Income Tax Folio

S4-F2-C1, Deductibility of Fines and Penalties

Series 4: Businesses

Folio 2: Deducting Business Expenses

Chapter 1: Deductibility of Fines and Penalties

Summary

This Chapter discusses the deductibility of fines and penalties for income tax purposes. Several provisions of the Act deny the deduction of a fine or penalty. The key provision is section 67.6, which specifically prohibits the deduction of a fine or penalty imposed under a statute. Where section 67.6 does not apply, various other provisions may preclude, or in some cases, permit, the deduction of certain fines or penalties. The purpose of this Chapter is to identify and discuss various income tax provisions that should generally be considered in determining the deductibility of a fine or penalty in any particular case.

The Canada Revenue Agency (CRA) issues income tax folios to provide technical interpretations and positions regarding certain provisions contained in income tax law. Due to their technical nature, folios are used primarily by tax specialists and other individuals who have an interest in tax matters. While the comments in a particular paragraph in a folio may relate to provisions of the law in force at the time they were made, such comments are not a substitute for the law. The reader should, therefore, consider such comments in light of the relevant provisions of the law in force for the particular tax year being considered.

Table of contents


Discussion and interpretation

Types of fines and penalties

1.1 The terms fine and penalty are not defined in the Act. For tax purposes, these terms should therefore be given their ordinary meaning having regard to the context in which the terms are used. A fine or penalty can generally be classified into one of the following categories:

  • Judicial These are imposed by a court of law or other competent tribunal for a breach of any public law, including carrying on an illegal business.
  • Statutory  – These are imposed as a result of the application of statutes (for example, federal statutes such as the Income Tax Act, Customs Act or Competition Act and provincial statutes such as the Business Practices and Consumer Protection Act of British Columbia).
  • Levied by professional and similar organizations  – Certain organizations recognized by statute or by regulatory authorities as the governing bodies of specific businesses, professions or trades are empowered to levy fines and penalties against their members for infractions of their own rules. Provincial law societies, accounting institutes, colleges of physicians and stock exchanges are examples of such organizations.
  • Levied by trade organizations and similar bodies  – Associations in which persons with common business or vocational interests participate for the collective benefit of those interests (such as trade associations, farmers' associations and similar bodies) often set standards of performance to be met in the operations of their members and, pursuant to voluntary agreements, impose penalties on infractions.
  • Levied under private contracts  – A party to a private contract may incur a penalty for failure to fulfil an obligation arising under that contract.

Relevant income tax provisions

1.2 There are several provisions of the Act that should be considered in determining whether a particular fine or penalty is deductible for income tax purposes. They include the following:

  1. Key provision – Applicable to fines and penalties imposed after March 22, 2004, section 67.6 specifically prohibits the deduction of a fine or penalty imposed under a federal, provincial, municipal or foreign law (see ¶1.4).
  2. General provisions – Where section 67.6 does not apply, a fine or penalty may be precluded from deduction under various general provisions in the Act. Specifically, a fine or penalty is not deductible as a current expense in computing income from a business or property, unless it satisfies each of the general tests outlined below:
    • the outlay must be deductible as a business expense in computing profit for purposes of subsection 9(1) (see ¶1.8);
    • the outlay must have been made for the purpose of gaining or producing income from the business or property (paragraph 18(1)(a)) (see ¶1.14);
    • the outlay must not be on account of capital (paragraph 18(1)(b)) (see ¶1.19);
    • the outlay must not be made for the purpose of gaining or producing exempt income (paragraph 18(1)(c));
    • the outlay must not be a personal expense (paragraph 18(1)(h)); and
    • the outlay must be reasonable in the circumstances (section 67).
  3. Other specific provisions – In addition to section 67.6, a fine or penalty may be precluded from deduction by:
    • paragraph 18(1)(t)  – Payments under different Acts (see ¶1.23);
    • section 67.5 – Non-deductible illegal payments (see ¶1.28).
  4. The following specific provisions may also be relevant:
    • subsection 18(9.1) – prepayment penalties (see ¶1.30);
    • subsection 62(3) – eligible moving expenses (prepayment penalties) (see ¶1.38).

