Date: 19980727
Dockets: 97-1866-IT-G; 96-4365-IT-G; 96-4041-IT-G
BETWEEN:
FRED C. HANSEN, H. ROBERT HEMMING, JOHN AMIRAULT,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
TESKEY, J.T.C.C.
[1] The Appellant, Fred C. Hansen, a businessman and consultant, appeals his assessments of income tax for the years 1988, 1990, 1991, 1992 and 1993.
[2] The Appellant, H. Robert Hemming, a chartered accountant appeals his assessments of income tax for the years 1993 and 1994.
[3] The Appellant, John Amirault, a professional engineer, appeals his assessments of income tax for the years 1991, 1992 and 1993.
[4] These three appeals were heard on common evidence.
Issues
[5] The issues are:
(a) Whether legal fees paid by the Appellant are deductible from income in the year paid and, if so,
(b) are they to be added to income the year received.
[6] In the Amirault appeal, there is the additional issue of an interest expense in the years 1992 and 1993 on money borrowed to pay legal fees in 1991.
Facts
[7] The facts are not really in dispute, it is the legal result of the facts that are before me. I accept the testimony without hesitation of the three Appellants. Where there may be any difference between their testimony and that produced in the written documentation and the Reasons for Judgment of the Nova Scotia Courts, I accept the documents and the Reasons for Judgment.
[8] George MacDonald, Q.C., ("MacDonald"), counsel for the Appellants in both the Nova Scotia cases and the Ontario case also gave evidence which I accept in full without hesitation.
[9] The Appellants herein and others were directors of Seabright Resources Inc. ("Seabright"). In 1987, Westminer Canada Holdings Limited ("Westminer") purchased all the shares of Seabright. The Appellants all resigned their directorships and none were officers of Seabright.
[10] In 1988, Westminer commenced an action in Ontario against all the former directors of Seabright for 90 million dollars alleging "wilful misrepresentation" which the Nova Scotia Trial Judge characterized as "fraud and dishonesty" and the Nova Scotia Court of Appeal characterized as "fraud".
[11] In MacDonald's opinion, the best defence was offence and the best forum for the issues was Nova Scotia. The Appellants and others started two actions in the Supreme Court of Nova Scotia against Westminer.
[12] The basis of one of the Nova Scotia lawsuits was that according to the By-Laws of the Company it was obliged to hold their directors harmless. Thus, the statement of claim in that action asked for:
(a) a Declaration that the defendants, jointly and severally, are obliged to indemnify the plaintiffs for all costs, charges and expenses including solicitor client costs, incurred or required to be paid as a result of the Ontario action;
(b) general damages;
(c) exemplary or punitive damages;
(d) prejudgment interest;
(e) solicitor-client costs.
[13] The second action was based on the allegation that Westminer either deliberately or negligently let the director's liability insurance lapse prior to commencing the Ontario Action, thus depriving the former directors of insurance funds to defend themselves with. The statement of claim in this action asked for:
(a) special damages;
(b) general damages;
(c) punitive and/or exemplary damages;
(d) prejudgment interest;
(e) costs on a solicitor-client basis.
[14] Each Appellant paid substantial legal fees over the years.
[15] Both the Ontario and Nova Scotia actions proceeded, with the Nova Scotia actions reaching the trial stage first. The two Nova Scotia actions were heard together by Nunn, J. in a long trial in 1992.
[16] The decision of Nunn, J. was released March 23, 1993 and reflected that the Appellants as plaintiffs had been almost wholly successful in their actions. Specifically, they were granted a declaration of indemnity with respect to costs to them of the Ontario action, general damages each in the amount of $200,000, applicable pre and postjudgment interest and solicitor-client costs in the two Nova Scotia actions.
[17] Nunn, J. when dealing with the insurance issue, said in paragraphs 606 and 608:
[606] The Nova Scotia plaintiffs were deprived of an opportunity to have a defence provided and, having found them to have been negligently deprived by the defendants whom I have found to be negligent, they are entitled to recover in damages.
