to him mortgage arrears in the amount of $18,301.63 which he had paid in November 1991 (in substance twice in order to keep the mortgage in good standing).[4] The Appellant concedes that these amounts have not yet been collected and that the decision of Boland J. has been appealed by both parties.

(b) Claims Related to Payment of Taxes, Overpayment of Taxes: The interim Order of Master Cork stipulated that the amount of interim support payable by the Appellant was to be "exclusive of any tax thereby attracted". This tax was to be paid by the Appellant on or before April 30th in each year for the preceding year "provided that the wife provides to her husband her income tax return by April 23rd, failing which the husband shall have seven days after receipt of a proper income tax return to pay the said tax". In his Order, Sutherland J. directed that all taxes, interest and penalties payable to Revenue Canada pursuant to the Order of Master Cork were to remain the obligation of the Appellant. Sutherland J. also directed that the child support to be paid by the Appellant was to be net of all taxes and that commencing April 1992 a copy of the mother's income tax return was to be provided to the Appellant before April 15th of each year. In 1992, the parties not being able to come to an agreement, Walsh J. of the Ontario Court (General Division) ordered that a reference be directed to Evelyn McGivney to inquire and report as to the respective liability of the parties for the outstanding income tax, interest and penalties of Richelle for the years 1987 to 1991, inclusive and as to the appropriate amount of the gross-up of future support payments. The Appellant maintains that the arbitrator failed to take into account payments already made by him which resulted in an overpayment in excess of $20,000. He further says that Richelle was obliged to provide information to him to permit his accountants to determine the quantum of taxes he would be required to pay. He alleges she failed to provide the necessary information and/or provided incomplete information as a result of which there was an overpayment by the Appellant of income tax incurred by Richelle related to the support payments. He alleges that as a result of information recently obtained, he has overpaid his responsibility for her taxes by an amount exceeding $90,000. McGivney's report dated September 24, 1992 required the Appellant to pay in excess of $56,000 to Richelle. The Appellant says that several days after the report was completed and, following a discussion with counsel and Walsh J. in Chambers, he agreed to pay the amount stipulated in the report without prejudice to his right to oppose confirmation thereof. As I understood the Appellant, to date there has been no resolution of this matter.

(c) Claim related to Revenue Canada Interest Refund: The Appellant alleges that his wife's failure to provide him with her income tax returns and other relevant information on the due dates led to late filing and payment of the taxes the Appellant was responsible for on her behalf which led to the assessment of both penalties and interest which were in due course paid by him. In 1989, the Appellant sought a review of the assessments by Revenue Canada on the basis that Richelle's failure to provide him with the relevant returns and notices of assessment in contravention of the Court Orders had made it impossible for him to file and pay the taxes due on her behalf in time. In December 1992, the Appellant was advised that Revenue Canada had reconsidered his request in light of new legislation and confirmed that "the interest charges will be cancelled".[5] Revenue Canada also advised the Appellant that a statement of account indicating the amount to be refunded or to be used to reduce any current balance outstanding would be issued shortly. Apparently it was, but to Richelle, and although the Appellant ultimately obtained a copy of the statement of account, the money had been paid or credited to Richelle who has since refused to account to the Appellant for it. The Appellant takes the position that these funds are properly his and as a result, this issue is still before the Court by way of applications by both the Appellant and his former spouse for Orders varying the Judgment granted by Sutherland J. in July 1989.

(d) Overpayment of Support: The Appellant says he also incurred legal costs with respect to his attempts to recover amounts paid to Richelle for support to which she was not entitled and with respect to claims related to her failure to pay into the children's scholarship trust fund as required and claims regarding her general misuse of funds specifically provided for the personal expenses of the children.

(e) Reputation: When the foregoing issues were raised by the Appellant by way of several motions to amend the Orders of Sutherland J., Richelle moved to have him held in contempt of court and, according to the Appellant, filed affidavit material containing a number of false allegations attacking his professional reputation and integrity. As a result he says it was necessary to retain legal assistance and to obtain and tender substantial evidence to demonstrate that the accusations were unfounded.

Appellant's Position

[6] The Appellant contends that the legal expenses in issue were incurred to permit him to gain or produce income from property pursuant to paragraph 18(1)(a) of the Income Tax Act (the "Act") and in this context specifically relies on the definition of property as set out in subsection 248(1) of the Act.[6] The property in issue, he says, is the bundle of rights associated with various orders of the Ontario Court made in the course of the legal proceedings between himself and his former spouse. By way of example he argues that an item such as the "right" to have the mortgage paid is property for the purposes of the Act:

"Because the Court Order requires my wife to take on the obligation of paying the carrying expenses and collateral, or (sic) the mirror image to that is my right, being a co-debtor on certain matters such as the mortgage, to ensure that when I provide that money to her, I have the right to ensure that that gets paid."

