In order for someone to claim a tax deduction, our tax system requires that there be an income source to which an expense relates, and that the purpose of the expense is to produce such income.
For a professional who ceases practice, it would thus seem unlikely that deductibility would be available for an amount expended after the business has ceased to exist. However, where that expense relates back to the pre-retirement period when professional services were being rendered, deductibility comes back into the picture.
Income Tax Act (ITA) Canada
ITA subsection 9(2) makes reference to calculation of a taxpayer’s loss from a “business or property” for a taxation year. It requires that a taxpayer’s loss, if any, from that source be determined by applying the ITA provisions for income computation. Put another way, if there is no business or property income for that taxation year, in principle there can be no deduction.
Furthermore, an expense must fulfill the purpose requirement under ITA paragraph 18(1)(a) dealing with business or property, whereby:
18. (1) “… no deduction shall be made in respect of
(a) 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”
A.G. (Canada) v. Poulin, 1996 DTC 6477 (FCA)
Poulin was a real estate broker who had ceased carrying on business in 1984. In 1987, he was found liable to a past client in relation to a transaction from 1976. Poulin sought to deduct the $385,802 adjudged award as a business loss in 1987, and to carry the remaining loss to other years.
The court held that the fact that Poulin was not carrying on the business in 1987 did not preclude him from seeking to claim under paragraph 18(1)(a), “as long as he was engaged in completing the things he had done in carrying on his profession, even though at that point he was no longer carrying on business and could no longer act on behalf of clients.” The claim would have to relate to an impugned act that was necessary in order to carry on a trade or profession, but may have been performed improperly.
Unfortunately for Mr. Poulin, the court went on to determine that the damages in the circumstances related to a tort – an unlawful or deliberate act committed with the aim of causing damages – which it found was foreign to his profession, thereby ruling out deductibility.
2015-0618981E5 - Deductibility of run-off insurance premiums
The question was posed to the Canada Revenue Agency (CRA) whether a retired professional can deduct run-off insurance premiums from business income in the year the premiums are paid, even if the professional has ceased to carry on business in that year.
Citing Poulin as authority, the author of this CRA letter opines that, despite that the taxpayer may no longer be in practice, run-off insurance premiums may be deductible in the year paid. The claim must conform with ITA deductibility requirements generally, and relate to work performed “during the ordinary course of the professional’s business operation.” in the pre-retirement timeframe. Presumably the reference to “ordinary course” distinguishes offside activities such as in Poulin.
- Tax deductibility requires that an expense relates to producing business or property income, most often with both expense and income arising in the same year.
- Bearing in mind that CRA letters are not legally binding, it would appear that CRA’s administrative position is that run-off insurance premiums may be deductible when paid in a post-retirement year.
- Irrespective of tax deductibility, a retiring professional would be well-advised to consider run-off insurance coverage if it is available, in order to provide a degree of protection from a post-practice claim.