Principal Issues: Can the taxpayer deduct the legal costs incurred in XXXXXXXXXX for the following purposes from her income, despite the fact that the underlying legal proceedings have not yet been concluded?
1. To contest a motion to retroactively set aside child support paid by the former spouse;
2. To contest a claim for spousal support by the former spouse;
2. To obtain an order increasing the amount of support paid to one of the children of the marriage for whom the taxpayer has financial responsibility.
Position: 1. Yes.
2. No.
3. No.
Reasons: The jurisprudence and administrative positions of the Canada Revenue Agency.
November 8, 2005
Jonquière Tax Centre HEADQUARTERS Ms.Line Audet François Bordeleau Client Services 541-2-1 (613) 952-1506
2004-010935
Request for technical interpretation: Legal costs and maintenance
This is in response to your letter dated December 24, 2004, in which you requested our opinion on the above subject. Your request for a technical interpretation refers to three situations where taxpayers have claimed a deduction for legal fees incurred in respect of support payments. However, you have confirmed that a technical interpretation is only required in the first case, that of XXXXXXXXXX. We apologize for the delay in responding to your request.
The Facts
XXXXXXXXXX (the “taxpayer") are legally pursuant to a judgment pronounced on XXXXXXXXXX which endorsed a draft separation agreement signed on XXXXXXXXXX in which the taxpayer was granted custody of the couple's two minor children.
The judgment stated that XXXXXXXXXX must pay the taxpayer child support in the amount of $XXXXXXXXXX per week for the entire period that either child requires orthodontic treatment. At the end of the treatment, the weekly payments were set at $XXXXXXXXXX.
A divorce judgment was issued on XXXXXXXXXX. The taxpayer retained custody of the children and the amount of support paid by XXXXXXXXXX remained unchanged.
In XXXXXXXXXX, the children moved from one parent to another because the taxpayer, for some reason, could not take care of them all the time. The children were now of age and several problems arose. The taxpayer's daughter cut ties with the taxpayer and returned to live with her father. The son returned to live with his mother and then went to XXXXXXXXXX to pursue university studies.
In XXXXXXXXXX, he filed a motion to modify the ancillary relief to retroactively cancel the support he was paying for his two children, starting in XXXXXXXXXX. In addition, he claimed support from the taxpayer for the daughter of the marriage.
In XXXXXXXXXX, the taxpayer, in response to XXXXXXXXXX's request, filed a document entitled "XXXXXXXXXX". According to that court document, the taxpayer sought the following remedies:
- That the application for retroactive cancellation of child support by the taxpayer's former husband be rejected;
- That she be relieved of any obligation to support her adult daughter;
- Obtain increased support from the former spouse for the child (their son) of the marriage for whom the taxpayer is financially responsible.
As a result of these legal proceedings, the taxpayer incurred legal costs of XXXXXXXXXX which she wishes to deduct. To date, none of the above issues have been resolved, as the case is still under consideration by the Court.
Question
In light of the above facts, you wish to know whether the legal costs incurred by the taxpayer in XXXXXXXXXX are deductible in computing the taxpayer's income for the XXXXXXXXXX taxation year for purposes of the Income Tax Act (the "Act"), notwithstanding the fact that the litigation has not yet been resolved.
Comments
The question of whether legal costs incurred in an action for support are deductible has given rise to extensive and often conflicting jurisprudence. Since the Act does not contain any specific statutory provision that provides for the deductibility of legal costs incurred in connection with an action for support, it is necessary to analyze the various lines of authority in order to understand the current state of the law in this area.
The Queen v. Burgess1 is the starting point for an analysis of the deductibility of legal costs incurred either to enforce an entitlement to support or to protect an existing right to support. This Federal Court, Trial Division decision is often recognized for distinguishing between expenses incurred to enforce or preserve an existing right to support and those incurred to create a new right.
Expenses incurred to create a new right versus expenses incurred to preserve an existing right
The distinction between expenses incurred to create a new right versus those incurred to preserve an existing right was confirmed by many post-Burgess cases. The analysis of Justice Cattanach was that the right to support is property within the meaning of the definition of that term in subsection 248(1) and that any expenditure to protect that right is an expenditure incurred to earn income from property and deductible by virtue of paragraph 18(1)(a).