[608] The quantification of damages under this heading is extremely difficult yet difficulty should not operate against the injured parties. Speculation as to what extent the insurer would be involved must not enter the picture. There is evidence of the amount spent for costs to date regarding the Ontario action and there certainly will be more costs incurred, although this decision may bring a hasty end to that litigation. It is only reasonable, in my view that damages under this heading be fixed at the total amount the plaintiffs are required to pay in defence of the Ontario action up to the limit of the policy, which is $1,000,000. Even if I am wrong on the amount and should have limited any recovery to costs to the date of the amendment, the matter may very well be academic in view of further consideration in this decision.
[18] In paragraph 656 of his Reasons, he assessed general damages for each of the Appellants herein in the amount of $200,000. It reads as follows:
[656] It would be extremely difficult, if not impossible, to try to make individual assessments of general damages in these circumstances. Each has been grievously harmed as a result of the allegations of fraud against them in every aspect of their lives, business, professional, social and personal as well as physical. I accept that such is the case. There certainly is an element of callous disregard of these plaintiffs shown by the defendants. I have been urged by the plaintiffs and their counsel that justice demands a substantial award of damages and I am in agreement that such is the case. I think the only appropriate way to deal with the individual plaintiffs in the circumstances of this case is equally with regard to general damages. Therefore I assess general damages for each of the plaintiffs in the amount of $200,000. This amount, in some circumstances may be looked upon as high but I am convinced, in the circumstances here, it is quite reasonable.
[19] The first paragraph of the order for Judgment before Nunn, J. reads:
1. That the Plaintiffs are entitled to be indemnified by Westminer against all costs, charges and expenses reasonably incurred, and to be incurred in connection with the Ontario Action.
Paragraph 4 awards solicitor and client costs of the Nova Scotia actions.
[20] Westminer appealed the judgment to the Nova Scotia Court of Appeal and the Appellants cross-appealed. The Westminer appeal was dismissed. The one area the cross-appeal was successful was prejudgment interest on the solicitor and client costs.
[21] MacDonald argued before the Court of Appeal that the Trial Judge wanted the former directors to be put back into the same position as if the Ontario Action had never been started. In order to fully compensate the former directors, prejudgment interest had to be awarded on the solicitor and client costs. This, however, was prevented by the terms of the Nova Scotia Judicative Act. The Court of Appeal agreed with this argument and said at paragraph 181 of its Reasons:
[181] In order to fully indemnify the respondents for all costs and expenses reasonably incurred in respect of the actions to which they were made parties, it is necessary that the costs awarded to them for their success in the Nova Scotia action be included as part of the indemnity. This ground of the cross-appeal is allowed.
[22] The Nova Scotia Court of Appeal, to facilitate the appellants receiving prejudgment interest on their solicitor-client costs for the Nova Scotia actions, decided that such costs should instead be reflected as an additional part of the indemnity award for the purpose of characterizing the award of costs as damages for loss of indemnity measured exactly by the total payment of the solicitor and client costs in the Nova Scotia actions, as previously awarded by Nunn, J.
[23] The Nova Scotia Court of Appeal in its Reasons, under the heading Conclusion, at page 312, paragraph 1, said:
1. The costs awarded the respondents on their success in the Nova Scotia actions are included as part of the indemnity award.
[24] The formal Order of the Court of Appeal reads:
1. The Appellant, Westminer Canada Limited is liable to pay and shall pay to the Respondents the sum of $188,663.55 representing prejudgment interest on the award of damages for the loss of indemnity in respect of expenses incurred by the Respondents in the trial of this proceeding, plus postjudgment interest thereon from May 15, 1993 until April 11, 1994, in the amount of $9,659.74 less a credit for postjudgment interest already paid by the Appellants in the amount of $4,790.41, totalling in all $193,532.88.
[25] The Appellants were paid the amounts specified in the Trial Division award in 1993, and were paid the further amounts (essentially prejudgment interest on the Nova Scotia legal fees) in 1994.