Other "rights" the Appellant claims are the right to get proper information from her; the right to ensure that proper amounts of tax are paid; the right to have a portion of the support payments dedicated for the children's scholarship trust fund and the right "that there not be an open-ended obligation but a budget with regard to child support matters". The Appellant says that he was entitled to enforce his "rights" and that accordingly, "when I enforce them and get the money back, I say that is income gained from enforcing the "rights" created by the Orders" and thus, the expenses incurred are deductible.

[7] In the alternative, the Appellant says the legal fees were incurred by him to earn income from business since

" ... The income I earn is dependent upon the time spent on my practice. The more time available to me, the more I practice law, the more work in progress is created, the more income is created and of course, the more taxes paid."

He submits it was appropriate to consider any expenses incurred that enabled the Appellant to continue and earn more income on which he paid tax should be allowed to be deducted in order to match his income and expenses.[7] In this context he submitted:

" ... that if there's going to be a matching, if one is to get a true picture of a taxpayer's net income, such as myself, then the true picture is, if I paid legal expenses in order to free up my time, to be able to earn income, then that expense to free up my time is a proper deduction."

Respondent's Position

[8] The Respondent's position is that no expense was incurred by the Appellant for the purpose of gaining or producing income from a business or property within the purview of section 18 of the Act. The Respondent further contends that if a portion of the legal fees were incurred to preserve the Appellant's reputation, the deduction of such expenses is prohibited by paragraph 18(1)(b) of the Act.[8]

Conclusion

[9] I am unable to accept the Appellant's submission that the expenses in issue were incurred to gain or produce income from property. The provision of the Act applicable to the deductibility of expenses for the determination of property (and of business) income is subsection 9(1). It reads:

9(1) Subject to this Part, a taxpayer's income for a taxation year from a business or property is the taxpayer's profit from that business or property for the year.

This subsection defines a taxpayer's income, be it from a business or from property, by reference to profit. It is well established that the concept of profit found in subsection 9(1) authorizes the deduction of business expenses, as profit is inherently a net concept, and such deductions are allowed under subsection 9(1) to the extent that they are consistent with "well accepted principles of business (or accounting) practice" or "well accepted principles of commercial trading".[9] Furthermore the expenses in issue may in any event be prohibited by section 18 of the Act which provides a number of prescribed statutory limitations on expense deductions of which two are particularly relevant. Paragraph 18(1)(a) sets out a general prohibition denying a deduction unless the amount is paid or incurred for the purpose of gaining or producing income while paragraph 18(1)(h) limits the deductibility of personal and living expenses which are defined in subsection 248(1) as follows:

“personal or living expenses” includes

(a) the expenses of properties maintained by any person for the use or benefit of the taxpayer or any person connected with the taxpayer by blood relationship, marriage or adoption, and not maintained in connection with a business carried on for profit or with a reasonable expectation of profit,

[Emphasis added]

(b) ...

[10] Even if one were to assume that the Orders made by the Ontario Court in the Appellant's matrimonial proceedings gave him the right to recover portions of certain support payments made to his former spouse and that this right constituted "property" for the purposes of the Act, the amounts, if and when recovered, cannot logically be considered to be income, i.e. profit from that "property". In Ivey v. M.N.R.,[10]the Court made the following observation:

... Paragraph 18(1)(a) of the Act has regard to the process of the computation, for the purpose of subsection 9(1), of 'profit' from a business or property. It has application, as plainly indicated by its opening words, only where such a profit is being calculated. When a claim for alimony or maintenance is asserted against a person, nothing in the activity of that person in respect of that claim has anything to do with the process involving the earning of profit from a business or a property.

It can equally be observed that when a claim for the recovery of overpayment of maintenance is asserted against a person nothing in the activity of the claimant has anything to do with the process involving the earning of profit from a property. Income from property is generally regarded as the return on invested capital and normally includes items such as dividends, interest, rents, and royalties. Put another way, income from property is normally investment income. The nature of the expenses in the Appellant's case is purely personal as it relates to the marital and post-marital affairs of the Appellant as an individual and were not incurred for the purpose of gaining or producing income from a property.

[11] I turn next to the Appellant's alternative position that the legal expenses incurred were not personal and living expenses and were in fact incurred "for the purpose of gaining or producing income from the business". At the outset I must say that I would have great difficulty in concluding that legal fees incurred in the course of matrimonial proceedings are anything but a personal expense. Expenditures of the type made by the Appellant pursuant to the support Orders are essentially expenditures of a personal nature made out of capital or income after is has been earned.

