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Legal Expenses, The Taxpayer and The Income Tax Act

12 Jul 2011
It is well established that the Income Tax Act permits a taxpayer to deduct legal expenses incurred to collect or to establish a right to salary or wages owed to the taxpayer by an employer or former employer. However, the Canada Revenue Agency ("CRA") only allows a deduction where the salary or wages are "owed" by an employer or former employer. Taxand Canada looks at a recent decision by the Tax Court of Canada which expands the applicability of the Income Tax Act.The decision in Chagnon c. La Reine ("Chagnon") by the Tax Court of Canada ("TCC") permits the deduction of legal expenses incurred by a taxpayer to defend against actions taken by an employer to reclaim salary previously paid.

The taxpayer in Chagnon was the former president and chief executive officer ("CEO") of Vid?otron (the "Employer"). He was granted stock options to purchase shares in his Employer. All parties agreed that the stock options were related to the taxpayer's employment and appointment as CEO. The taxpayer's total salary and benefits were determined by an independent member of the Employer's board of directors with external advice. The stock option plan was subsequently amended to allow the taxpayer to receive additional salary in lieu of exercising the options, for an amount equal to the difference between the strike price and the fair market value of the shares, multiplied by the number of shares.

The taxpayer chose to receive the additional salary in lieu of exercising his options when his Employer was acquired by QMI. Two years after this, the Employer and QMI sued the taxpayer for a breach of the duty of loyalty to his Employer, and sought to reclaim the additional salary paid. The taxpayer prevailed in the lawsuit, and deducted his legal expenses CRA disallowed the deduction, and the taxpayer appealed to the TCC. The TCC ruled in favour of the taxpayer.

Taxand's Take

It is difficult to fully assess the merit of the decision in Chagnon, and whether the decision is vulnerable to being overturned in the future. The TCC did not provide a detailed and convincing analysis in its judgment. It merely referred to and approved of comments made, in obiter, of an earlier judgment, Fenwick vs The Queen. However until Chagnon is overruled, the scope of the Income Tax Act has been effectively expanded in favour of taxpayers.

Read the full article from Taxand Canada to understand more.

Your Taxand Contact for further queries is:
Eric Koh
T. +1 613 786 0121

Taxand's Take Author