[26] I am satisfied that each Appellant herein was forced to defend against the allegations of fraud and the claim for 90 million dollars by Westminer in order to protect their reputation and their capital assets acquired over their lifetime. Not defending the Ontario action was not an option as it had to be defended.
[27] The tactics of MacDonald in commencing the two Nova Scotia actions and getting them to trial first were undoubtedly sound and proved to be successful.
Appellants' Position
[28] The Appellants argued that the legal fees were made for the purpose of gaining or producing income from a business or property within the meaning of paragraph 18(1)(a) of the Income Tax Act (the "Act").
[29] They argued that each would have been bankrupt and their reputation ruined if Westminer had been successful. Thus the defence of the action was mandatory as they would all have lost their ability to earn income. They argue that the successful defence of the Westminer lawsuit was to protect their income earning capacity.
[30] They also argued that a person's reputation is personal goodwill with no market value and is not a capital asset.
[31] They put forward the position that the litigation arose out of them being directors of Westminer for which they were paid $100 a meeting and that was sufficient nexus to bring the legal expenses within the ambit of paragraph 18(1)(a).
[32] They further argued that the solicitor and client costs that were consistent to damages by the Nova Scotia Court of Appeal was not a reimbursement and therefore does not have to be taken into income to offset the deduction of the legal expenses. They rely on the Federal Court of Appeal decisions in Her Majesty the Queen v. Westcoast Energy Inc., 92 DTC 6253 that upheld the Federal Court Trial decision reported at 91 DTC 5334.
Respondent's Position
[33] The Respondent argued that the claimed expenses do not fall within the provisions of paragraph 18(1)(a) of the Act and therefore are not deductible and in any event they should be excluded as they were expenses to protect capital and therefore excluded within the provisions of paragraph 18(1)(b) of the Act, and in the alternative, that if I should find that the expenses fall within the provisions of paragraph 18(1)(a), that the portion of the damages awarded which represented the solicitor and client costs are a reimbursement within the provisions of subparagraph 12(1)(x)(iv) and therefore is awash.
Analysis
[34] I accept as factual that all three Appellants were forced into this litigation by Westminer when it commenced its Ontario Action. The compelling reason to defend was that each would have lost all their assets if Westminer had been successful. Included in their individual list of assets was their good name and reputation in their community.
[35] In regards to Amirault's claim, Nunn, J. stated in his reasons, at paragraphs 645 to 648:
[645] Amirault testified that by 1987 he was at the peak of his career after having worked hard throughout his life and enjoyed a good reputation being regarded as a "fair, and honest and thoughtful consultant". This allegation of fraud struck at the very heart of his whole career. He described the allegation and action as a "gorilla on is back" which impaired his ability to conduct his affairs, his image with his partners and his image in the mining community in Nova Scotia and in Canada. The topic arises almost daily in discussions with friends and associates. In his personal life it has had profound effect. He does not sleep well and awakens early with this on his mind. His concentration is affected which in turn affects his work. His family life, the relationship with his wife and children has been strained and seriously affected as the matter absorbs what used to be enjoyable private time. The allegation of fraud permeates all his activities.
[646] He cannot say whether he lost clients or failed to be consulted by others but believes business was lost as a result of the claim against him. He says he cannot quantify the injury done him but states the value of the injury is very high.
[647] Financially these actions have consumed all his assets to the extent that he could contribute no more to his defence and is being carried in these actions by others.
[648] He testified that he needs a very public statement that "he is not a crook" and feels that Westminer should publicly apologize for what they have done to him so that he can be publicly vindicated.
[36] In respect to Hemming's claim, Nunn, J. stated at paragraphs 649 to 652 as follows:
[649] Hemming, a successful accountant, also at the peak of his career, testified much to the same effect. An allegation of fraud goes to the very heart of his professional life. He says that he has spent four years of an uphill battle to explain his innocence in a number of circumstances to clients, friends and to charitable organizations to which he had allied himself. For example, he indicated that he was treasurer of the executive group organizing the "Tournament of Hearts" and since he would be dealing with funds he had to explain to the others that he was being used for fraud.
