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Deducting Something from Nothing: Paragraphs 80(h) and (i)

First published by the Canadian Tax Foundation in (2005) Vol. 53, No.1 Canadian Tax Journal

In Williams v. The Queen, the Tax Court of Canada addressed the question of whether it was appropriate for the taxpayer to deduct certain employment expenses pursuant to paragraphs 8(1)(h) and (i) of the Income Tax Act in circumstances where the employer paid the expenses and the taxpayer, although obligated, had not yet reimbursed the employer.

The taxpayer, Tom Williams, was employed by a securities brokerage firm as a senior technology analyst in 1997 and 1998.  He was responsible for performing due diligence and selling large‑scale high‑tech securities offerings.  There was no written employment agreement.  Instead, Mr. Williams entered into a verbal agreement with his employer that he would be remunerated on a commission basis.  As part of the agreement, he was able to take regular monthly draws as advances against anticipated commissions.  All draws and other advances were treated as employment income paid to Mr. Williams.  He was provided with T4 statements that included these amounts.

In performing his duties, Mr. Williams was required to travel extensively in Canada and the United States.  He was responsible for paying his own travel expenses and the payment of a salary to his sales assistant.  These expenses were necessary for him to arrange and negotiate transactions for his employer.  Although he was not specifically required by the terms of his contract of employment to hire a sales assistant, it was not possible for him to perform his duties without one.  Mr. Williams did not receive an allowance and was not reimbursed or entitled to reimbursement for any of his expenses.  However, the employer paid the expenses on his behalf.  and the amounts paid were treated as a debt owing to it by him.  The employer expected to recover these payments from future commissions earned by Mr. Williams.

In 1998, Mr. Williams ceased his employment with the company.  None of the transactions were completed, and he earned no commissions.[i]  However, he did receive amounts in the form of monthly draws and other advances against commissions.  Pursuant to an agreement with his employer, he was required to repay the advances when he left the company.  However, Mr. Williams did not repay any of the money he received.  In filing his 1997 and 1998 income tax returns, he included the advances as income and claimed the expenses as deductions for those taxation years.  The minister reassessed the returns and denied the deduction of the expenses.

The minister argued that Mr. Williams did not pay any expenses in the year and, as a result, was not entitled to a deduction under paragraph 8(1)(h), (i), or (f).  The minister’s position was that because Mr. Williams did not repay the amounts advanced by his employer, the expenses were not paid by him.  The minister also argued that Mr. Williams was not entitled to deduct the expenses under paragraph 8(1)(f) because he only received advances on account of future commissions, and no actual commissions were earned.  In his argument, Mr. Williams relied on paragraphs 8(1)(h) and (i).  Paragraph 8(1)(f) was presented as an alternative argument.  The court did not address this provision because the matter was disposed of on the basis of the applicability of the other two provisions.

Pursuant to paragraph 8(1)(h), under certain conditions, a taxpayer may deduct reasonable amounts expended for travelling in the course of employment.  The taxpayer is entitled to a deduction under this provision only if the amount expended was incurred to carry on employment duties away from the employer’s place of business.  The taxpayer must not have received an allowance for these expenditures[ii] and must not claim a deduction under certain other provisions.[iii]  In addition, the taxpayer must be required to pay these amounts under a contract of employment.  In circumstances where all the conditions have been met, courts will disallow deductions under this provision if there is no requirement for the taxpayer to incur these expenses by virtue of his or her employment.[iv]

In this case, Mr. Williams met all the conditions.  However, at issue was whether the amounts were expended by him or by the employer.  A similar issue arose in Nissim v. The Queen,[v] a decision of the Tax Court of Canada, where the taxpayer relied on the Ontario Legal Aid Plan (OLAP) to cover legal expenses.  The taxpayer later attempted to deduct the legal expenses paid by OLAP on the tax return for the relevant year.  The minister denied the claim.  At trial, Justice Bowman found that although the taxpayer did not pay the amount directly, the legal expense was deductible.  The court stated that since the taxpayer had a very real and immediate liability to OLAP to repay the legal costs, the cost should be deductible.[vi]

It was clear that Mr. Williams was responsible for his own travel expenses and did not receive an allowance for those expenses.  He was also not reimbursed or entitled to reimbursement.  However, the fact that the employer paid the expenses on his behalf (notwithstanding that the expenses were treated as debt owing to the employer) appeared to trouble the minister.  Justice Miller found that each time the employer paid Mr. Williams’s expenses, it was his money that was being spent.  Also, the court found that under the agreement, it was clear that the employer expected to recoup the payments from future commissions.  On the basis of this evidence, the court found that an immediate and absolute liability existed and, therefore, that Mr. Williams had made these payments.  The court stated:

It is not the exchange of physical cash or whose credit card was used to pay that determines who expended the money, but it is the legal relationships that are in play which must be examined... .

[The taxpayer] was obliged to reimburse [his employer] on a demand basis...  .  This is more than simply an employee advance only to be recouped from subsequent earnings.  It was more in the nature of a demand loan....  I find that [the taxpayer] effectively made these payments.[vii]

Clearly, one of the factors that motivated the minister in making the reassessment was the fact that Mr. Williams had never repaid the debt to his employer.  However, as Justice Miller points out in his decision, that situation is addressed by subsection 6(15) of the Act, which provides that a debt to an employer that is not repaid must be included in income as a taxable benefit.  In the context of deductibility pursuant to paragraph 8(1)(h), provided that an employee has a genuine liability to repay expenses paid on his or her behalf by the employer, the employee will be entitled to a deduction for expenses, even where the employee has not repaid those amounts.  The court was correct in finding that the amounts expended by the employer were monies expended by the taxpayer, since the taxpayer had a genuine liability to repay those amounts.  As a result, the appropriate treatment of the unpaid amounts should not be to deny the deduction, but to include it in the calculation of the taxpayer’s income.

Mr. Williams also incurred expenses to hire a sales assistant.  Subparagraph 8(l)(i)(ii) provides that an employee may deduct an amount on account of payment of a salary to an assistant, to the extent that the employee has not been reimbursed and is not entitled to reimbursement for the payment.  In addition, the payment must be required under the contract of employment between the employer and the taxpayer.  The leading case on this issue is Cival.[viii]  In Cival, the trial judge concluded that the taxpayer was required under his contract of employment to pay the travel expenses that he incurred in the performance of his employment duties.  The Federal Court of Appeal disagreed with this conclusion.  The Federal Court held that Mr. Cival was not contractually bound to use his car in doing his job and to pay the expenses incurred.  If he had refused to use his car for this purpose, his employer would not have had a cause of action for breach of contract.  As a result, the courts found that Mr. Cival was not required under the contract of employment to pay the expenses he incurred in using his car in the performance of his employment duties, and therefore could not deduct the expense.

In Slawson v. MNR,[ix] Justice Sarchuk indicated that certain expenses are deductible by a taxpayer where they are incurred in connection with the selling of property for his employer and where, under the contract of employment, the employee was required to pay his own expenses.  The court stated that the evidence must lead to a conclusion that the taxpayer was required by the contract of employment to pay certain expenses he incurred.  Although Justice Sarchuk found that the taxpayer may have been expected to do many of the things that led to his incurring these expenses, on the basis of the evidence he concluded that the taxpayer was not required by his contract of employment to do so.  In his judgment, Justice Sarchuk stated:

I cannot equate the expectations of the employer as described by both [the taxpayer] and by [the employer] to a contractual requirement imposed upon [the taxpayer], breach of which would have given a cause of action to the employer against him.[x]

Further, the courts have held that for a deduction to be claimed under subparagraph 8(1)(i)(ii), a written employment agreement is not necessary.[xi]

The court distinguished Williams from Civil and Slawson.  In Williams, the parties agreed that Mr. Williams could not perform his employment duties without a sales assistant and that it was his responsibility to pay the assistant.  This evidence was sufficient for the court to conclude that hiring an assistant was an implied term of the contract.  In addition, the court found that Mr. Williams was responsible for this expenditure because his employer had loaned him money to cover this expense; therefore, he was entitled to a deduction.  This decision reinforces the principle under paragraph 8(1)(i) that a taxpayer will be entitled to deduct expenses incurred to pay an assistant even though the terms of the employment contract may not specifically refer to the expense, provided that the taxpayer is required to pay the expense as an implied term of the contract.  The court was correct in allowing the deduction.

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[i]  For the purposes of a discussion of paragraph 8(1)(h), it is irrelevant whether the taxpayer earned any commission.  This is not one of the tests for deductibility under this provision.  Only paragraph 8(1)(f) restricts the amount of expenses that can be claimed against the amount of commissions earned.

[ii]  The employee cannot be in receipt of an allowance for travel expenses that was excluded from income by virtue of subparagraph 6(l)(b)(v), (vi), or (vii) if the employee wants to take advantage of the deduction under paragraph 8(1)(h).

[iii]  In particular, the taxpayer must not claim a deduction under paragraph 8(1)(f) (salesperson’s expenses).  This was not in issue in this case.

[iv]  The Queen v. Cival, 83 DTC 5168; [1983] CTC 153 (FCA).

[v]  [1999] 1 CTC 2119 (TCC).

[vi] The result was different in Ryan v. The Queen, [2000] 2 CTC 2329 (TCC).  The court found that no absolute liability existed to OLAP for the payment of legal expenses when the taxpayer did not pay the expense in the taxation year in question.  The court did not allow the deduction in this case.

[vii]  2004 DTC 3549, at paragraphs 14 and 16 (TCC).

[viii]  Supra note 4.

[ix]  85 DTC 63; [1985] 1 CTC 2075 (TCC).  See also The Queen v. Gilling, 90 DTC 6274; [1990] 1 CTC 392 (FCTD).

[x]  Slawson, supra note 9, at 64; 2077.

[xi]  Bryant v. MNR, 80 DTC 1428; [1980] CTC 2529 (TRB).  Also, in Tkachuk v. MNR, 78 DTC 1830; [1978] CTC 3114 (TRB), the board stated that the words "under the contract of employment" do not require the existence of a written employment contract, nor does the requirement of payment have to be discussed explicitly between the employee and his employer.  If the facts support the existence of such a condition in the contract, subparagraph 8(1)(i)(ii) is satisfied.


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