Expenses from former businesses generally don’t get relief, but a recent tax court ruling shows an exception
Self-employed professionals take on plenty of risks, which is the reason they are able to write off a range of business expenses against their income. That flexibility may, in some cases, go so far as to allow losses sustained from such expenses to be carried forward for use against future income for up to 20 years.
But what happens when someone incurs ongoing expenses from a business that they’ve already stopped operating, and which they don’t expect to generate any further profits?
That’s the issue Jamie Golombek, Managing Director, Tax & Estate Planning with CIBC, brought up in a recent article. He cited a recent case heard by the Tax Court, which involved a retired Nova Scotia lawyer who counted $57 in professional dues and $1,200 in file storage fees as expenses on her 2015 tax return. “The Canada Revenue Agency allowed her annual dues, but it disallowed her storage fees,” Golombek said.
The taxpayer had acquired 27 years’ worth of files over the course of her career as a lawyer. In 2012, she started providing legal services from her home; having given up her traditional business office, she moved the client files to a paid storage facility. The next year, she stopped providing active legal services and became a “retired” member of the Nova Scotia Barristers Society.
Members of the society get insurance against professional liability insurance through the Lawyers Insurance Association of Nova Scotia (LIANS). To mitigate legal liability from premature destruction of client files, LIANS has rules and recommendations for client file storage; some may be scanned, others destroyed, and still others must be kept for anywhere from three to 25 years.
The CRA argued that even though the file storage expense originated from the taxpayer’s former law business, they should no longer be deductible against her income in 2015 as the taxpayer was not getting income from said business anymore. Quoting the Income Tax Act, the agency said “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.”
But the taxpayer countered that file maintenance or storage “is an inherent risk of the profession” and is necessary to practice law. Had she not done so, she would have faced “progressive sanction ascending to possible disbarment.” She added that maintaining her closed files in storage was required by the “guidelines and standard and acceptable business practice” laid out by LIANS and the law society. She also cited prior jurisprudence in support of her claim for a tax deduction on business expenses that go past its operation.
The Tax Court judge opined that lawyers typically accrue “run off” responsibilities involving file retention, accessibility, and future storage obligations in the course of providing clients with legal services. If she did not adhere to the required storage periods for files and client records relating to legal advice, the judge added, she could be sued for professional negligence.
The judge ruled that the file storage fees were deductible in 2015 because keeping the files constituted an “enduring and current provision of legal services” for which income had been earned in previous years. He added, however, that the need for costly storage “is not one which will exist forever” as new client files in the present legal profession are digitized as they are created, and can be easily stored electronically.