It is well established that paragraph 8(1)(b) of the Income Tax Act permits a taxpayer to deduct legal expenses incurred to collect or to establish a right to salary or wages owed to the taxpayer by an employer or former employer.  However, the Canada Revenue Agency (“CRA”) only allows a deduction where the salary or wages are “owed” by an employer or former employer.1  Nevertheless, the decision in Chagnon c. La Reine (“Chagnon”)2 by the Tax Court of Canada (“TCC”) expands the applicability of paragraph 8(1)(b) to permit the deduction of legal expenses incurred by a taxpayer to defend against actions taken by an employer to reclaim salary previously paid.


The taxpayer in Chagnon was the former president and chief executive officer (“CEO”) of Vidéotron (the “Employer”).  He was granted stock options to purchase shares in his Employer.  All parties agreed that the stock options were related to the taxpayer’s employment and appointment as CEO.  The taxpayer’s total salary and benefits were determined by an independent member of the Employer’s board of directors with external advice.  The stock option plan was subsequently amended to allow the taxpayer to receive additional salary in lieu of exercising the options, for an amount equal to the difference between the strike price and the fair market value of the shares, multiplied by the number of shares.

The taxpayer chose to receive the additional salary in lieu of exercising his options when his Employer was acquired by QMI.  Two years after this, the Employer and QMI sued the taxpayer for a breach of the duty of loyalty to his Employer, and sought to reclaim the additional salary paid.  The taxpayer prevailed in the lawsuit, and deducted his legal expenses pursuant to paragraph 8(1)(b).  CRA disallowed the deduction, and the taxpayer appealed to the TCC.  The TCC ruled in favor of the taxpayer.

Scope of Paragraph 8(1)(b) and the Meaning of “Owed”

The TCC reviewed its earlier decision by Woods J. in Fenwick v. The Queen (“Fenwick”)3.

In Fenwick, the taxpayer incurred legal expenses to defend against legal actions by other shareholders and the private corporation of which he was president.  One of the claims involved the payment of excessive remuneration to the taxpayer.  The taxpayer in Fenwick did not prevail because the court ruled that the taxpayer did not incur the legal expenses to establish a right to salary or wages.

Nevertheless, in obiter dictum, Woods J. suggested that the narrow interpretation of “owed” in paragraph 8(1)(b) put forward by CRA was likely incorrect.  CRA had argued that “owed” in the context of paragraph 8(1)(b) only applied to unpaid remuneration.  Therefore, any legal expenses incurred to defend against actions to reclaim excessive remuneration is not deductible under paragraph 8(1)(b).  In contrast, Woods J. thought that it was more sensible to interpret the word “owed” as being equivalent to “earned”.  Since the court ruled against the taxpayer on other grounds, Woods J. did not decide on the definition of “owed”.  Fenwick was upheld on appeal to the Federal Court of Appeal (“FCA”) which also discussed, but did not decide, the proper definition of “owed” in paragraph 8(1)(b).4

After reviewing the FCA’s and TCC’s prior decision in Fenwick, the TCC in Chagnon agreed with “the obiter comments of Woods J. in Fenwick that paragraph 8(1)(b) is capable of being interpreted, and should be interpreted, as extending to legal expenses incurred by an employee in order to retain salary already paid, when that employee is faced with litigation seeking to reclaim such amount”5.  According to the court, regardless of whether an employee is seeking to claim unpaid remuneration, or defending against an action to reclaim excessive remuneration, in each instance, the employee is still seeking to establish his/her rights or legal entitlement to the salary.

Having defined the meaning of “owed” in paragraph 8(1)(b) as being equivalent to “earned”, the court in Chagnon then ruled that the taxpayer did indeed incur the legal expenses to establish his right to the salary earned and previously paid to him.  The claims against the taxpayer related to the issuance of the employment related stock options, and the amount at issue was equal to the additional salary paid.

Concluding Remarks

It is difficult to fully assess the merit of the decision in Chagnon, and whether the decision is vulnerable to being overturned in the future.  The TCC did not provide a detailed and convincing analysis in its judgment.  It merely referred to and approved of comments made, in obiter, in an earlier judgment.  Moreover, the obiter comments by Woods J. in Fenwick were hardly comprehensive or extensive.  Nevertheless,  until Chagnon is overruled, the scope of paragraph 8(1)(b) has been effectively expanded in favor of taxpayers.