In the Sembinelli2 decision, the taxpayer had incurred court costs to contest a motion by her former spouse to set aside a support order. In that case, Lamarre-Proulx J. found that the legal costs incurred by the appellant to prevent the extinguishment of the right to receive the income in question were incurred for the purpose of gaining income from an existing income producing right and not for the purpose of acquiring an asset of an enduring nature nor to defend an item of fixed capital. Lamarre-Proulx J. also added the following:
A right to an alimony is a personal right. The obligation is attached exclusively to the person of the payor… . It is a right that may vary with the financial circumstances of the payor and the payee and also depends on the life of each person. It is a right to income that is not of a capital nature.
The Federal Court of Appeal dismissed the Crown's appeal in this case.
In Ryan3, the taxpayer had incurred court costs partly to vary a support order and partly to obtain payment of any arrears of support. In that case, Mogan J. - following Burgess among others - confirmed the principle that legal costs incurred to preserve an existing right to support were deductible.
Burgess is also recognized with enunciating a controversial rule that a claim for support in a divorce action is a claim for a new right. According to Justice Cattanach, the right born of marriage is the right to support during marriage and this right is extinguished on dissolution of the marriage; in a divorce action, it is the court which, in its discretion, grants the right to support to one of the former spouses.
The Gallien decision and the administrative position of the Canada Revenue Agency
With respect to this second point, the Tax Court of Canada's decision in Gallien4 contradicted what Justice Cattanach had stated. In that case, Justice Lamarre-Proulx distinguished the facts in Gallien from those in Burgess, even though in both cases the taxpayers had incurred legal costs to obtain support in divorce proceedings.
Lamarre-Proulx J. also refused to adopt the conclusions of Burgess that the right to support during a marriage is extinguished upon its dissolution:
Quite apart from that distinction, I would add that I think, notwithstanding the great respect that I have for the judgments of Justice Cattanach, that the distinction that he drew in 1981 may not accord with the social and economic realities of the world in 1998.
Although the Federal Court of Canada's Nadeau5 decision recently called into question the validity of Gallien, the Canada Revenue Agency ("CRA") announced in Income Tax Technical News No. 24 that it accepts that legal fees incurred to obtain spousal support under the Divorce Act6, or under provincial law in the case of a separation agreement, are legal fees that were incurred to enforce an existing right to support. We consider such costs to be deductible in computing a taxpayer's income.
A line of cases, originating in the Tax Court of Canada's Bergeron7 decision, has muddied the waters for some time. In that case, Justice Archambault concluded that the right to support payments - property as defined in subsection 248(1) - does not give rise to income from property since it is income to be included pursuant to subdivision d of the Act. Thus, in order for court costs incurred in respect of support payments to be deductible, it would have been necessary for a legislative provision to be inserted into subdivision e of the Act. In the absence of such a legislative provision, Justice Archambault concluded that those legal fees were never deductible from a taxpayer's income.
Although Justice Archambault succeeded in convincing some judges of the Tax Court of Canada of the merits of this approach,8 the Nadeau decision of the Federal Court of Appeal buried this "maverick" approach.
Today, it is now established that legal costs incurred to create a new right to support are capital in nature, whereas those incurred to preserve an existing right are current and deductible from the taxpayer's income. We accept, notwithstanding the conclusions of Justice Cattanach in Burgess, that legal costs incurred to obtain spousal support are legal costs incurred to enforce an existing right to support.
On the other hand, there is a line of cases dealing with the deductibility of court costs that were incurred to terminate or reduce a former spouse's obligation to pay support. Without exception, those cases hold that such court costs are not deductible because they were not incurred for the purpose of earning income from property.9
Child support
In the context of child support, court costs incurred to create a right to child support are not considered to be of a capital nature. This is because both the father and the mother have an obligation to support their children. It should be noted that under the Divorce Act, this obligation is not extinguished by the dissolution of the marriage. Thus, a taxpayer's action against the individual’s former spouse for child support does not create an entitlement to child support, but merely the amount, given the statutory conditions. This principle was articulated in Wakeman10 and Sol11 and confirms the position taken by the CRA in IT-99R5.
In addition, where court costs have been incurred to increase child support or to make child support non-taxable, the CRA accepts that those costs are deductible in computing the taxpayer's income.12
Application to the facts of this case
In this case, the taxpayer incurred legal costs for the following purposes:
- In order to collect arrears of support (for the benefit of children born of the marriage) from her ex-spouse;
- In order to be relieved of any support obligation towards her adult daughter;
- To obtain increased support from her ex-spouse for the benefit of the son born of their marriage.
What contributes to the complexity of your question is the fact that the legal proceedings in which the taxpayer has incurred the said expenses are not yet over. Thus, can that factor influence the deductibility of the legal costs in question? We do not believe so.