[650] He testified that he has not slept through one night since the action started, waking two or three times through the night with this on his mind. The effect of the allegation radiates through his every activity and has a profound effect on his family. Financially, he indicated that it has taken every cent he can raise by work and loans to pay the legal costs. He cannot afford vacations, which were formerly customary, and indicated that he lost the opportunity to attend the Queen Mother's Birthday, to which he had been invited through his involvement with the Canadian Red Cross Society, because he could not afford to go.
[651] He estimated that, for him, this litigation has consumed about 100 days of his time in just preparation time perusing the documentation, discoveries, meeting with solicitors and the meeting with the other directors. During this period, if working he would be charging that time at rates of $150 to $190 per hour.
[652] He also says that the value of his injury for four years of false charges is very high and Western Mining and the other companies should pay dearly for what they have done. It was his view that the action was brought against them so that Morgan would not have to face his Board for his own negligence.
[37] Hemming gave evidence before me that he would loose his C.A. designation if he was bankrupt. I do not accept this as a valid statement of the law. An act, entitled An Act to Incorporate the Institute of Chartered Accountants of Nova Scotia, provides in Section 25, that the institution has the right to pass by-laws. By-laws require proof before the Court and I cannot take judicial notice thereof. Knowing that here in Ontario, bankruptcy is not an automatic bar to preventing a lawyer from the practice of law, I simply do not accept Hemming's statement as factual.
[38] In regards to Hansen's claim, Nunn, J. stated at paragraph 653:
[653] Hansen testified that prior to the action having been commenced he had built a successful business life over 30 years, that he was well-off enjoying a good reputation and a good family life. Since the action, his health deteriorated, he had sleep problems, developed high blood pressure and began to experience feelings of rage which were becoming uncontrollable and for which he had to receive medical assistance. The matter was on his mind every day and he was unable to make everyday business decisions with serious effects on his business. His family life has deteriorated and he describes his situation as "pure hell for four years and still not over". He says he has lost a number of investment opportunities primarily because of the injury to his reputation.
[39] Paragraph 18(1)(a) of the Act appears under the heading "Deductions":
(1) In computing the income of a taxpayer from a business or property, no deduction shall be made in respect of
(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income for the business or property.
[40] Both counsel rely on the Supreme Court of Canada decision of Symes v. The Queen, 94 DTC 6001.
[41] The Appellants argued that Symes is authority for the proposition that it is the purpose and not the result of the expenditure that is in issue. I agree with this position.
[42] Justice Iacobucci writing for the Court said at page 6012:
In order to be deductible as business expenses, the appellant's child care expenses must have been incurred "for the purpose of gaining or producing income from the business" within the meaning of s. 18(1)(a) of the Act. This is not to say that the expenses must directly lead to the production of income. Even with respect to the more restrictively worded ancestor of s. 18(1)(a), it was recognized in Imperial Oil Ltd. v. Minister of National Revenue, [1947] C.T.C. 353 (Ex. Ct.), at p. 371, that it is not necessary to prove a causative relationship between a particular expense and a particular receipt. Indeed, provided that an expense otherwise satisfies s. 18(1)(a), an expense may be deductible even if it results in a loss.
[43] He went on to say at page 6013:
that the current wording of s. 18(1)(a) is sufficient justification for the view that Parliament acted to amend its predecessor section in such a way as to broaden the scope for business expense deductibility. Professor Brooks adopts this view, and suggests that the only true question under s. 18(1)(a) is: "was the expense incurred for a personal or business purpose?"
and again he said at page 6014:
Upon reflection, therefore, no test has been proposed which improves upon or which substantially modifies a test derived directly from the language of s. 18(1)(a). The analytical trail leads back to its source, and I simply ask the following: did the appellant incur child care expenses for the purpose of gaining or producing income from a business?
