Are business expenses still tax deductible if you no longer operate said business?
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 practicing 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 wind-up 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.”