At the outset, in light of the jurisprudence, we believe that the taxpayer would be entitled to deduct the portion of the court costs incurred in collecting the arrears of support from her former spouse. Those expenses are of a current nature.
On the other hand, we do not recognize the taxpayer's right to deduct the portion of the court costs that relate to the taxpayer's objective of being relieved of any support obligation towards her adult daughter. Indeed, those expenses were not incurred with a view to earning income from property.
Finally, with respect to the taxpayer's claim for increased support from her former spouse for the benefit of the son born of the marriage, we do not believe that the underlying legal expenses are deductible from the taxpayer's income. Although the jurisprudence indicates that the right to such support is not extinguished by the dissolution of the marriage and that the related legal fees are current in nature, our refusal is explained in another way. Indeed, we do not believe that the amounts claimed by the taxpayer truly constitute support, since the taxpayer has no discretion as to the use of the funds under subsection 56.1(1) and the definition of "support" in subsection 56.1(4).
Since the court costs in this case are paid to obtain three separate remedies, two of which can be considered "inadmissible uses", it is necessary to make a reasonable allocation of the court costs in order to target the portion of the court costs relating to the "allowable use", i.e. the order for payment of arrears of support. For example, we could pro-rate the court costs and say that one-third of the court costs are deductible in computing the taxpayer's income for the taxation year XXXXXXXXXX.
Suspension of proceedings
Under numerous technical interpretations, the CRA has already accepted that legal costs incurred in connection with a support payment are deductible from a taxpayer's accrual-basis income.13 Does this principle remain applicable where the underlying legal proceedings are still pending? We believe so.
Where court costs are incurred to protect the right to support or any other qualifying purpose, they are deductible in computing a taxpayer's income pursuant to paragraph 18(1)(a). That provision prohibits the deduction of any expense except to the extent that it was made or incurred for the purpose of gaining or producing income from a business or property. Thus, based on the wording of that provision, it is our view that the deductibility of legal expenses depends on the intention of the taxpayer when the legal costs were incurred and not on the result obtained from the legal proceedings. A taxpayer who incurs legal expenses to protect the taxpayer’s entitlement to support should not be penalized because the proceedings are not completed at the time the deduction is claimed or because the court has not ruled in the taxpayer’s favour.
As such, we believe that Ferro v. Her Majesty the Queen14 supports our contention. In that case, the taxpayer was a lawyer who charged on a contingency basis. For the years in question, he sought to deduct certain expenses relating to his personal injury litigation files. The court accepted the taxpayer's contention that the expenses were incurred for the purpose of earning business income - even if that income was not received until later - and were deductible in the year they were incurred. What is interesting in that case is that the deductibility of the expenses depended on the taxpayer's intention in incurring them.
In this case - and with respect to the expenses we have previously held to be deductible - there is no doubt that the taxpayer, in incurring those expenses, intended to earn income from property. Thus, we do not believe that the fact that the legal proceedings are currently suspended can affect the deductibility of the expenses in question.
If you have any questions or comments arising from this document, we encourage you to contact François Bordeleau at (613) 952-1506.
Best regards,
Phil Jolie
Director
Business and Partnerships Division
Income Tax Rulings Directorate
ENDNOTES
1 [1982] 1 F.C. 849 (Trial Division)
2 [1993] T.C.C. no 236, aff’d. by [1994] F.C.A. no 1352 (C.A.)
3 [2000] T.C.C.. no 51
4 [2000] T.C.C.. no 729
5 [2004] 1 F.C.R. 587 (C.A.)
6 R.S.C. 1985, ch. 3 (2nd Supp.)
7 99 D.T.C. 1265 (T.C.C.)
8 See Mathieu v. Canada, [2001] T.C.C. No. 542, Lemieux v. Canada, [2003] C.T.C. 2799 (T.C.C.) and Casavant v. Canada, [1999] T.C.J. No. 938.
9 See Sabour v. Canada, [2001] I.C.J. No. 783, Nadeau v. Minister of National Revenue, [2004] 1 F.C.R. 587 (C.A.) and Lanthier v. Canada, [2003] T.C.C. No. 149.
10 [1996] T.C.C. no 477
11 [2000] T.C.C. no 689
12 See Income Tax Technical News No. 24.
13 See Technical Interpretations 2001-0067255 and 2004-0104261.
14 2003 D.T.C. 491 (T.C.C.)