1.3 The deductibility of a fine or penalty can only be determined after examining all the relevant facts. Comments are provided in this Chapter to assist in making a determination under several of the provisions noted in ¶1.2.

Key provision - section 67.6

1.4 Section 67.6 prohibits the deduction of any amount that is a fine or penalty imposed under a federal, provincial, municipal or foreign law by any person or public body that has authority to impose the fine or penalty. Generally, an amount must be characterized as a fine or penalty in the relevant legislation in order for section 67.6 to apply. The legislation imposing the fine or penalty will therefore determine whether an amount is a fine or penalty that may be precluded from deduction by section 67.6.

1.5 A person or public body may include, for example, a government or government agency, regulatory authority, court, tribunal or authorized representatives of such bodies. Section 67.6 will apply where such persons or public bodies are authorized to levy the fine or penalty that is imposed under a federal, provincial, municipal or foreign law.

When section 67.6 will not apply

1.6 Section 67.6 does not prohibit the deduction of prescribed fines or penalties. Pursuant to section 7309 of the Regulations, the only prescribed fine or penalty for purposes of section 67.6 is a penalty imposed under paragraph 110.1(1)(a) of the Excise Act.

1.7 Section 67.6 also does not prohibit the deduction of:

  • penalties or damages paid under a private contract (for example, a penalty charged for late performance);
  • interest charges, including interest arising on fines or penalties. However, certain interest charges may be precluded from deduction under another provision of the Act, such as paragraph 18(1)(t) (see ¶1.23);
  • amounts not characterized as a fine or penalty under the legislation imposing the particular amount; or
  • fines or penalties imposed before March 23, 2004.

Example 1

 

W Corp. operates in the construction industry. In 2014, an employee of W Corp. was injured in a workplace accident. An occupational health and safety (OHS) review of the accident was conducted. W Corp. was found to be partially at fault for the accident due to its failure to provide the employee with proper safety equipment, training and supervision. Section 67.6 prohibits the deduction of any fine or penalty imposed on W Corp. under provincial OHS legislation by the governing provincial OHS body authorized to do so.

Example 2

 

X Corp. is subject to greenhouse gas emission limits under provincial climate change legislation in the province in which it operates. In order to comply with its prescribed emission limit for a particular year, X Corp. purchases carbon offset credits. Such credits are purchased as a compliance measure and are not considered a penalty under the relevant provincial climate change legislation. Accordingly, section 67.6 does not prevent X Corp. from deducting the credits purchased.

The following year, X. Corp exceeds its prescribed emission limit and does not implement compliance measures within the necessary time period in which to avoid penalty. Any amount payable under the provincial climate change legislation that is described as a fine or penalty as a consequence of the non-compliance will be precluded from deduction by section 67.6. Additional information about the taxation of emission reduction and offset credits is available in Income Tax Technical News No. 34.

 

Example 3

 

Y Corp. operates in the securities industry in Ontario. In 2014, Y Corp. is subject to monetary sanctions from the Ontario Securities Commission for breaches of Ontario securities legislation. Section 67.6 prohibits the deduction of any such monetary sanction that is characterized as a fine or penalty under the Securities Act (Ontario).

Example 4

 

Mr. A is a sole proprietor who leased an automobile in 2010 for use in his business. Mr. A exceeded the allowable mileage specified in the lease agreement. As a result, at the end of the lease term in 2014, Mr. A was required to pay a penalty to the lessor. Section 67.6 does not prevent Mr. A from deducting the penalty because the penalty was not imposed under a federal, provincial, municipal or foreign law. In this case, the penalty imposed under the lease agreement arose under a private contract. However, the amount of the penalty eligible for deduction might be restricted by section 67.3, which applies to limit the deduction of expenses related to the lease of a passenger vehicle.

