Date: 20000203
Docket: 98-2488-IT-I
BETWEEN:
MAUREEN RYAN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
(Delivered orally from the Bench at Toronto, Ontario on January 13, 2000.)
Mogan J.T.C.C.
[1] In the 1996 taxation year, the Appellant deducted in computing income the amount of $9,534 with respect to amounts paid to a lawyer who was retained by the Appellant concerning a matrimonial matter. By notice of assessment, the deduction of that amount was disallowed by the Minister of National Revenue. The Appellant has appealed to this Court from that assessment and has elected the Informal Procedure.
[2] The Appellant was married in the 1970s. Two children were born of the marriage, Patrick in 1975 and Megan in 1977. Around 1986 or 1987, the Appellant and her husband separated and divorced. According to the uncontested evidence of the Appellant, after the divorce she was entitled to receive from her former husband certain payments for the maintenance of their two children but she did not receive maintenance payments for herself. I assume that she was employed and able to support herself.
[3] From 1986 to 1996, there were three occasions when the Appellant and her former husband went to Court. On two occasions, she initiated the proceedings either to recover arrears of amounts owing as maintenance for the children, or to modify some prior order or agreement. On the third occasion, the former husband was brought to Court by some arm of the provincial government concerned with recovering maintenance payments following the break-up of a marriage.
[4] In this appeal, I am concerned with a proceeding in the Ontario Courts in the calendar years 1994, 1995 and 1996. The Respondent entered as Exhibit R-1 a copy of the Appellant's 1996 income tax return showing her deduction of the amount $9,534. Exhibit R-2 is a letter dated May 23, 1995 to the Appellant from her lawyer, Shamim Shivji, who represented the Appellant in the proceedings with her former husband. This letter states in part:
Further to the above matter, I enclose, herewith, a copy of my interim account in the above matter.
Kindly note that the above document is for your information and records only. My account will be paid by the Ontario Legal Aid Plan. Please note that the costs of these proceedings to and including my present account are as follows.
Fees $8,252.68
Disbursements $1,281.35
GST $ 653.00
Total $9,534.03
I anticipate that work involved in the preparation for trial and attendance at trial will amount to about 50 hours. I do not anticipate that the additional fees and disbursements will exceed $5,000.00 and I have advised the Ontario Legal Aid Plan accordingly.
Attached to the letter are three accounts dated September 30, 1994; May 19, 1995; and February 29, 1996. The last account dated in 1996 could not have been enclosed with the letter sent in May 1995. In computing her income for 1996, the Appellant deducted this amount of $9,534 referred to in the letter which is part of Exhibit R-2. In passing, I note that the addition in the letter is in error but that is not relevant in the overall view I take in this appeal.
[5] Counsel for the Respondent cross-examined the Appellant on the lawyer's account dated February 29, 1996. This account is seven pages long and is detailed in the sense that it shows the date when each legal service was rendered and a few words describing each service. By reviewing the seven pages, one can see that the account covers the period from May 4, 1995 to February 19, 1996 when apparently a judgment was obtained in connection with the proceeding against the former husband.
[6] The Appellant's claim is based on the fact that she was enforcing the collection of monies owing by her former husband with respect to the maintenance of their two children. It appears that under the terms of an agreement between the Appellant and her former husband or a relevant court order, the former husband was obliged to maintain the children while their education continued and the maintenance did not necessarily end upon their achieving the age of 18. That is why these payments are continuing into the mid-1990s. Upon being cross-examined, the Appellant acknowledged that in the last account she received from her lawyer dated February 29, 1996, some of the items related to amending the maintenance provisions under which the former husband was required to maintain the children. The Appellant said there were special circumstances around 1994, 1995 and 1996 because her daughter, Megan, required dental work in the nature of orthodontics. There may have been a question as to whether that kind of cost was covered by the agreements or court order.
[7] On the wording of the account there were two particular instances where the Appellant acknowledged that the legal services were, in part, to vary the maintenance arrangement. The item for January 17, 1996 states:
3 schedules prepared re: children's expenses; revised support-made calculations; pre-trial memo finalized and delivered; file reviewed in preparation for pre-trial.
The Appellant acknowledged that the "revised support" calculations were to amend whatever the maintenance provisions were for the two children. For February 1, 1996, the following item appears in the lawyer's account:
T/C" – (which normally is telephone call) -- "from Beth Beattie, husband's counsel; brief review of conditions and amendments of Minutes.
