Principal Issues: [TaxInterpretations translation] Can an employee who incurs legal costs in defending a harassment action deduct those costs in computing her employment income under paragraph 8(1)(b) of the Income Tax Act?
Position: No.
Reasons: The costs were not incurred by the employee to recover an amount of wages due to her or to establish her entitlement to them.
Ms. Louise Girard Canada Revenue Agency Shawinigan-Sud Tax Centre 4695 12nd Avenue Shawinigan-Sud QC G9N 7S6 2005-014780
September 12, 2006
Dear Madam,
Subject: Request for technical interpretation: Deduction of legal costs incurred by an employee
This is in response to your fax of August 18, 2005, requesting our opinion on the above subject.
Facts
You have attached a note to your fax stating the following facts:
- The client works as XXXXXXXXXX for XXXXXXXXXX;
- In XXXXXXXXXX, an employee filed a harassment complaint against the client;
- The client immediately took steps to defend herself, such as hiring a crisis counsellor;
- The harassment complaint against the client was dismissed and the client did not suffer any loss of salary or employment;
- In XXXXXXXXXX, she incurred legal fees in the amount of $XXXXXXXXXX, while in XXXXXXXXXX, the fees paid amounted to $XXXXXXXXXX;
- In XXXXXXXXXX, her employer agreed to reimburse part of these costs, i.e. the sum of $XXXXXXXXXX;
- The client therefore claimed a deduction of $XXXXXXXXXX for the XXXXXXXXXX and XXXXXXXXXX taxation years pursuant to paragraph 8(1)(b) of the Income Tax Act (the "Act");
- According to the client's representative (before the Canada Revenue Agency at the Notice of Objection stage), the legal fees were incurred by the client to protect her livelihood, as a finding of culpability or liability would likely mean the end of her employment.
Questions
You wish to know whether the client is entitled to claim a deduction under paragraph 8(1)(b) in the amount of $XXXXXXXXXX for costs paid to defend herself in a harassment action.
Analysis
For the purposes of our analysis of the application of paragraph 8(1)(b) to the facts of this case, we have assumed that XXXXXXXXXX was at no time - particularly when the legal expenses costs were incurred by the client - liable to the client for any amount of salary or wages. Furthermore, we have assumed that the costs incurred by the client were "legal expenses” within the meaning of that paragraph.
The deduction for legal expenses paid by an employee is found in paragraph 8(1)(b). This statutory provision reads as follows:
8 (1) In computing a taxpayer’s income for a taxation year from an office or employment, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto
[…]
Legal expenses of employee
(b) amounts paid by the taxpayer in the year as or on account of legal expenses incurred by the taxpayer to collect or establish a right to salary or wages owed to the taxpayer by the employer or former employer of the taxpayer; [emphasis added]
It is appropriate to note here that subsection 8(2) provides that no deduction may be made by a taxpayer in computing income from an office or employment except as specifically provided in section 8. Consequently, if paragraph 8(1)(b) does not allow a deduction for the amounts paid by the client in this case, there is no other statutory provision that will allow her to deduct those expenses (accepting that those expenses were not incurred to recover a pension benefit within the meaning of paragraph 60(o.1)).
In light of the jurisprudence we have reviewed as part of our analysis, and in light of the facts you have provided, we are of the view that the amounts that were paid by the client cannot be deducted from her income from an office or employment under paragraph 8(1)(b).
In Blagdon v. Canada1 , a serious explosion occurred during the cleaning of a ship of which the taxpayer was the captain. Two investigations were conducted under the Canada Shipping Act into allegations of incompetence by the taxpayer. If the allegations were upheld, the taxpayer could have lost his master's certificate for a prolonged period and even permanently. He therefore retained a lawyer to defend him in both investigations.
The Tax Court of Canada, in dismissing the taxpayer's appeal, wrote as follows:
…There is no suggestion that any salary or wages were owing to the appellant by his employer. Indeed, the connection of the inquiry with salary and wages was at best remote and indirect. It is true, if the appellant lost his Master's certificate, it would have a serious impact on the salary or wages that he might earn from some other employer in the future. Nonetheless the representation of the appellant before the board of inquiry was not to collect salary or wages owing to him but to protect his means of livelihood. [emphasis added]
The taxpayer took this case to the Federal Court of Appeal, arguing that it was necessary to interpret paragraph 8(1)(b) to allow a deduction for legal costs incurred to protect a person's right to retain his or her livelihood. The Court rejected this contention and upheld the decision of the Tax Court of Canada. We are enclosing copies of the Tax Court of Canada and Federal Court of Appeal decisions in that case.
We also wish to bring to your attention the decision in Esposito v. Canada2. In that case, the taxpayer, a police officer, was charged with assault causing bodily harm to a prisoner in his custody. If the charges had been upheld, the taxpayer would have been dismissed from his position and would not have been able to work as a police officer. The taxpayer therefore incurred legal costs in defending himself against those charges.
In dismissing the taxpayer's appeal, the Court referred to numerous decisions interpreting paragraph 8(1)(b). Those decisions are unanimous in stating that the existence of an amount owed by the taxpayer's employer or former employer is a sine qua non condition for the deduction under paragraph 8(1)(b)3. The Court also recognized that no amount was owed to the taxpayer and that the legal fees were paid to protect a future source of income (i.e. future income from his employment as a police officer). A copy of the decision in that case is attached.
In this case, according to the client's representative, the legal expenses were incurred by the client to protect a source of income, namely her employment in the federal public service. They were not costs incurred to recover an amount of salary or wages owed to her by her employer or to establish an entitlement to such amounts. Furthermore, when those costs were incurred, no amount was owed to the client by XXXXXXXXXX. It is therefore our view that the client is not entitled to deduct the $XXXXXXXXXX expense - under paragraph 8(1)(b) - from her income from an office or employment for the XXXXXXXXXX and XXXXXXXXXX taxation years.
In the course of our research, we also became aware of the decision in Wilson v. Her Majesty the Queen 90 DTC 6382 (F.C.T.D.) which confirms our position. However, we would caution you as to the probative value of that decision since the wording of paragraph 8(1)(b) at the time of that decision is somewhat different from the current wording of that provision.
We also wish to bring to your attention a proposed legislative amendment, applicable to amounts paid in the 2001 and subsequent taxation years, to paragraph 8(1)(b). This proposal, last published in July 2005 in a document entitled Legislative Proposals Relating to Income Tax, would have the effect of allowing the deduction of legal fees paid to recover an amount that, if received by the taxpayer, would be required to be included in the taxpayer's income under subdivision a of the ITA. On the facts of this case, we do not believe that this amendment would be of any assistance to the client.
Best regards,
Phil Jolie
Director
Business and Partnerships Division
Income Tax Rulings Directorate
Encl.
ENDNOTES
1 [2002] T.C.C. no 79, aff'd [2003] F.C.A. no 945
2 [2004] T.C.C. No. 105 - You will note that this case has not yet been translated into French and that only the English version is available.
3 Refer for example to the decision in Turner-Lienaux c. Canada, [1997] F.C.A. no 562.