As in other areas of law where purpose or intention behind actions is to be ascertained, it must not be supposed that in responding to this question, courts will be guided only by a taxpayer's statements, ex post facto or otherwise, as to the subjective purpose of a particular expenditure. Courts will, instead, look for objective manifestations of purpose, and purpose is ultimately a question of fact to be decided with due regard for all of the circumstances. For these reasons, it is not possible to set forth a fixed list of circumstances which will tend to prove objectively an income gaining or producing purpose. Professor Brooks has, however, in summarizing some re-occurring factual patterns, elucidated factors to be considered, and I find his discussion generally helpful: supra, at pp. 256-59. In the following paragraphs, I will make reference to some of these factors.
[44] At page 6015, he goes on to say:
It may also be relevant to consider whether a particular expense would have been incurred if the taxpayer was not engaged in the pursuit of business income.
[45] Then on the same page, he deals with what can be described as the "but for" test, he said:
I recognize that in discussing food, clothing and shelter, I am adverting to a "but for" test opposite to the one discussed earlier. Here, the test suggests that "but for the gaining or producing of income, these expenses would still need to be incurred". I must acknowledge that because it is a "but for" test, it can be manipulated. One can argue, for example, that "but for work, the taxpayer would not still require expensive dress clothes". However, in most cases, the manipulation can be easily rejected. Continuing with the same example, one can conclude that the expense of clothing does "not increase significantly" (Brooks, supra, at p. 258) in tax terms when one upgrades a wardrobe. Alternatively, one can focus upon the change in clothing as a personal choice. Or, finally, considering that all psychic satisfactions represent a form of consumption within the ideal of a comprehensive tax base, one can focus upon the increased personal satisfaction associated with possessing a fine wardrobe.
Taking up this last point, I note that in a tax system which is at least partly geared toward the preservation of vertical and horizontal equities ("[h]orizontal equity merely requires that `equals' be treated equally, with the term `equals' referring to equality of ability to pay" and "vertical equity merely requires that the incidence of the tax burden should be more heavily borne by the rich than the poor": V. Krishna, "Perspectives on Tax Policy" in Essays on Canadian Taxation, supra, at pp. 5 and 6-7), one seeks to prevent deductions which represent personal consumption. To the extent that a taxpayer can make a lifestyle choice while maintaining the same capacity to gain or produce income, such choices tend to be seen as personal consumption decisions, and the resultant expenses as personal expenses. Professor Brooks gives the example of commuting expenses, which necessarily vary according to where one chooses to live (assuming, of course, that the taxpayer has some choice in this regard). In some cases, it may be helpful to analyze expenses in these terms.
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.
[46] Any lawsuit for substantial sums puts the assets of the defendants therein at risk. The appellants herein would have been forced into defending themselves even if they were all retired and not earning income. The expenditure of the legal fees was for the purpose of protecting their accumulated assets. I use the term accumulated assets in the broadest of sense. The Appellants' reputations were at stake. However, the Federal Court of Appeal in upholding the decision of Upenieks v. The Queen, 94 DTC 6656 confirmed that legal expenses paid for the purpose of maintaining and preserving a taxpayer's reputation were not deductible.
[47] I see no need to review the many authorities quoted to the Court as the expenses just do not qualify under the provisions of paragraph 18(1)(a) as commented on by Iacobucci, J. in the Symes decision.
[48] Nevertheless, it is my opinion that a C.A. designation, just like the right to practice law or an engineering degree, are all capital assets the same as reputation. Thus, the legal costs to defend the right to be a chartered accountant are spent to preserve a capital asset.
[49] Paragraph 18(1)(b) disallows inter alia deduction for outlay of capital or payment on account of capital which would prevent the deduction of legal fees to preserve capital. It reads:
(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;
[50] In any event, I am satisfied that the Nova Scotia Court of Appeal, both in its Reasons and in the formal Order, made it abundantly clear that what they were ordering was a complete indemnification of "all" legal costs and awarded prejudgment interest thereon to all the former directors of Seabright.
[51] Thus the Appellants herein had no costs to deduct from income as they were fully indemnified of those costs plus prejudgment interest by the courts, and they collected thereon in full.
[52] The appeals are dismissed with costs.
Signed at Edmonton, Alberta, this 27th day of July 1998.
"Gordon Teskey"
J.T.C.C.