Deducting legal fees related to spousal support.

The costs involved in ending a marriage are significant, in both financial and emotional terms. To the extent a deduction may be claimed for the financial component, the tax department can be called upon to subsidize these costs. Ordinarily, the costs of a divorce are considered personal in nature and, as such, are not deductible. However, a considerable grey area has always existed in respect of the costs of obtaining support.

Historically, the common law has developed to classify this type of legal fees in one of two categories, fees incurred to create a right to support and fees incurred to enforce an existing right.

The cost of bringing a right into existence has been considered capital in nature, prohibiting any income tax deduction for such amounts. Costs related to property division are also capital in nature, and as such no deduction has been permitted for these costs. Costs of enforcement, collection, or defending an existing order, however, have been considered to relate to the earning of income and were deductible for income tax purposes. Where the statute under which support was pursued provided an absolute right to maintenance, any costs of obtaining an agreement or court order related to such maintenance have been held by the courts to be deductible.

Regardless of the income tax treatment of the recipient of support payments, no deduction has ever been permitted to a payer of support. Only the recipient has a source of income against which the legal fees would relate, and such a source of income is a necessary prerequisite to the availability of any deduction.

When the Child Support Guidelines were introduced in 1997, it was generally believed no deduction would be available for related legal fees as the support itself would not be taxable. However, Canada Customs & Revenue Agency (CCRA, formerly Revenue Canada) determined that, because child support was not "exempt income" under the Income Tax Act, related legal fees would continue to be deductible provided they met the requirements established under the historical cases. However, the Child Support Guidelines had changed the situation dramatically in that they incorporated an absolute right to support attributing to the custodial parent. CCRA eventually confirmed that they agreed with this interpretation, such that legal fees incurred in respect of an application for child support under the Guidelines would always be deductible.

Spousal support, however, was a different story. Under some provincial legislation, an absolute right to support existed. The Ontario legislation, for example, was analyzed by the tax courts and held to provide an absolute right to support. Under other statutes, including the federal Divorce Act, broad discretion provided to the courts was considered indicative that no absolute right to support existed. As such, costs incurred to obtain a spousal support order or agreement under these statutes were held to be non-deductible by CCRA, a viewpoint the courts historically agreed with. However, recent developments before the courts indicate that this historical interpretation may not be correct.

In the 1999 case of Bracklow v. Bracklow, the Supreme Court of Canada addressed the right to spousal support in some detail. In a recent Tax Court of Canada case, Raymonde Gallien v. MMQ, 2000, the court considered the impact of the Supreme Court's analysis on the deductibility of legal fees incurred to obtain an order requiring payment of spousal support under the federal Divorce Act. The Tax Court held that the comments of the Supreme Court indicated that the right to support is not created by the courts, but rather is a pre-existing right inherent within the Divorce Act itself. Based on the existence of this pre-existing right, the Tax Court allowed Ms Gallien to deduct the costs incurred in obtaining her spousal support order.

Assuming the reasoning in the Gallien case is accepted, this would seem to indicate that all legal fees incurred to obtain spousal support under the Divorce Act relate to the enforcement of an existing right. On this basis, these legal fees would be deductible, just as legal fees related to obtaining child support may be deducted.

The Gallien case was decided by the Tax Court of Canada on October 26, 2000. Given the magnitude of legal fees incurred across Canada for spousal support applications, it seemed likely that CCRA would not simply accept the case, and would appeal it to a higher level. However, to date, we are not aware of any appeal having been filed. It is, of course, possible that a different judge, or a higher court, may interpret the comments of the Supreme Court differently than Judge Lamarre Proulx, who heard the Gallien case. Given that the Supreme Court also acknowledged the possibility that, in a particular fact situation, support may not be payable, it is also possible CCRA would seek to restrict deductibility to those cases where support was, in fact, awarded on the basis that no right to support existed where the courts refuse to award support.

Income tax returns cannot be refiled or amended outside the usual period for objection based on new court decisions. The deadline for objecting to a personal assessment is normally 90 days after its assessment (or reassessment); however the deadline cannot fall sooner than one year after the filing deadline for the return. Thus, all tax returns for 2000 remain open for objection in this regard, but returns for prior years cannot generally be reopened. It might be possible if the return was filed late enough, or was recently reassessed, such that the 90 day window remains open.

Individuals who have incurred legal fees related to spousal support may wish to consider deducting those costs on their 2001 income tax returns, and filing adjustment requests for costs incurred in 2000. CCRA generally requests further details of claims for legal fees, so such filings may be examined closely. To our knowledge, CCRA has not yet commented on the Gallien case. Depending on their interpretation of the case, individuals making similar claims may be required to pursue their own cases before the courts. Even if CCRA accepts the Gallien decision, they may seek to restrict it to identical facts, requiring individuals whose circumstances vary to take their own cases before the courts. It would seem fairly certain, however, that CCRA will not seek out individuals who fail to claim a deduction with the intent of refunding their taxes paid. Thus, we would suggest individuals claim a deduction consistent with the Gallien case, but refrain from spending the tax savings until CCRA's position is clarified.

In order to assist their clients in advancing claims for their fees incurred in respect of support, lawyers should provide their clients with detailed statements of their fees. These statements would ideally incorporate all of the following information:

* The total fees paid by the client in the year -- legal fees of this nature are deductible only when paid, so invoices rendered in 2000, but paid in 2001, would only be deductible on a 2001 income tax return. Receipts for payments received would serve the same purpose; however many clients fail to retain their receipts. You should retain all invoices and receipts as they may be needed to support any related income tax deductions.

* A breakdown of fees between the various issues to which the fees relate. These would generally include some or all of the following:

- The costs of the divorce itself (non-deductible)

- Costs related to division of property (generally non-deductible)

- Costs related to custody and access (generally non-deductible)

- Costs related to securing, defending and enforcing receipt of child support (generally deductible, as discussed above)

- Costs related to defending and enforcing receipt of spousal support under pre-existing orders or agreements (generally deductible, as discussed above)

- Costs related to securing spousal support (historically believed non-deductible, but may be deductible based on recent jurisprudence as discussed above).

In our experience, it is frequently easier to assess the percentage of total fees related to each area, rather than providing absolute dollar amounts. For example, perhaps 10% of the costs incurred relate to costs of property division, 30% to spousal support and 60% to child support. This could be provided directly on invoices, or as separate correspondence. Either manner of allocation is generally acceptable to CCRA.

Further to the Gallien case, I requested CCRA advise us as to whether their interpretations of the deductibility of legal fees would change in light of that decision. Subsequent to the preparation of this article, I received a reply from CCRA dated July 6, 2001 (CCRA file number 2001-007338). Their response advises that their policy remains unchanged at the present time, but that the Agency has "undertaken a general study of the deductibility of legal fees relating to support" and anticipates a public announcement in the event that this results in a change to their policy.

While it is encouraging to know that CCRA is reviewing its interpretations in light of this case, it will likely be some time before their study is complete. In the meantime, unfortunately, it appears individuals wishing to advance a deduction claim similar to that claimed by Ms Gallien will likely be required to pursue their claim before the courts. As the Gallien case was heard under the "Informal Procedure" of the Tax Court, it is not a binding precedent. However, it is not uncommon for judges to follow the reasoning set out in decisions under the Informal Procedure.