Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: (1) Can a trust deduct any portion of cost of legal fees that it incurred to litigate its right to amounts in respect of the shares proceeds under an oppression remedy? (2) Can the trust deduct a portion of the legal fees against the interest income it was awarded pursuant to the Judgment Interest Act?
Position: Yes, if the amounts are reasonable and pro-rated on a reasonable basis.
Reasons: The amount the trust received under its claim constitutes compensation for the shares that were injuriously affected by virtue of the majority shareholders' actions. As such, the amount awarded constitutes proceeds of disposition of a capital property and the legal fees that were incurred to establish the right to compensation should be deducted from the proceeds of disposition pursuant to paragraph 40(1)(a). In litigation there is often the expectation of an interest award, and pro-rating the legal fees between the amount awarded in respect of the shares and the amount awarded for interest related to that award reasonably reflects that expectation.
October 3, 2006
XXXXXXXXXX Tax Service Office HEADQUARTERS
S. Lewis
Attention: XXXXXXXXXX (613) 941-7239
2006-018119
Deduction of Legal Fees by Inter Vivos Trust
We are writing to you in reply to your letter dated April 11, 2006, wherein you requested a technical interpretation of whether legal fees are deductible under the Income Tax Act (the "Act") in the situation described below.
We understand the salient facts to be as follows:
1. XXXXXXXXXX (the "Company"), a corporation incorporated under the Alberta Corporations Branch Act, was in the business of XXXXXXXXXX.
2. From XXXXXXXXXX until XXXXXXXXXX ("Mrs. A") held XXXXXXXXXX% of the capital stock of the Company (the "Shares") directly and XXXXXXXXXX% of the Shares in a trust (the "Trust") for her children. The remaining XXXXXXXXXX% of the Shares were held by Mrs. A's husband ("Mr. A").
3. In XXXXXXXXXX a new investor ("Mrs. X") bought XXXXXXXXXX% of the Shares for $XXXXXXXXXX This included all of Mrs. A's Shares, XXXXXXXXXX% of Mr. A's Shares and XXXXXXXXXX% of the Shares that Mrs. A held as trustee ("Trustee") for her children.
4. On or about XXXXXXXXXX, Mrs. X, Mrs. A in her capacity as the Trustee and Mr. A entered into a unanimous shareholder agreement (the "Agreement") which limited the borrowing of the Company to $XXXXXXXXXX.
5. With the apparent consent of Mr. A, a trust controlled by Mrs. X (the "Estate Trust") loaned $XXXXXXXXXX (the "Loan") to the Company on XXXXXXXXXX.
6. Despite the existence of the Agreement, Mrs. A was not consulted about the Loan and subsequent loans (the "Loans").
7. The Estate Trust called in the Loans on XXXXXXXXXX and all of the Company's assets were sold off to satisfy the debt.
8. The Company was placed into receivership on XXXXXXXXXX.
9. Mrs. A in her capacity as the Trustee brought an oppression remedy suit (the "Claim") on behalf of the Trust under section 234 of the Alberta Corporations Branch Act.
10. The Claim was successful. The judge awarded $XXXXXXXXXX as the fair market value of the Trust Shares and $XXXXXXXXXX in interest pursuant to the Judgment Interest Act, S.A. 1984, c. J-0.5.
11. The T3 return of income for the Trust reported the $XXXXXXXXXX as a capital gain from the disposition of qualifying small business corporation shares and the $XXXXXXXXXX as interest income. The total legal fees of $XXXXXXXXXX were proportionately allocated between the interest income and the capital gain. As such, $XXXXXXXXXX of the legal fees was treated as a capital expenditure made for the purpose of disposing of the right to proceeds from the Trust Shares and $XXXXXXXXXX was treated as an expense to earn income from property.
12. The legal fees are in excess of the solicitor-client costs the judge awarded at trial and are in respect of fees charged for actual services rendered by the legal representative.
You are concerned with how the legal expenses incurred by the Trust should be treated. Specifically, you asked:
(a) whether any portion of the legal fees can be deducted against the proceeds of disposition; and
(b) whether a portion of the legal fees can be deducted against the interest income awarded pursuant to the Judgment Interest Act.
The definition of "proceeds of disposition" in paragraph (e) of section 54 of the Act includes compensation for property injuriously affected, whether lawfully or unlawfully or under statutory authority or otherwise. In our view, the amount the Trust received under the Claim constitutes compensation for the Trust Shares that were injuriously affected by virtue of the majority shareholders' actions. As such, the amount awarded constitutes proceeds of disposition of a capital property and the legal fees that were incurred to establish the right to compensation should be deducted from the proceeds of disposition pursuant to paragraph 40(1)(a). This treatment is consistent with the discussion in paragraph 14 of the Interpretation Bulletin IT-99R5 Legal and Accounting Fees. With respect to the interest award, although it was as a result of the automatic application of the Judgment Interest Act, it is our view that a respectable argument can be made that a portion of the legal expenses were incurred for the purpose of earning interest income.
In litigation there is often the expectation of an interest award, and it is our view that pro-rating the legal fees between the amount awarded in respect of the Trust Shares and the amount awarded for interest related to that award reasonably reflects that expectation.
For your information a copy of this memorandum will be severed using the a and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. You should make requests for this latter version to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
We trust that these comments will be of assistance.
Randy Hewlett
For Director
Business and Partnerships Division
Legislative Policy and Regulatory Affairs Branch
All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5
© Her Majesty the Queen in Right of Canada, 2006
Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.
© Sa Majesté la Reine du Chef du Canada, 2006
Email this Content