Gouveia v. R. – TCC: Taxpayer Unsuccessful in Attempt to Deduct Legal Fees Relating to OSC Charges and Class Action

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Gouveia v. The Queen[1] (December 20, 2013) involved an attempt to deduct legal fees incurred in connection with both charges brought by the Ontario Securities Commission and a related class action.  The amounts sought to be deducted were very large:[2]

Year OSC Proceedings Class Action Class Action & OSC Total for Year
2004 $0.00 $0.00 $70,123.18 $70,123.18
2005 $363,832.11 $0.00   $363,832.11
2006 $1,154,593.49 $13,359.92   $1,167,953.41
2007 $587,488.81 $52,323.76   $639,812.57
TOTAL: $2,105,914.41 $65,683.68 $70,123.18 $2,241,721.27

The factual background was complex but could be summarized as follows:

Atlas and the Trust

5.         On May 14, 1997, the Associated Freezers Income Trust (“AFIT”) made an initial public offering on the Toronto Stock Exchange.

6.         AFIT was an open-ended, limited purpose trust established under the laws of the Province of Ontario, which was created to invest in common shares, preferred shares and notes of Associated Freezers Ltd. (“AFL”).

7.         On August 10, 2000, AFL merged with Atlas Cold Storage Holdings Limited. The merged entity was called the ACS Freezers Income Trust (“ACSFIT”).

8.         ACSFIT changed its name to Atlas Cold Storage Income Trust (the “Trust”) on June 25, 2001.

9.         The Trust was an open-ended, limited purpose trust established under the laws of the Province of Ontario. Its head office was in Toronto.

10.       The Trust, through its wholly owned subsidiary, Atlas Cold Storage Holdings Inc. (“Atlas” or “ACSHI”), and through the wholly-owned subsidiaries of ACSHI, operated a Canadian and US based network of public refrigerated warehouse facilities, a transportation business, and a retail management business.

The appellant

15.       In or about November of 2003, the appellant, through 1177325 Ontario Ltd., held approximately 8.1% of the units of the Trust.

16.       The appellant was a director, the president and the chief executive officer of Atlas commencing August 11, 2000.

17.       The appellant had a contract of employment dated August 11, 2000 with Associated Freezers Ltd. (“AFL”) [the “Employment Agreement”]. Under the Employment Agreement, the appellant received a base salary of $ 400,000 and was entitled to receive a bonus in each calendar year of no less than $100,000, payable in quarterly instalments.

Termination of employment with Atlas

32.       The appellant resigned from Atlas on November 21, 2003.

33.       The appellant made a wrongful dismissal claim against Atlas and its successors. It was an arbitration proceeding. The wrongful dismissal proceeding was settled in November 2010 without admission of liability on the part of any party.

Patrick Gouveia Consulting

37.       Since 2002, the appellant has reported income from a sole proprietorship known as Patrick Gouveia Consulting (“PGC’).

38.       PGC is a management consultancy business. Its purpose is to manage the business of 1177325 Ontario Ltd., through Spire Group Limited, a related company, and to solicit business in the public refrigerated warehousing industry.

39.       From 2002 onwards, the appellant reported income in the form of management fees from PGC, paid to PGC by Spire Group Limited, a related company to 1177325 Ontario Ltd., as follows:

            a) 2002: $230,000

            b) 2003: $230,000

            c) 2004: $250,000

            d) 2005: $0

            e) 2006: $0

            f) 2007: $583,000

[Footnote omitted]

40.       The appellant continues to carry on business through PGC.

The OSC charges and the class action all related to the appellant’s role as a director and officer of Atlas.  The OSC charges were ultimately withdrawn.  The class action was ultimately settled.

The court concluded that the legal fees were not deductible:

[35]        By incurring the legal fees, what risk was the appellant trying to avert? According to the appellant, it was the risk of losing the opportunities to make lucrative transactions such as joint ventures in the cold storage industry. The appellant incurred the legal fees to defend the OSC proceedings and the Class Action to protect his ability to earn business income through Patrick Gouveia Consulting which depends on the appellant’s unblemished record of business experience, acumen and service.

[36]        By way of the OSC proceedings, what was sought was an order reprimanding the appellant and prohibiting him from trading in securities or serving as a director or officer of a reporting issuer. This, in and by itself, would not deprive the appellant of his ability to earn business income through Patrick Gouveia Consulting in countries not covered by the non-competition clause of the appellant’s employment agreement.

[37]        With respect to the Class Action, among the relief sought was a declaration that the appellant accounts to the plaintiffs for all proceeds received from trading in trust units. The appellant’s motivation for defending the Class Action and the consequences that may have resulted from the Class Action do not appear to have any relationship to the consulting activities of the appellant.

[38]        The consequences that the appellant was facing from a conviction in the OSC proceedings or from a finding of liability in the Class Action would impact more directly his future employment prospects than his current and future consulting activities. In my opinion, the connection between the legal expenses incurred and the consulting activities is too remote to enable the appellant to deduct them.

The preservation of the appellant’s reputation and capacity to earn future income

[39]        Preserving the appellant’s reputation and his capacity to earn future income was central to his decision to defend himself at the OSC proceedings and the Class Action. The appellant’s unblemished record of business experience, acumen and service was under attack by the OSC proceedings and the Class Action (paragraph 12 of Section G of the Notice of Appeal).

[40]        In Cimolai, supra, at paragraph 15, the Federal Court of Appeal confirmed that “legal expenditures made to protect one’s professional reputation and hence one’s capacity for future earnings are by definition capital in nature”.

[41]        Deduction of legal fees incurred to preserve the appellant’s reputation and capacity to earn future income is prohibited by paragraph 18(1)(b) of the Act and is considered to be capital in nature.

[42]        The appeals from the assessments for the 2003, 2004, 2005 and 2006 taxation years are dismissed and the appeal from the reassessment for the 2007 taxation year is allowed solely to give effect to the concession made by the Minister to reduce the business income of the appellant for that year by an amount of $33,000; the reassessment is referred back to the Minister for reconsideration and reassessment on the basis that the business income of the appellant for the 2007 taxation year shall be reduced by an amount of $33,000.

[43]        The whole with costs to the Respondent.

Comment:  This decision is similar to the recent (October 25, 2013) decision of the Tax Court in Ironside v. The Queen:


[1] 2013 TCC 414.

[2] There was an additional claim for 2003 which was quashed since the notice of objection was not filed in a timely fashion.