Are busi­ness ex­penses still tax de­ductible if you no longer op­er­ate one?

Calgary Herald - - FINANCIAL POST - Jamie Golombek [email protected] Jamie Golombek, CPA, CA, CFP, CLU, TEP is the manag­ing di­rec­tor, Tax & Es­tate Plan­ning, at CIBC Fi­nan­cial Plan­ning & Ad­vice Group in Toronto.

One of the ad­van­tages of be­ing self-em­ployed is the abil­ity to write off a va­ri­ety of busi­ness ex­penses against your in­come. In some cases, those ex­penses may even lead to a loss that may be used against other in­come of the cur­rent year or car­ried back up to three years. That loss can also be car­ried for­ward for use against fu­ture in­come for up to 20 years.

But are the ex­penses from a busi­ness you no longer op­er­ate and from which you have no ex­pec­ta­tion of fu­ture prof­its still tax de­ductible? That is­sue came be­fore the Tax Court in a re­cent case in­volv­ing a re­tired Nova Sco­tia lawyer who de­ducted pro­fes­sional dues of $57 and file stor­age fees of $1,200 as ex­penses on her 2015 tax re­turn. The Canada Rev­enue Agency al­lowed her an­nual dues, but it dis­al­lowed her stor­age fees.

The tax­payer had ac­quired the files dur­ing 27 years of prac­tic­ing law. In 2012, after giv­ing up her tra­di­tional busi­ness of­fice, the tax­payer moved the client files to a paid stor­age fa­cil­ity and briefly pro­vided le­gal ser­vices from her home. The fol­low­ing year, she ceased pro­vid­ing ac­tive le­gal ser­vices and be­came a “re­tired” mem­ber of the Nova Sco­tia Bar­ris­ters So­ci­ety.

The so­ci­ety’s mem­bers are in­sured against pro­fes­sional li­a­bil­ity risk through the Lawyers In­sur­ance As­so­ci­a­tion of Nova Sco­tia (LIANS), which rec­om­mends that client files be re­tained for any­where from three to 25 years, de­pend­ing on the type of file. There are “elab­o­rate and pre­cise di­rec­tives for files which may be scanned, may be de­stroyed and must be kept in­def­i­nitely … the files should be read­ily avail­able where nec­es­sary and needed to mit­i­gate le­gal li­a­bil­ity aris­ing from pre­ma­ture de­struc­tion, mind­ful of rel­e­vant lim­i­ta­tion pe­ri­ods.”

The is­sue in this case was whether the tax­payer, as a re­tired mem­ber of the so­ci­ety with no cur­rent busi­ness in­come, was en­ti­tled to deduct the file stor­age fees as a cur­rent ex­pense, not­with­stand­ing that the fees re­lated to stor­ing client files cre­ated dur­ing prior tax years in which she did have busi­ness in­come and pur­sued a profit from her le­gal prac­tice.

The CRA main­tained that not all busi­ness ex­penses are de­ductible. It quoted the In­come Tax Act, which states “no de­duc­tion shall be made in re­spect of an out­lay or ex­pense ex­cept to the ex­tent that it was made or in­curred by the tax­payer for the pur­pose of gain­ing or pro­duc­ing in­come from the busi­ness.”

Essen­tially, the CRA’s po­si­tion was that be­cause the tax­payer no longer had any in­come from pro­vid­ing le­gal ser­vices, she no longer op­er­ated a busi­ness in the 2015 tax­a­tion year and so she could not deduct her ex­penses and re­sult­ing busi­ness loss against her other 2015 in­come. The CRA cited a prior de­ci­sion of the Tax Court that stated “be­ing a lawyer is not, in and of it­self, a busi­ness” and, there­fore, lawyers are not al­ways able to per­son­ally deduct their busi­ness ex­penses.

The tax­payer, on the other hand, ar­gued that file main­te­nance or stor­age “is an in­her­ent risk of the pro­fes­sion” and one nec­es­sary to prac­tise law. Fail­ure to do so would have re­sulted in “pro­gres­sive sanc­tion as­cend­ing to pos­si­ble dis­bar­ment.” In ad­di­tion, main­tain­ing her closed files is needed to com­ply with the guide­lines and “stan­dard and ac­cept­able busi­ness prac­tice” laid out by LIANS and the law so­ci­ety.

The tax­payer also cited prior jurispru­dence to sup­port her claim that ex­penses can con­tinue to be de­ducted even when oper­a­tions have ceased. In one cited case, re­pair ex­penses in­curred on a tax­payer’s ren­tal prop­erty be­fore the owner moved back in were per­mit­ted to be de­ducted even though no fu­ture ren­tal in­come was to be earned from the prop­erty.

The Tax Court judge, who was a prac­tis­ing lawyer for more than 25 years be­fore be­ing ap­pointed to the bench in 2011, an­a­lyzed the facts as­so­ci­ated with the typ­i­cal wind-up and dis­con­tin­u­ance of a pro­fes­sional ser­vices prac­tice. His opin­ion was that lawyers typ­i­cally ac­crue, an­nu­ally, “run off ” re­spon­si­bil­i­ties con­cern­ing file re­ten­tion, ac­ces­si­bil­ity and, ul­ti­mately, fu­ture stor­age obli­ga­tions when pro­vid­ing le­gal ser­vices to clients.

Be­cause of the lawyer’s re­spon­si­bil­ity and li­a­bil­ity as a pro­fes­sional, the tax­payer could be sued for pro­fes­sional neg­li­gence aris­ing from ad­vice given as a le­gal ser­vice. But she could also be sued for not keep­ing the ap­pro­pri­ate files and client records, which would in­clude ev­i­dence of the ad­vice given, for the re­quired hold­ing pe­ri­ods.

The judge al­lowed the file stor­age fees, con­clud­ing that both the past ac­crual of fu­ture record-keep­ing ser­vices, file stor­age and the on­go­ing need to con­tinue to pro­tect her in­sur­ance cov­er­age for past le­gal ser­vices all rep­re­sent the “en­dur­ing and cur­rent pro­vi­sion of le­gal ser­vices” be­yond the pe­riod in which the in­come was ac­tu­ally earned or re­ceived. In other words, the fees in­curred in 2015 were de­ductible since they were con­nected to the in­come earned, re­ported (and pre­sum­ably taxed) in prior years.

As the Fed­eral Court of Ap­peal stated in a prior case: “Pro­vided ac­tiv­i­ties un­der­taken after ces­sa­tion of busi­ness were iden­ti­cal to ac­tiv­i­ties un­der­tak­ing dur­ing oper­a­tions, then the con­tin­ued un­der­tak­ing of such ac­tiv­i­ties was ev­i­dence of par­tial con­tin­u­a­tion of busi­ness ac­tiv­i­ties. Sim­i­larly, the com­ple­tion of steps nec­es­sary to windup a busi­ness after ces­sa­tion may be ev­i­dence of a sun­set phase of the busi­ness not­with­stand­ing no in­come is be­ing sought, pro­cured or earned.”

One fi­nal note: the judge noted that the need for costly stor­age “is not one which will ex­ist for­ever for the present le­gal pro­fes­sion as new files are now dig­i­tized as they are cre­ated and then eas­ily and ef­fi­ciently stored in elec­tronic for­mat.”

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