Again, the Appellant acknowledged that that probably related to attempts to vary the maintenance provisions. In the absence of more precise evidence, I find that a portion of the legal fees incurred by the Appellant with respect to the proceedings against her former husband were concerned with varying the maintenance provisions. I also find that a portion of the legal fees were to enforce the payment of maintenance amounts that may have fallen into arrears. Therefore, the legal services were rendered for two different purposes.
[8] In The Queen v. Burgess, 81 DTC 5192, Cattanach J. sets out the distinction between a payment on account of capital to create a right and payment on account of revenue to enforce collection after the right has been created. In Burgess, the taxpayer had been successful before the Tax Review Board and so it was the Minister of National Revenue who was the plaintiff in the Federal Court Trial Division and Burgess was the defendant. Cattanach J. stated:
The question is, as I view it, whether the legal expenses paid by the defendant were expended by her for the purpose of obtaining income which was hers as of right. Put yet another way, were the legal fees expended by her for the purpose of collecting income to which she was entitled? If this be so, then the expenses are properly deductible.
There is no doubt that the defendant was entitled to the payments, but the question is by virtue of what circumstance did that entitlement arise. That entitlement is the right under which the defendant receives the payment and that right is 'property' within the broad definition in section 248 previously quoted.
The question which next arises is what was the circumstance which gave rise to the defendant's right to maintenance, (1) was it a right which arose upon the defendant's marriage as contended by her counsel, or (2) was it a right which arose upon the order absolute granted by the High Court of Ontario as contended by counsel for the plaintiff.
Put yet another way, did the judgment of the High Court of Ontario create the right to maintenance, or was that judgment merely a continuation and quantification of a right to maintenance already vested in the defendant.
...
Therefore, the legal expenses are in the nature of a capital expenditure, by bringing the right into being, rather than in the nature of a revenue expenditure to enforce payment of income from a right in being.
The appeal of the Minister in Burgess was allowed. That case was cited to me because counsel for the Respondent relies on the distinction and argues that a portion of the legal fees in question were incurred to vary the agreement or court order under which the former husband was paying maintenance for the children. To the extent that a former amount of maintenance was being increased, the Appellant may have acquired a new right to a higher stream of income.
[9] A second and very different argument advanced on behalf of the Respondent is that the amount is not deductible because the Appellant did not pay that amount in 1995 or 1996. It was paid by the Ontario Legal Aid Plan ("OLAP"). The Appellant states, however, that under the terms of her arrangement with OLAP, although her legal costs were paid by the plan, there is a provision that if a person obtains legal aid and owns property in Ontario, then OLAP can put a lien on the property for the amount that it expends on behalf of the person. Apparently, the amount paid out by OLAP becomes recoverable from that person if the property is sold or if the mortgage on the property is refinanced. The Appellant said that there is a lien on her property in favour of OLAP, and that she expects to continue to own her home but that the mortgage comes up for renewal in the year 2000. She expects that she will have to pay the plan sometime this year when she refinances her mortgage.
[10] I am required to consider two arguments. The first is whether part of the legal costs are to be disallowed as a payment on account of capital because they bring a new right into existence. The second is whether any part of the legal costs are deductible if they were paid by the Ontario Legal Aid Plan under the arrangement described by the Appellant. There were no documents put in evidence by the Appellant. I pointed out to her how important it is to bring to this Court documents such as the pleadings in the Ontario Court where she brought an action against her former husband so that this Court could determine what right she was attempting to obtain or enforce, and any agreement with OLAP concerning the lien on her home and how it would be removed. Unfortunately, no documents of this type are before me.
[11] I find the Appellant totally credible and have no reason to doubt her word. In the circumstances of this case, however, there are many documents which were not produced but would have provided a more detailed description of what the Appellant was seeking to recover from her husband and what her obligations are to OLAP.
[12] The Appellant presented her own case and was not represented by counsel but counsel for the Respondent, consistent with a long tradition of the Bar, brought to my attention certain decisions which run against the Respondent. I will refer to them because they touch on both issues of whether a new right is brought into existence, and whether an amount paid by a legal aid plan would be deductible.
