Principal Issues: 1) Are legal fees that were incurred by an employer in defending against a prosecution related to a workplace fatality deductible? 2) Is the court ordered payment as a result of that prosecution to a registered charity deductible?
Position: 1) Yes. 2) No.
Reasons: 1) The legal fees appear to have been incurred for defending the employer's negligence relating to an accident which caused the death of an individual. The repairs appeared to be routine repairs made to equipment used in operating its business. 2) The court ordered payment was pursuant to the applicable occupational health and safety legislation and as such is a penalty described in section 67.6 of the Act. The payment to the Foundation would not be deductible under 110.1 since it was not a gift for those purposes.
XXXXXXXXXX Michael Cooke, CA
2008-029470
February 20, 2009
Dear XXXXXXXXXX :
Re: Deductibility of Fines, Penalties and Legal Fees
We are writing in response to your letter of August 27, 2008, wherein you asked for our views on the deductibility of legal fees and a court-ordered payment to the XXXXXXXXXX (the "Foundation") in the circumstances described in your letter.
Briefly, we understand that a corporation (the "Employer") incurred legal fees of $XXXXXXXXXX in defending itself from a prosecution for negligence under the XXXXXXXXXX . The prosecution under the XXXXXXXXXX arose because a fatality occurred while repairs were being made to equipment used in the Employer's business. The Employer was ordered by the court to pay $XXXXXXXXXX to the Foundation pursuant to XXXXXXXXXX .
Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. This Circular and the other publications referred to in this letter are available on our website at http://www.cra-arc.gc.ca. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office, a list of which is available on the "Contact Us" page of our website.
The determination of the income tax treatment of payments, such as those described in your letter, involve questions of fact that can only be determined after reviewing all of the relevant documentation related to the particular court action. However, based on the information available to us, we are prepared to offer the following comments, which may be of assistance.
Payment to the Foundation
Subject to certain prescribed exceptions, section 67.6 of the Income Tax Act (the "Act") provides that no deduction shall be made in respect of any amount that is a fine or penalty imposed under a law of a country or a political subdivision of a country (including a state, province, or territory) by any person or public body that has authority to impose the fine or penalty.
In our view, a court-ordered payment pursuant to XXXXXXXXXX would be a fine or penalty (other than a prescribed fine or penalty) described in section 67.6 of the Act. As such, the amount paid by the Employer to the Foundation would not be deductible pursuant to section 67.6 of the Act. Moreover, the court-ordered payment to the Foundation would not be deductible as a charitable gift under section 110.1 of the Act, because in order to be deductible as a charitable gift there must be a voluntary transfer of property without valuable consideration (see for example, paragraph 3 of Interpretation Bulletin IT-110R3, Gifts and Official Donation Receipts).
Legal Fees
We have assumed that all of the legal fees were incurred solely in connection with the Employer's defense from negligence prosecution under the XXXXXXXXXX in the circumstances described above.
Interpretation Bulletin IT-99R5, Legal and Accounting Fees, provides some guidance on the deductibility of legal fees. Generally, absent a specific provision in the Act, legal fees may only be deductible in computing income if the following tests are met:
(a) the outlay must have been made for the purpose of gaining or producing income from business or property (paragraph 18(1)(a) of the Act);
(b) the outlay must not be on account of capital (paragraph 18(1)(b) of the Act);
(c) the outlay must not be made for the purpose of gaining or producing exempt income (paragraph 18(1)(c) of the Act); and
(d) the outlay must be reasonable in the circumstances (section 67 of the Act).
Paragraph 30 of IT-99R5, appears to be applicable to the facts described in your letter. Paragraph 30 states:
"An employer may deduct the legal expenses incurred in defending an employee, officer or director against charges of having committed an illegal or wrongful act in the ordinary course of carrying on the employer's business. This could include expenses incurred in relation to allegations of offences under business practices or competition law. See for example, the criteria set out in The Car Strip Ltd. v. MNR, [1967] Tax A.B.C. 361, 67 DTC 259 and the decision of the Federal Court, Trial Division, in Border Chemical Company Ltd. v. The Queen, [1987] 2 CTC 183, 87 DTC 5391."
Based on our limited understanding of the particular facts and circumstances, it would appear that the legal fees should be deductible by the Employer under the Act. However, we would caution that the determination of the deductibility of these types of expenses is the ultimate responsibility of the relevant Tax Services Office.
We trust our comments will be of assistance to you.
Yours truly,
Renée Shields
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch