Tax-deductible fines

Fines and levies and related interest and legal expenses may be deductible from income as a business expense, the Supreme Court of Canada has ruled. The deductions, whether the result of criminal or civil penalties, can be applied even to create a loss.

In the ruling, 65302 British Columiba Ltd. v. Canada, released November 25, 1999, the court said deductibility applies:

• only if the penalty was incurred for the purpose of earning income, even if the penalized activity was carried out with knowledge it was illegal;
• unless deductibility is specifically prohibited by law (e.g., the Income Tax Act precludes deductibility of bribe payments and payments of interest and penalites levied for Income Tax Act violations); or
• unless the case is “so egregious or repulsive that the fine subsequently imposed could not be justified as being incurred for the purpose of producing income.” However, such a situation, the court said, would “likely be rare.”

The court observed that “in calculating income, the deduction of expenses incurred to earn income generated from illegal acts is allowed. For example, not only is the income of a person living from the avails of prostitution liable to tax, but the expenses incurred to earn this income are also deductible.” The court rejected the argument that deduction of penalties should be disallowed as contrary to public policy, noting that Parliament can prohibit deductions if it chooses.

The court said that even if the offence that led to the penalty was avoidable, the taxpayer would still be entitled to the deduction.

Deductibility does not create profit for the taxpayer, the court noted. Rather the deduction is part of calculating the taxpayer’s profit, which is then taxed. The taxpayer may generate a loss as a consequence of recognizing the penalty and legal expense.

The court was ruling in the case of a B.C. egg producer penalized for producing over-quota and who had deducted the over-quota levy and related legal fees as a business expense.

In its decision, the court examined the interpretation of Section 18(1)(a) of the Income Tax Act which states:

“In computing the income of a taxpayer from a business or property 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 or property.”