[13] In Donald v. The Queen, [1999] 1 C.T.C. 2025, my colleague Bonner J. was faced with circumstances similar to this appeal. The taxpayer in Donald testified that she paid $32,564 in legal fees to establish child support. Although there were no documents presented to support the taxpayer's case, Judge Bonner stated that he believed her testimony (as he was entitled to) and he stated at pages 2027-2028:
... In my view, the decision in Burgess is not of assistance in this case. Insofar as part of the payments made by the Appellant relate to the securing of the Court order, that order cannot be viewed as a capital asset. What is in question here is a right to payment of an allowance which is described in the order as 'interim interim support.' The order was replaced in February of 1994. It had none of the lasting qualities which are characteristic of a capital asset. The order of October 2, 1990 did not create a right; it simply quantified a pre-existing obligation of the Appellant's spouse to support his children and directed compliance with that obligation. Furthermore, Burgess must now be viewed as wrongly decided.
Judge Bonner relied on the recent decision of our colleague Bowman J. in Nissim v. The Queen, [1999] 1 C.T.C. 2119, decided in August 1998, just one month before the decision in Donald.
[14] Nissim was also a case somewhat similar to this appeal involving a wife who had to recover amounts from a separated or divorced husband, and she obtained assistance under the OLAP. The taxpayer in Nissim apparently agreed that there would be a lien on her property which would permit the legal aid plan to recover sometime the amount of legal costs paid on her behalf. In Nissim, Judge Bowman addressed himself to the legal aid plan question and stated at page 2123:
Based on the Appellant's obvious credibility, I am satisfied that the amounts claimed were incurred and were in fact paid. A substantial part of the amounts claimed in 1994 and 1995 were paid by the Ontario Legal Aid Plan and she owes the amounts to the plan which has put a lien on her house for that indebtedness.
It was argued that she did not pay the amounts. I am unable to accept this contention. She became liable for the legal fees. The Ontario Legal Aid Plan paid them on her behalf and continues to demand payment from her. The situation does not differ significantly from that which would prevail had she borrowed the money to pay the fees from the bank.
[15] I have difficulty following my colleague Judge Bowman on this point. Paragraph 18(1)(a) of the Income Tax Act permits the deduction of an outlay or expense made or incurred for the purpose of gaining or producing income from business or property. If a right was already in existence which permitted the taxpayer in Nissim to recover an amount from her former husband, that right could be "property" within the meaning of paragraph 18(1)(a). The question in my mind is whether the taxpayer in Nissim had "incurred" an expense with respect to the costs paid by the legal aid plan.
[16] The Appellant admits that she did not pay the legal costs of $9,534. Her legal costs were paid by OLAP. She clearly has not paid any amount within the meaning of paragraph 18(1)(a). The question is whether she has incurred a liability? The Appellant's access to the Ontario Legal Aid Plan is part of what Canadians sometimes call "the social net". The lien placed on the Appellant's home by OLAP may not be evidence of an absolute liability. It may be evidence of only a conditional claim dependent upon the value of the home at the time of its sale.
[17] I think the situation does differ significantly from that which would prevail if the Appellant had borrowed money from a bank to pay her legal costs. She would have a very real and immediate liability to the bank. As part of the social net, OLAP provides legal services to persons who, without the plan, might not be able to afford a lawyer. When the plan pays for legal services for a person who owns real property and registers a lien against the property with respect to the amount paid, we have no evidence concerning the terms of the arrangement between the plan and the person who owns the property. What if the fair market value of the property goes down and, at the time of sale or refinancing, the value is less than the encumbrances including the legal aid lien? Does the person have an absolute liability to the legal aid plan? If so, then that liability would run against the concept of the social net. Is the liability limited to the value of the lien with respect to the value of the land? If so, then the liability cannot be quantified until the lien is discharged, and the person may be forgiven all or part of the amount represented by the lien.
[18] Considering the words in paragraph 18(1)(a), the Appellant's intangible and domestic right to maintenance for the children, as property, is different from a tangible asset like land and building or a commercial right to interest or royalty. In my opinion, the Appellant was on a cash basis (and not accrual) with respect to the cost of legal proceedings against her former husband. She did not pay the amount $9,534 in 1996 or in any other taxation year. Accordingly, she has nothing to deduct until she actually pays an amount. If I am wrong on this question, and if the Appellant was on the accrual basis, there is no evidence that the Appellant has incurred an unconditional liability with respect to her legal costs. The terms of the arrangement between the Appellant and OLAP are not in evidence. Without reviewing those terms, I cannot determine whether the Appellant has an absolute or contingent liability and whether any such liability could be quantified in 1996.