Deductible business expense – subsection 9(1)

1.8 Subsection 9(1) states that a taxpayer's income for a tax year from a business or property is the taxpayer’s profit from that business or property subject to the rules in Part I of the Act. The determination of profit is a question of law. The Act neither defines profit nor directs how it should be computed. The meaning of the term profit for purposes of section 9 was analyzed by the Supreme Court of Canada in 65302 British Columbia Ltd. v The Queen , [1999] 3 SCR 804, 99 DTC 5799, where the court stated:

"It is well established that the concept of profit found in s. 9(1) authorizes the deduction of business expenses, as profit is inherently a net concept, and such deductions are allowed under s. 9(1) to the extent that they are consistent with “well accepted principles of business (or accounting) practice” or “well accepted principles of commercial trading”: Symes  v. Canada …"

1.9 In its earlier decision in Symes v Canada, [1993] 4 SCR 695, 94 DTC 6001, the Supreme Court of Canada discussed the deductibility of business expenses under subsection 9(1), stating:

"… the "profit" concept in s. 9(1) is inherently a net concept which presupposes business expense deductions. It is now generally accepted that it is s. 9(1) which authorizes the deduction of business expenses; the provisions of s. 18(1) are limiting provisions only."

1.10 Accordingly, a fine or penalty that is a business expense for purposes of computing profit under subsection 9(1), will be deductible for income tax purposes, unless such deduction is limited or precluded by another provision of the Act (such as section 18 or 67.6).

1.11 In determining whether a particular amount is deductible in computing profit for purposes of subsection 9(1), the Federal Court of Appeal in Canadian Imperial Bank of Commerce v The Queen, 2013 FCA 122, 2013 DTC 5098, stated:

"…it may be necessary to consider whether there is a sufficient factual connection between the amount in issue and the business in respect of which the deduction is claimed."

1.12 In the CRA’s view, a fine or penalty incurred in relation to a transaction that is outside the scope of a taxpayer’s normal business activities should not be included in the computation of profit from that business for purposes of subsection 9(1). Whether a particular transaction is outside the scope of a taxpayer’s normal business activities is a question of fact that can only be conclusively determined after an examination of all relevant facts.

1.13 However, in determining whether profit is correctly computed for purposes of subsection 9(1), the Federal Court of Appeal clarified in Canadian Imperial Bank of Commerce that questions relating to the morality of a taxpayer’s conduct will not be relevant.

General limitation - paragraph 18(1)(a)

1.14 Paragraph 18(1)(a) provides that, in computing a taxpayer's income 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. In determining whether an amount is deductible under paragraph 18(1)(a), the Supreme Court of Canada stated in Symes that the language of the provision itself provided the most appropriate test. That is:

"… were the expenses incurred for the purpose of gaining or producing income from a business? Courts will look for objective manifestations of purpose, and purpose is ultimately a question of fact to be decided with due regard for all the circumstances. It may be relevant to consider whether a particular deduction is ordinarily allowed as a business expense by accountants, whether the expense is one normally incurred by others involved in the taxpayer's business, and whether it would have been incurred if the taxpayer was not engaged in the pursuit of business income."

1.15 The leading decision from the courts with respect to the deductibility of fines and penalties and the interpretation and application of the general limitation under paragraph 18(1)(a) is 65302 British Columbia Ltd. This Supreme Court of Canada decision was heard prior to the introduction of section 67.6 but continues to be relevant where section 67.6 does not apply. In this case, the Supreme Court of Canada stated that, “on its face, fines and penalties are capable of falling within the broad and clear language of s. 18(1)(a)”. However, the Court went on to say that, " if the taxpayer cannot establish that the fine was in fact incurred for the purpose of gaining or producing income, then the fine or penalty cannot be deducted."

1.16 Based largely on case law, the CRA will not consider the following factors to be relevant in determining whether a fine or penalty was incurred by a taxpayer for the purpose of gaining or producing income from the business or property:

  • whether the taxpayer attempted to prevent the act or omission that gave rise to the fine or penalty;
  • whether the taxpayer’s income-earning purpose was achieved through the act or omission that gave rise to the fine or penalty;
  • whether the fine or penalty was avoidable;
  • whether it would be contrary to public policy to allow the taxpayer to deduct the fine or penalty in the circumstances; or
  • whether the taxpayer’s conduct that gave rise to the fine or penalty could be considered egregious or repulsive.

