Legal fees from disability fight deductible: Tax Court confirms P.E.I. woman's claim

National Post

2005-06-18


Mary Farrell was an employee with the Worker's Compensation Board in Prince
Edward Island when she became medically disabled and unable to work. Her
employment benefit package at the WCB included compensation for her lost wages
should she become disabled.

Ms. Farrell testified in court that she had a lot of trouble trying to get
the insurer to pay her disability claim and subsequently declared bankruptcy.
She hired two separate lawyers to pursue her disability claim until, eventually,
a settlement was reached with the insurance company and she received a lump-sum
amount. She paid more than $23,000 in legal fees to pursue her claim, and
proceeded to deduct those on her 2002 tax return.

Under the Income Tax Act, an individual can deduct legal fees paid "to
collect or establish a right to salary or wages owed to the taxpayer by the
employer or former employer of the taxpayer." The term "salary or wages"
includes disability payments made to compensate someone for lost salary or
wages.

Last month the Tax Court of Canada was asked to determine whether legal fees
paid to pursue Ms. Farrell's disability settlement are tax deductible.

The Canada Revenue Agency did not dispute that the legal fees paid by Ms.
Farrell were "incurred to collect a replacement for lost salary or wages."
Rather, it took issue with the fact that the legal action was between Ms.
Farrell and the insurance company, and not between Ms. Farrell and her employer,
the WCB.

The question the court had to answer, therefore, was whether the insurance
company was paying Ms. Farrell directly or simply paying her "on behalf of the
employer."

The judge reasoned since the WCB, as part of its benefits package, entered
into an agreement with an insurance company to pay disability benefits to its
employees in case of disability, the fact that the payments were actually made
by the insurance company was irrelevant.

The judge therefore concluded the legal fees were properly tax deductible on
the basis that the contract with the insurer to pay Ms. Farrell disability
benefits was pursuant to her employment contract with the WCB. Since the insurer
was paying her on behalf of the WCB, "the amounts were therefore owed by the
employer."

This decision should provide some welcome tax relief to injured parties who
often incur substantial legal fees to pursue their claims.