25 June 2012

Tax Court Rules on Deductibility of Legal Fees to Claim or Enforce Support

Ron Hooge, a respected Vancouver chartered accountant and business valuator with SmytheRatcliffe, has distributed a commentary on a recent Tax Court case, Sarophim v. Her Majesty the Queen, concerning the tax deductibility of legal fees incurred in relation to support payments to be made following separation.

The basic rule, as I had understood it, is that legal fees incurred to obtain or enforce a spousal or child support entitlement are tax deductible whereas legal fees incurred to defend a support claim are not. The taxpayer in Sarophim argued that this distinction was unconstitutional.

As Ron says in his commentary, the taxpayer lost:
"The Court found that it is now settled law that legal fees incurred by the payer of support (for example, to establish or increase, or decrease or terminate it) cannot be considered to have incurred for the purpose of earning income, and therefore not deductible. The Court referenced Interpretation Bulletin, IT-99R5, paragraph 21. 
"Except where there is a specific provision in the [Income Tax Act] dealing with legal or accounting fees, legal and accounting fees are deductible only to the extent that they 
a) are incurred for the purpose of gaining or producing income from business or property, and 
b) are not outlays of a capital nature."
Ron then quotes paragraphs 17 to 21 of the Interpretation Bulletin, which are indeed worth the effort to read if you can make it through the heavy legal prose. What the Interpretation Bulletin says is this:
  1. Legal fees incurred to establish a right to spousal support are not deductible.
  2. Legal fees incurred to establish a right to child support are deductible.
  3. Legal fees incurred to obtain an increase in the amount of child support or spousal support paid are not deductible.
  4. Legal fees incurred to enforce a right to child support or spousal support established in an order or agreement are deductible.
My thanks to Ron for his commentary and to Megan Ellis, QC for bringing it to my attention. My extra thanks to Kathleen Packard for helping me find and correct an error in this post.