1.17 Ultimately, whether a fine or penalty was incurred by a taxpayer for the purpose of gaining or producing income from a business or property within the meaning of paragraph 18(1)(a) is a question of fact that should be determined with regard to all relevant circumstances. It is a taxpayer’s responsibility to establish that this requirement is met.

1.18 Even if a fine or penalty was incurred for the purpose of gaining or producing income from a business or property within the meaning of paragraph 18(1)(a), other provisions of the Act may prohibit deduction of the fine or penalty.

Capital outlay or loss - paragraph 18(1)(b)

1.19 Paragraph 18(1)(b) provides that no deduction shall be made in respect of a payment on account of capital, except as expressly permitted under Part I of the Act. A fine or penalty will be on account of capital if it meets one of the following accepted legal criteria for distinguishing a payment on account of capital from a payment on account of income:

  1. the payment represents the acquisition cost (or part of the acquisition cost) of a capital asset;
  2. the payment can be considered to have been made to preserve or protect a capital asset; or
  3. the payment creates an enduring benefit to a business.

1.20 If a fine or penalty is incurred in connection with the acquisition of an asset for which capital cost allowance (CCA) may be claimed, the fine or penalty may be included in the capital cost of that asset (or the CCA class to which the asset belongs). If a fine or penalty is incurred in connection with the acquisition or production of inventory, the fine or penalty is included in the cost of inventory.

1.21 If a fine or penalty is incurred in connection with the acquisition of an eligible capital property, the fine or penalty is an eligible capital expenditure provided all the other tests in the subsection 14(5) definition of eligible capital expenditure are met. A penalty paid on the prepayment of a mortgage or hypothec does not qualify as an eligible capital expenditure by virtue of paragraph (d) of that definition in subsection 14(5).

1.22 If a fine or penalty (such as a penalty paid on the prepayment of a mortgage or hypothec) is incurred in connection with the disposition of a capital property, the fine or penalty is taken into account under subsection 40(1) for purposes of calculating any gain or loss on that disposition. See ¶1.30 for more information concerning the income tax treatment of prepayment penalties.

Payments under specific acts – paragraph 18(1)(t)

1.23 Paragraph 18(1)(t) prohibits the deduction of any amount paid or payable under the Act (such as income tax, fines, penalties and interest), with the exception of tax paid or payable under Part XII.2 or Part XII.6. Paragraph 18(1)(t) also prohibits a deduction for any amount paid or payable as interest under Part IX of the Excise Tax Act (relating to the goods and services tax), or as interest under the Air Travellers Security Charge Act. Paragraph 18(1)(t) does not preclude the deduction of fines, penalties and interest levied under other statutes. However, section 67.6 might apply (refer to ¶1.4 1.7).  

Example 5

 

In 2013, X Corp. fails to collect tax levied under the Tobacco Tax Act of Ontario. Interest and penalties are imposed under subsections 18.1(1) and 19(2) of that Act, respectively.

The penalty imposed under subsection 19(2) of the Tobacco Tax Act is imposed under a law of a province and is not a prescribed penalty. This means that pursuant to section 67.6, the amount cannot be deducted.

The interest charge imposed under subsection 18.1(1) of the Tobacco Tax Act of Ontario does not represent interest paid or payable under the Income Tax Act, Part IX of the Excise Tax Act or the Air Travellers Security Charge Act. This means that the interest is not precluded from deduction by paragraph 18(1)(t). Such interest may be deducted where it was made or incurred by X Corp. for the purpose of gaining or producing income from the business or property and otherwise meets the requirements for deduction under the Act.

Provincial income tax

1.24 Paragraph 18(1)(t) does not prohibit the deduction of provincial income tax. However, provincial income tax is not an expense made or incurred by a taxpayer for the purpose of gaining or producing income from a business or property and is therefore precluded from deduction by paragraph 18(1)(a). This position is consistent with the Exchequer Court of Canada’s decision in Clinton W. Roenisch v. MNR , [1931] Ex. C.R. 1, 1 DTC 199. Section 67.6 prohibits the deduction of a fine or penalty imposed under provincial income tax legislation (see ¶1.4).

