Canada:
Toronto Tax Lawyer Guidance On Employee Legal Expenses Deduction
09 December 2020
Rotfleisch & Samulovitch P.C.
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Introduction – Employee Legal Expenses Tax Guidance
In some circumstances, taxpayers earning income from employment
may be able to deduct employment related expenses from their income
to reduce the income tax they owe to the Canada Revenue
Agency. However the types of expenses that can be deducted as an
employment expense are strictly limited to those specifically
enumerated in the Income Tax Act. Canadian income tax law
does allow employees to claim deductions relating to certain
specific employment related legal expenses, which can be a source
of significant tax savings for taxpayers. This article provides tax
guidance as to those deductible expenses.
Collecting or Establishing a Right to Salaries or Wages –
Employee Legal Expenses Tax Guidance
Under paragraph 8(1)(b) of the Income Tax Act,
employees can deduct amounts paid in a year on account of legal
expenses paid by the employees to collect, or to establish a right
to, an amount that if paid to the employee would be taxed as
employment income under Canadian income tax law. The relevant type
of amounts include salaries and wages, but also other types of
employment income such as taxable employee benefits or employee
stock option benefits.
The relevant amount must be an amount allegedly already owed to
the employee relating to past services performed. Paragraph 8(1)(b)
does not cover expenses relating to protecting an employee’s
job or establishing a right to earn future income through
employment. Legal expenses associated with negotiating an
employment contract or establishing a right to a promotion are also
not deductible. A different provision of the act discussed below
addresses wrongful dismissal cases.
The Courts have repeatedly found that legal expenses of the type
described above are deductible regardless of whether the
employee’s claim for wages is well founded in law or is likely
to succeed. The CRA however has expressed the view that that
deductibility of legal expenses for claiming retroactive
performance pay depends on whether the legal action is successful.
If the Canada Revenue Agency has denied your deduction claim for
employment related legal expenses, you should contact an expert
Toronto tax lawyer to advise on whether there are grounds for
disputing CRA’s decision to deny the deduction claim.
If an employee’s qualifying legal expenses exceeds his or
her income from employment, then that employee has a loss from
employment that can be applied against other types of income. If
there is insufficient income to make use of the loss during the
relevant year, the loss can be carried over to other years as a
non-capital loss.
Pensions and Retiring Allowances – Employee Legal Expenses Tax
Guidance
Paragraph 60(o.1) of the Income Tax Act, allows
employees, within certain limits, to deduct legal expenses paid to
collect or establish a right to pension benefits or a
“retiring allowance”. This deduction is not applicable to
legal actions for pension benefits under the Canada Pension Plan or
Quebec Pension Plan. Legal expenses relating to the division or
settlement of property arising out of the breakdown of a marriage
or common law partnership are specifically excluded from being
covered by this paragraph of the Income Tax Act. For the
most part, legal expenses relating to separation, divorce and
family disputes are not deductible. A key exception is some legal
expenses related to legal actions to collect or increase support
payments paid by recipient of the support payments. The full
details of the legal deductibility of family law related legal
expenses are beyond the scope of this article. The deduction can
only be claimed for a tax year if the legal expenses were paid in
that year or one of the preceding seven tax years.
A retiring allowance includes an amount received by an
individual:
- on or after retirement of the individual from employment in
recognition of the individual’s long service; or - in respect of loss of employment of the individual, whether or
not received as, on account of or in lieu of payment of, damages or
pursuant to an order or judgement of a competent tribunal.
Note that this means damages arising from wrongful dismissal or
loss of employment often qualify as a retiring allowance and can
ground a corresponding claim for deducting related legal
expenses.
When an individual dies and an amount of one of the types
described above is received by the individual’s dependant,
relation or legal representative the receipt may also be a retiring
allowance. In those circumstances the dependant, relation or legal
representative can claim a deduction for legal expenses paid to
collect or establish a right to the retiring allowance of the
deceased individual provided all other criteria are met.
The amount of expenses that can be deducted is subject to
certain limitations. In particular the amount of expenses claimed
cannot exceed the amount of pension benefits or retiring allowance
received by the taxpayer and included in their income plus any
amounts reimbursed to the taxpayer for the legal expenses and
included in the taxpayer’s income. This effectively means that
the taxpayer’s ability to claim legal expenses is largely
determined by the extent to which the taxpayer is successful in his
or her legal action and that unsuccessful taxpayers may not be able
to access the deduction at all. In effect the employee loses twice:
no amount received and no deduction for legal expenses incurred.
The quantum of expenses the taxpayer can claim is also adjusted
downward to the extent any of the amounts received as a result of
the legal action give rise to a deduction for the taxpayer relating
to the transfer of the relevant amount to a registered pension plan
or registered retirement savings plan.
Pro Tax Tips – Employee Legal Expenses Tax Guidance
Employment cases can involve issues relevant to both paragraphs
8(1)(b) and 60(o.1). In such cases it may be important for
taxpayers to track how much legal work is being done on distinct
issues so as to maximize their legal expense deduction and defend
their claims for legal expense deductions against CRA tax audits. Great care may also need to be
taken when negotiating a settlement as they way the settlement
allocates damages between different issues under dispute can effect
what amounts the taxpayer can deduct. If the legal expenses for an
employment case are anticipated to be significant, it is essential
to consult an experienced Toronto tax advisor for advice on these
issues.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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