[19] If the lien is enforced and if OLAP recovers an amount from the Appellant, either on the sale or refinancing of her property, that is the time (year) when the Appellant should deduct an amount in computing her income because on a cash basis that will be the year in which she will have paid the legal costs. That may be long after 1995 and 1996 when her lawyer was in fact paid by OLAP, but it will be the year when the Appellant, in fact, pays an amount with respect to legal costs. To the extent that part or all of those legal costs is deductible as an attempt to collect maintenance, it would be deductible in that year.
[20] On the facts before me, the dissolution of the marriage took place 13 years ago. The separation and divorce occurred around 1986 and 1987. And in 1994, 1995 and 1996, for the third time, the Appellant's husband was brought to court to pay arrears of maintenance. To that extent, a portion of the legal costs should be deductible. He was also brought to court to amend the maintenance provisions which, on the Burgess line of thinking, may create a new right. To the extent that there was an enhanced right or the Appellant was attempting to increase the maintenance provisions, that would be the creation of a new right, and a portion of the legal costs referable to that claim may be on capital account and may not be deductible.
[21] On the question of whether the decision in Burgess should now be viewed as wrongly decided, I think that Judge Bonner was relying on the following statement of Judge Bowman in Nissim:
... Whatever validity there may be to the distinction between the costs of enforcing an existing right to income and establishing such a right I do not think that the courts should strain to find legalistic reasons to deny the deductibility of these very necessary expenses. ...
There is much to be said for that statement but the Federal Court of Appeal in September 1994, just four years prior to the decisions in Nissim and Donald, seems to have reinforced the importance of that very distinction. In Attorney General of Canada v. Sembinelli, 94 DTC 6636, the taxpayer incurred legal expenses defending a support order she had previously obtained at the time of her divorce. In that case, this Court had allowed the taxpayer's appeal and, when the Crown appealed to the Federal Court of Appeal, the taxpayer was the Respondent. Hugessen J.A. speaking for the Court said:
The Respondent incurred legal expenses in successfully defending against an attack brought by her former husband on a support order previously obtained by her pursuant to the Divorce Act at the time of her divorce. The result which she obtained did not create any rights for the Respondent. The judgment simply dismissed the husband's application. The Respondent's rights continued under the previously existing support order and were not altered. Nothing new came into being. No asset was created or preserved. ...
[22] The Crown's appeal in Sembinelli was dismissed. In my view, the Federal Court of Appeal in Sembinelli thought that the distinction between expenses incurred to create a new right and expenses incurred to enforce or preserve an existing right was important. Having regard to the decision in Sembinelli, I hesitate to conclude that Burgess was wrongly decided.
[23] I have reviewed the recent decision of this Court in Bergeron v. The Queen, 99 DTC 1265. In that case, my colleague Archambault J. concluded that maintenance payments received by a former spouse after a marriage break-up were not income from business or property under Subdivision b (sections 9 to 37) of the Income Tax Act, but were income from some other source by reasons of Subdivision d (sections 56 to 59). Accordingly, Judge Archambault held that legal expenses incurred by a plaintiff to collect maintenance payments or by a defendant to resist making such payments are not deductible under the exception in paragraph 18(1)(a) of the Act. The decision in Bergeron is far-reaching having regard to (i) the many cases in this Court concerning the deductibility of expenses incurred to collect or resist paying amounts described in paragraphs 56(1)(b) and (c) of the Act; and (ii) the policy of Revenue Canada to permit the deduction of many of those expenses. Because I have decided for other reasons to dismiss this appeal, it is not necessary for me to consider the effect of the Bergeron decision.
[24] On the limited facts before me, I am inclined to the view (without making a decision) that a portion of the legal costs were for the creation of a new right and would not be deductible; and that the remaining portion would be deductible. If I were going to allow this appeal, I would ask the parties to come back with more documentation so that I could determine what was claimed in the proceedings before the Ontario Court in which these legal costs of $9,534 were expended. I will not allow the appeal, however, because the Appellant did not pay any legal costs in 1996 and she did not prove that she incurred an unconditional liability in that year with respect to such costs. The appeal is dismissed.
Signed at Ottawa, Canada, this 3rd day of February, 2000.
"M.A. Mogan"
J.T.C.C.