Foreign income or profits tax

1.25 Paragraph 18(1)(t) does not prohibit a deduction for income or profits tax paid or payable to a foreign jurisdiction. However, a foreign income or profits tax is not an expense made or incurred by a taxpayer for the purpose of gaining or producing income from a business or property and is therefore precluded from deduction by paragraph 18(1)(a). This position is consistent with the Exchequer Court of Canada’s decision in Quemont Mining Corporation Limited, Rio Algom Mines Limited, and MacLeod-Cockshutt Gold Mines Limited v. MNR , [1966] CTC 570, 66 DTC 5376.

1.26 An exception to the general limitation in paragraph 18(1)(a) applies to the deduction of certain foreign taxes under subsections 20(11), (12) and (12.1). Income or profits taxes paid to a foreign jurisdiction may also qualify for a foreign tax credit. For more information on these topics, see Income Tax Folio S5-F2-C1, Foreign Tax Credit and Interpretation Bulletin IT-506, Foreign income taxes as a deduction from income.

1.27 Section 67.6 prohibits the deduction of a fine or penalty imposed under a foreign statute (see ¶1.4).

Illegal payments - section 67.5

1.28 Section 67.5 prohibits the deduction of an outlay made or expense incurred for the purpose of doing anything that is an offence under section 3 of the Corruption of Foreign Public Officials Act or under any of sections 119 to 121, 123 to 125, 393 and 426 of the Criminal Code, or an offence under section 465 of the Criminal Code as it relates to an offence described in any of those sections.

1.29 Fines or penalties levied as a result of a criminal conviction may be precluded from deduction by section 67.6 or various other provisions as outlined in ¶1.2.

Prepayment penalties - subsection 18(9.1)

1.30 In some circumstances, a rate reduction fee or prepayment penalty paid in respect of a debt obligation will be deductible for income tax purposes. Where the requirements of subsection 18(9.1) are met, such payments are deemed for purposes of the Act to have been paid by the taxpayer and received by the recipient as interest on a debt obligation pursuant to paragraph 18(9.1)(e). An amount deemed to have been paid as interest under paragraph 18(9.1)(e) will be deductible under paragraph 20(1)(c) if the requirements in that paragraph are met (see ¶1.37).  Where the requirements of subsection 18(9.1) are not met, a rate reduction fee or prepayment penalty will not generally be deductible for income tax purposes (see ¶1.38).

Meaning of rate reduction fee and prepayment penalty

1.31 The term rate reduction fee refers to the consideration paid by a taxpayer for a reduction in the rate of interest payable by the taxpayer on a debt obligation. A prepayment penalty is a penalty or bonus paid by a taxpayer because of the repayment by the taxpayer of all or part of the principal amount of a debt obligation before its maturity.

Conditions under subsection 18(9.1)

1.32 In order for subsection 18(9.1) to apply, a rate reduction fee or prepayment penalty must have been paid: 

  • in the course of carrying on a business in respect of borrowed money or on an amount payable for property acquired by the taxpayer (referred to as a debt obligation); or
  • in the course of earning income from property in respect of a debt obligation.

1.33 In addition, paragraphs 18(9.1)(a) and (b) provide that a payment will not be deemed to have been paid as interest under subsection 18(9.1) where the payment:

  • can reasonably be considered to have been made in respect of the extension of the term of a debt obligation;
  • can reasonably be considered to have been made in respect of the substitution or conversion of a debt obligation to another debt obligation or share;
  • is contingent or dependent on the use of or production from property;
  • is computed by reference to revenue, profit, cash flow, commodity price or any other similar criterion; or
  • is computed by reference to dividends paid or payable to shareholders of any class of shares of the capital stock of a corporation.

Computing the deemed interest amount

1.34 For tax purposes, an amount deemed to have been paid as interest under paragraph 18(9.1)(e) will be considered interest for tax years ending after the rate reduction fee or prepayment penalty is paid (such tax years are referred to below as future tax year(s) ). The deemed interest is limited to the amount of the payment that reasonably relates to the value of the interest otherwise payable on the debt obligation (see ¶1.35) in a future tax year if the interest rate had not been reduced, or all or part of the debt obligation had not been repaid before its maturity.

