Cra Denies Tax Deduction For Paying Someone Else’s Legal Fees

Lawyers are expensive. I should know: I married one. And if she ever decided to start billing me at her hourly rate for our conversations around the dinner table, suffice it to say, we’d soon be eating in silence.

In some situations, the burden of high-priced legal advice can be somewhat offset if you can deduct those legal fees on your tax return. For example, employees (or former employees) can claim legal fees they paid to collect or establish a right to salary or wages owed to them as well as to collect (or establish a right to) a retiring allowance or pension benefit. Business owners can generally deduct legal fees paid for the purpose of earning business income.

When it comes to tax advice, legal fees are also tax deductible if you incur them to challenge a Canada Revenue Agency assessment, perhaps because the CRA has questioned your income, deductions or credits for a particular tax year or you decide to object to, or appeal, a tax assessment or decision.

But what if you pay for someone else’s legal fees to challenge their CRA reassessment? Are those legal fees tax deductible to the payor?

That was the question before the Tax Court in a recent case decided late last month. The taxpayer, a semi-retired accountant, still assists various family members in preparing their tax returns. This, she says, is done “out of affection for her family,” and the work is unpaid.

The taxpayer has a niece whose husband claimed employment expenses on his 2017 tax return which were denied. The taxpayer’s niece’s husband objected and the taxpayer appeared as his agent in Tax Court in March 2022. She was interested in the case because he was part of her family although she had no monetary stake in the outcome of the case. Unfortunately, they were unsuccessful in Tax Court.

The taxpayer then decided to appeal the lower court’s decision to the Federal Court of Appeal, this time retaining experienced Ottawa tax litigator Susan Tataryn, who is both an accountant and a lawyer, to represent the husband. For this, she was paid approximately $6,200 in fees and disbursements. The appeal was ultimately discontinued before it was heard.

On her 2022 tax return, the taxpayer deducted the $6,211 in legal fees she paid Ms. Tataryn to work on her niece’s husband’s appeal. The CRA reassessed her in 2024 and denied the legal expenses she paid. The taxpayer objected, and took the matter to Tax Court, represented by Ms. Tataryn.

As the judge noted, “the issue is straightforward:” Could the taxpayer deduct the costs that she incurred to contest her niece’s husband’s tax assessment?

The judge first turned to the plain text of the Income Tax Act, which states that a taxpayer may deduct “amounts paid by the taxpayer in the year in respect of fees or expenses incurred in preparing, instituting or in relation to an assessment of tax, interest or penalties under this Act.”

As the judge observed: “It is not so much what is in the text that is contentious as what is missing from the text.” He went on to explain that the plain meaning of the text seems to suggest that a taxpayer can deduct the fees paid by the taxpayer related to an assessment of her own tax, to an assessment of her niece’s husband’s tax, or, for that matter, to an assessment of anyone else’s tax.

“Under a plain meaning rule, (the taxpayer’s) appeal should succeed,” wrote the judge. However, based on a seminal 2005 Supreme Court of Canada ruling , the law must be interpreted by looking at the “text, context and purpose of the provision.”

The judge proceeded to examine the text, context and purpose of the rule governing the deductibility of legal fees. He reviewed the history of the provision, noting that before the 1960s taxpayers generally had no entitlement to deduct the costs of disputing tax assessments. This was based on a U.K. case which found that tax disputes generally relate to events that occur after the income-earning process is over. As a result, any outlays, such as legal fees, were not incurred for the purpose of earning income and were therefore not deductible.

In 1964, however, the Tax Act was amended, when the predecessor to the current rule was first introduced. The new rule was tabled with a budget speech in which the Minister of Finance stated that “taxpayers be allowed to deduct expenditures they incur in preparing a notice of objection to an income tax assessment or in appealing an assessment.”

The judge therefore concluded that the legislation was “not intended … to provide some broad-based access-to-justice type of relief for taxpayers who could call on other persons to fund their tax disputes. … There was never any intent … to allow taxpayers to deduct the cost of disputing the assessments of other taxpayers. That was not the problem at which the provisions were addressed.”

Consequently, the judge dismissed the taxpayer’s appeal, finding that she wasn’t entitled to deduct the legal fees paid to fight her niece’s husband’s tax reassessment.

This begs the question: Why not have the person funding the tax litigation simply reimburse the taxpayer who has the dispute, who can then pay and properly deduct the legal fees himself or herself?

I posed this question to Ms. Tataryn. In an e-mailed response she said that, in her practice, she has seen many taxpayers who do not have the income to pursue an appeal. The family pays the legal fees but the taxpayer doesn’t have sufficient income to claim the deduction so gifting the money would result in “no or very little tax break.”

Ms. Tataryn also pointed out that the deduction for legal fees must be taken in the year it is paid. Taxpayers might pay a significant amount but not be able to claim it all in the current year, as their income isn’t high enough. Since there is no carry forward opportunity, “the individual is ‘screwed.’”

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Meanwhile, Ms. Tataryn’s client is “seriously considering an appeal” of the judge’s decision, calling her client’s case “a huge access to justice issue. This is part of an initiative to make (the system) more fair.”

Jamie Golombek, FCPA, FCA, CFP, CLU, TEP, is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto. Jamie.Golombek@cibc.com .

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