Legal Fees as Deductions on Income Tax Return

Did you know….your Legal Fees might be deductions on your Income Tax Return

We are all familiar with the process of filing income tax returns. Every year, we gather our T3’s, T4’s and T5’s, visit our accountant and they file our income tax return to the Canada Revenue Agency. What you might not know is that some of the legal fees you pay to your lawyer may be included as deductions on your income tax return.

Generally, legal fees for personal use, in comparison to business use, are only deductible when incurred to recover amounts which you believe are owing to you involving employment or family support obligations. Some examples of legal fees for personal use, which are generally not tax deductible, include purchasing a home, getting a divorce, making a will or managing a family estate, and establishing custody rights.

Business-Related Legal Fees

Legal fees are generally allowable deductions when they are incurred in connection with normal activities, transactions or contracts, which are incidental or necessary to the earning of income from a business or property. Such of these routine business functions, which incur legal fees include:

1. Preparing contracts in relation to the sale of inventory;
2. Obtaining security for and collecting trade debts owing;
3. Preparing financial records and minutes of shareholders’ and directors’ meetings;
4. Making annual corporate filings;
5. Routine or regular audits of financial statements;
6. Conducting appeals in respect of sales tax including Goods and Services Tax/Harmonized Sales Tax, excise, municipal or property taxes; and
7. Watching legislation (including customs and other regulations) affecting the business operations of the taxpayer.

Legal fees incurred in connection with the following may also be deductible:

1. Issuing bonds, debentures, or mortgages;
2. Borrowing money for certain business or property purposes;
3. Incurring indebtedness that is an amount payable for certain business or property purposes; and
4. Rescheduling or restructuring a debt obligation.

Taxpayers may make deductions for certain expenditures, generally of a capital nature, which are incurred and paid for making any representation relating to a business carried on by the taxpayer. Additionally, legal fees directly associated with the purchase of goodwill qualify as eligible tax expenditures.

Legal costs to prosecute or to defend most tort, contract or other civil claims arising in the ordinary course of business will generally be deductible.

In limited circumstances, legal fees have been deductible where they are incurred in connection with the defence by a taxpayer against a charge of performing illegal actions in the operation of a business or defence of the day-to-day methods of carrying on business.

Legal costs incurred to fight a bid to take over control of a corporation are not deductible.

Legal Fees Related to Family Support Obligations

Legal costs incurred in establishing the right to spousal support amounts, such as the costs of obtaining a divorce, a support order for spousal support, or a separation agreement, are not deductible. However, since children have a pre-existing right to support or maintenance, legal costs to obtain an order for child support are deductible. Legal costs associated with obtaining an increase in spousal or child supports are non-deductible.

Legal costs incurred in order to enforce your pre-existing rights to interim or permanent support amounts are deductible. Pre-existing rights to support can arise from a written agreement, a court order or legislation, such as the Divorce Act. Additionally, legal expenses to defend against the reduction of support payments are deductible because the expenses do not create any new rights to income.

From the perspective of the individual paying the support, legal costs for negotiating or contesting an application for support payments are not deductible. As well, legal costs incurred for the purposes of terminating or reducing the amount of support payments are not deductible.

Legal expenses associated with obtaining custody or visitation rights to children are non-deductible.

Legal Fees to Collect Salary or Wages

You can deduct on your income tax any legal fees you paid in the year to collect or establish a right to collect salary or wages. You can also deduct legal fees you paid to collect or establish a right to collect other amounts. A deduction is only allowed if you are actually found to be owed funds. Your claim must be reduced by any amount awarded to you for those fees or any reimbursements you received for your legal expenses.

Legal Fees for Tax Advice or Assistance

Legal fees incurred for advice and assistance in preparing and filing of returns for income tax purposes are normally deductible.

As well, you may deduct fees or expenses incurred for advice or assistance in preparing, instituting, or prosecuting an objection or appeal under the following:

1. An assessment of tax, interest or penalties under the Income Tax Act, or similar provincial law;
2. A decision of the Canada Employment and Immigration Commission, the Canada Employment and Insurance Commission, or a board of referees under the Unemployment Insurance Act or the Employment Insurance Act;
3. An assessment of income tax, interest or penalties by a foreign government or political subdivision;
4. An assessment or decision under the Canada Pension Plan or a similar provincial plan.

Legal Fees Concerning a Retiring Allowance or Pension Benefit

Within the confines of certain limits, a taxpayer may deduct legal expenses paid to collect or establish a right to a pension benefit or retiring allowance.

Specific criteria and qualifications can determine whether your legal fees are deductible. This article is only intended to be a guideline for common instances where legal fees are deductible. Speaking to a qualified accountant or tax lawyer before you file your income tax return is highly recommended in order to determine whether your legal fees are deductible.