[12] Furthermore I am satisfied that the Appellant did not incur the legal expenses for the purpose of gaining or producing income from his practice. It is clear from the evidence that the primary objective of the legal proceedings he initiated and vigorously pursued was the recovery of substantial amounts of money which he says represented overpayments of support to Richelle.[11] Based on his testimony and on the documents submitted which, amongst other matters, included several detailed affidavits of the Appellant, no other conclusion is possible other than that the Appellant would have incurred these particular legal expenses even in the absence of the Appellant's business activity.

[13] In Symes v.The Queen, et al,[12] Iacobucci J. in the course of analyzing the provisions of paragraph 18(1)(a) of the Act, observed:

Since I have commented upon the underlying concept of the "business need" above, it may also be helpful to discuss the factors relevant to expense classification in need-based terms. In particular, it may be helpful to resort to a "but for" test applied not to the expense but to the need which the expense meets. Would the need exist apart from the business? If a need exists even in the absence of business activity, and irrespective of whether the need was or might have been satisfied by an expenditure to a third party or by the opportunity cost of personal labour, then an expense to meet the need would traditionally be viewed as a personal expense. Expenses which can be identified in this way are expenses which are incurred by a taxpayer in order to relieve the taxpayer from personal duties and to make the taxpayer available to the business. Traditionally, expenses that simply make the taxpayer available to the business are not considered business expenses since the taxpayer is expected to be available to the business as a quid pro quo for business income received. This translates into the fundamental distinction often drawn between the earning or source of income on the one hand, and the receipt or use of income on the other hand.

[Emphasis added]

[14] Paragraph 18(1)(a) of the Act deals with the process of computation of profit from a business for the purpose of subsection 9(1). It is relevant to consider whether a particular deduction is ordinarily categorized as a business expense by accountants. I am not aware of that being the case nor was any evidence tendered to the effect that the deduction of legal costs as a business expense in circumstances such as those before me would be in accordance with well-accepted principles of business practice.

[15] For the foregoing reasons, I am satisfied that the expenses in issue are prohibited by the limiting provisions found in paragraphs 18(1)(a) and 18(1)(h) of the Act.

[16] The Appellant has also taken the position that a portion of the legal expenses were incurred to protect his ability to earn income by preserving his professional reputation and integrity. Even if that were the case, the deduction of those legal fees is prohibited by paragraph 18(1)(b) of the Act which reads:

18(1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) ...

(b) an outlay, loss or replacement of capital, a payment on account of capital or an allowance in respect of depreciation, obsolescence or depletion except as expressly permitted by this Part;

The Respondent does not challenge that some of the legal expenses (albeit the amount is uncertain) may have been expended for the purpose of protecting his reputation. However, the Respondent's position is that the reputation of a professional is an asset upon which his fees are based and expenses to preserve and protect this asset are for the purpose of preserving a capital asset. Accordingly, the deduction of legal fees is prohibited by paragraph 18(1)(b) of the Act.[13] In my view, the Respondent's position is correct in law.

[17] For the foregoing reasons, I have concluded that the Appellant is not entitled to deduct the legal expenses in issue.

[18] One further comment is warranted. The Appellant produced and reviewed a number of invoices regarding the expenses incurred.[14] It soon became apparent that not all of the expenditures could be directly related to the Appellant's "enforcement of his rights to property". By way of example there were several accounts which related to what might generically be referred to as tax matters. However, the fact is that while the Orders required the Appellant to pay certain taxes on behalf of his former spouse the parties were never able to agree as to the correct method of calculating that tax. This resulted in appearances before Walsh J. and the appointment of an arbitrator. Clearly a substantial part of these costs cannot be directly related to the Appellant's attempts to "enforce his rights" vis-à-vis the "overpayment of tax". Other accounts relate to the mortgage action which, when one reads the reasons of Boland J., appears to involve issues other than the recovery of amounts arising out of Richelle's alleged failure to pay the mortgage; to legal expenses incurred in defending himself in a lawsuit commenced by VISA against him and his former spouse; and last, responding to a complaint to the Law Society made against the Appellant's counsel by his former spouse. How the latter relates to a "right" was not evident. Unfortunately, this aspect of the matter was not fully addressed by either the Appellant or by counsel for the Respondent and had I ruled otherwise with respect to the deductibility of the expenses further submissions would have been called for.

[19] The appeals are dismissed, with costs.

Signed at Ottawa, Canada, this 1st day of May, 2000.

"A.A. Sarchuk"

J.T.C.C.

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