Date: 19980727
Docket: 97-2968-IT-I
BETWEEN:
RON FALCK,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Rip, J.T.C.C.
[1] Ron Falck, the appellant, appeals from an income tax assessment for the 1991 taxation year in which the Minister of National Revenue (“Minister”) did not permit the appellant to deduct the amount of $17,996 in computing his income since the amounts were incurred for the purpose of earning income from a business or property in respect of offences for which [he] was liable for a summary conviction pursuant to section 239 of the Income Tax Act (“Act”) in respect of [matters pertaining to his] 1986, 1987, 1988 and 1989 taxation years. In fact. Mr. Falck was charged with respect to 1988 and 1989. Mr. Falck states that amounts aggregating $17,996 were incurred by him for legal and accounting fees to assist him in "preparing, organizing, and communicating" - all to assist Revenue Canada and provide accurate information during an audit. At trial Mr. Falck claimed that the actual amount incurred by him with respect to this matter "now appears to be $23,099.71 or more".
[2] The amount of $17,996 comprises two amounts, the amount of $4,499 which Mr. Falck included as "the deduction" in computing his net income and the amount of $13,497 which he deducted as legal and accounting fees in computing his income from a business.
[3] Mr. Falck acted on his own behalf at trial. He recalled that sometime in 1991, probably during the month of February, officials of Revenue Canada visited him at home. Apparently the officials had started to audit Mr. Falck's tax returns and wanted to look at his books and records for the taxation years 1986 to 1989 inclusive. Mr. Falck said he realized that there were "possible discrepancies" in his income tax returns and contacted his lawyer. He and his lawyer subsequently met with officials of Revenue Canada to inform Revenue Canada of possible discrepancies. Mr. Falck said he offered to assist Revenue Canada to find areas of unreported income.
[4] Mr. Falck testified that for a period of about six years his "books were out of order" and amounts were not included in income.
[5] Mr. Falck also retained the services of an accountant. He required both an accountant and a lawyer to "help to compute income for many years, to organize income and to get [his books] in an orderly fashion" for Revenue Canada. In his view, calculating his income was a complicated matter and he wanted the work performed so that he would be able to communicate with Revenue Canada and assist the tax authorities. [He insisted on several occasions that he engaged professionals for the purpose of helping Revenue Canada audit his returns.]
[6] Mr. Falck said that he realized his lawyer was not experienced in tax matters and so he then retained a lawyer in the London office of a major law firm. Mr. Falck stated that the new lawyer had worked at Revenue Canada and was familiar with the proceedings then underway. Further, the new lawyer had a litigation practice and earlier had acted for him before the Provincial Court.
[7] At the same time as Mr. Falck's returns were being reviewed his wife's returns were also being reviewed by Revenue Canada. The evidence indicated that legal counsel and the accountant retained by Mr. Falck were performing services on behalf of both Mr. Falck and his wife at the time. In around June 1992, Mr. Falck and his spouse separated and on July 2 the lawyer hired to represent both of them advised Revenue Canada Mrs. Falck had engaged a different lawyer.
[8] In July 1992 Revenue Canada exercised a search warrant against Mr. Falck. Eventually Mr. Falck was charged with four counts of tax evasion in February 1993. The case was heard in May 1993 and he pleaded guilty; two counts had been withdrawn by the Crown.
[9] Mr. Edward John Sheehan, an investigator with Revenue Canada's Special Investigation Section, was assigned Mr. Falck's file in January 1992. Previously the file had been in the Audit Section of Revenue Canada. He interviewed Mr. Falck for the first time in January 1992.
[10] Mr. Sheehan prepared a chronology of events with respect to meetings and negotiations between Mr. Falck and Revenue Canada during the period May 1991 to 1993. He prepared the chronology of events from notes and memos on file and from reviewing notes of the original auditors who had the file prior to 1992, in particular a Mr. Faubart, who was the auditor who visited Mr. Falck at the latter's home in February 1991.
[11] Mr. Sheehan testified that the possibility of Mr. Falck evading tax came to Revenue Canada's attention when officials realized that at the time Mr. Falck's business income was stagnant or showing losses, the value of his investment capital was increasing.
[12] Mr. Falck told Mr. Sheehan, as he testified earlier, that when he attended at Revenue Canada's office in February 1991, he went there to assist Revenue Canada. Mr. Sheehan replied that Revenue Canada's files record show that a Revenue Canada auditor, Mr. Wilson of Special Investigation, had informed Mr. Falck's solicitor that if the quantum of suppressed funds were high, he would recommend prosecution of Mr. Falck. Revenue Canada's audit of Mr. Falck commenced before Mr. Falck attended at Revenue Canada's office in February 1991 and this is the reason why Revenue Canada did not consider Mr. Falck's voluntary disclosure that he had suppressed income.
[13] In his submissions, Mr. Falck relied upon paragraph 6 of Interpretation Bulletin IT-99R4, Legal and Accounting Fees, dated August 2, 1991:
It is the Department's practice to allow a taxpayer to deduct amounts expended in connection with legal and accounting fees incurred for advice and assistance in making representation having been informed that the taxpayer's income or tax for a taxation year is to be revised, whether or not a formal notice of objection or appeal is subsequently filed.
[14] Mr. Falck insisted that he incurred legal and accounting expenses for advice and assistance in making representations to Revenue Canada so that the tax officials would be able to assess him in a proper manner.
[15] Respondent's counsel referred to paragraph 28 of the same Interpretation Bulletin. Paragraph 28 addresses the Department's position with respect to legal and accounting fees incurred in connection with criminal prosecution under section 239 of the Act:
Legal and accounting fees incurred in connection with a prosecution under section 239 (tax evasion) are generally not allowable expenses since in most cases they are not laid out to earn income. These fees are not deductible under paragraph 60(o) inasmuch as the information laid with respect to the charge is not an assessment within the meaning of that paragraph. Pursuant to the comments in the current version IT-104, any fine in such a situation would not be deductible either. ...
[16] At the culmination of argument I advised Mr. Falck and counsel for the respondent that I would give Mr. Falck 45 days to obtain additional evidence as to what proportion of legal and accounting fees were attributable to him and his former wife. During that period he would also have the opportunity to gather evidence that the legal and accounting fees were incurred with respect to advice and assistance in making representations to Revenue Canada with respect to civil reassessments and not for purpose of defending himself against any criminal charges, actual or potential. The 45 days have expired without any such information being submitted or forwarded to the Court for review.
[17] It is clear from the evidence that the legal and accounting expenses incurred by Mr. Falck, to the extent they were actually incurred for his own benefit, related primarily to potential criminal prosecution pursuant to section 239 of the Act. It is no doubt true that any reassessments for 1988 and 1989 were the result of the investigation by Revenue Canada commencing in 1991. But the main purpose Mr. Falck incurred the legal and accounting expenses was to reduce his exposure to any criminal sanction and not to earn income from a business or property or to mitigate the quantum of reassessments of income. The legal and accounting expenses are not deductible in computing Mr. Falck's income for 1991.
[18] The appeal for the 1991 taxation year is dismissed.
Ottawa, Canada, July 27, 1998.
"Gerald J. Rip"
J.T.C.C.