1.35 The value of the interest otherwise payable on the debt obligation must be measured at the time the rate reduction fee or prepayment penalty is paid and may be determined using a straight line or present value method. In ¶1.37, we refer to this value as the hypothetical interest value.

Deduction of deemed interest

1.36 Pursuant to paragraph 18(9.1)(f), an amount deemed to have been paid as interest under paragraph 18(9.1)(e) is also deemed, for purposes of computing the taxpayer’s income from the business or property, to have been paid or payable by the taxpayer in that future tax year as follows:

  • in the case of a rate reduction fee, as “interest pursuant to a legal obligation to pay interest … on the debt obligation”;
  • in the case of a prepayment penalty, where the repayment is in respect of all or part of the principal amount of a debt obligation that was borrowed money (except to the extent that the borrowed money was used by the taxpayer to acquire property), as “interest pursuant to a legal obligation to pay interest … on borrowed money used in the year for the purpose for which the borrowed money that was repaid was used”;
  • in the case of a prepayment penalty, where the repayment is in respect of all or part of the principal amount of the debt obligation that was either borrowed money used to acquire property or an amount payable for property acquired by the taxpayer, as “interest pursuant to a legal obligation to pay interest … on the debt obligation to the extent that the property or property substituted is used by the taxpayer in the year for the purpose of gaining or producing income or for the purpose of gaining or producing income from a business”.

1.37 The deeming rule in paragraph 18(9.1)(f) addresses some of the requirements for the deduction of interest under paragraph 20(1)(c).  If the requirements of paragraph 20(1)(c) are met, a taxpayer will be entitled to an interest deduction in a future tax year to the extent of the hypothetical interest value. If the payment exceeds the hypothetical interest value, the excess is:

  • not deemed to be interest under paragraph 18(9.1)(e); and
  • not deductible under any provision of the Act.

For more information concerning the deductibility of interest under paragraph 20(1)(c), see Income Tax Folio S3-F6-C1, Interest Deductibility.

Treatment where subsection 18(9.1) does not apply

1.38 Where subsection 18(9.1) does not apply, a rate reduction fee or prepayment penalty will generally be considered to be on account of capital and precluded from deduction by paragraph 18(1)(b). However, exceptions to this rule may apply where:

  • a prepayment penalty is incurred in connection with the disposition of a capital property (see ¶1.22.);
  • a prepayment penalty qualifies as a current expense for the particular business, e.g., the business of trading in mortgages.

Fees incurred to object to or appeal an assessment of penalties

1.39 Paragraph 60(o) provides a deduction for (among other things) certain fees or expenses paid in the year to prepare, institute or prosecute an objection to, or an appeal relating to:

  • an assessment of tax, interest or penalties under:
    • the Act; or
    • an act of a province that imposes a tax similar to the tax imposed under the Act; or
  • an assessment of any income tax deductible by the taxpayer under section 126 of the Act (concerning foreign tax credits) or any interest or penalty relating to such assessment.

Application

This updated Chapter, which may be referenced as S4-F2-C1, is effective December 22, 2015.

When it was first published on July 10, 2015, it replaced and cancelled Interpretation Bulletin IT-104R3, Deductibility of fines or penalties.

Any technical updates from the cancelled interpretation bulletin can be viewed in the Chapter History page.

Except as otherwise noted, all statutory references herein are references to the provisions of the Income Tax Act, R.S.C., 1985, c.1 (5th Supp.), as amended and all references to a Regulation are to the Income Tax Regulations, C.R.C., c. 945, as amended.

Links to jurisprudence are provided through CanLII.

Income tax folios are available in electronic format only.

Reference

Section 67.6, subsection 9(1) and paragraph 18(1)(a) (also section 67.3 and 67.5, subsections 18(9.1), 40(1) and 142.4(10), paragraphs 18(1)(b), 18(1)(c), 18(1)(h), 18(1)(t), 20(1)(c), 60(o) and paragraph (d) of the definition of eligible capital expenditure in subsection 14(5))

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