The Tax Court has ruled in favour of a small consulting firm that tried — and failed — to get a new investment vehicle up and running.

Getting a new venture going can be costly and risky: if it fails, those financing the startup will want to deduct the costs of trying to get the ball rolling. But what if the Canada Revenue Agency thinks the new, but revenue-free, corporation must take the deduction? That could create a double whammy for the entrepreneur: first, it is out the costs of a failed startup; then it cannot deduct those expenses from its income.

The Tax Court of Canada recently considered this issue: a two-person consulting partnership that incurred legal expenses to start a new corporation successfully argued that it should be able to deduct those costs. The judgment overrules the CRA’s contention that the new (income-free) corporation should take the deduction.

The April decision in Archibald v. The Queen dealt with business expenses of about $18,000, claimed as deductions by a consulting partnership run by Audrey and Ian Archibald. Most of that expense represented legal fees. Those fees were incurred to prepare the paperwork for a new business that would issue securities to investors in a new corporation.

The funds were to be used to purchase resort condominiums and sell fractional interests in them. A large chunk of the legal work involved the preparation of a prospectus for the securities: invoices were addressed to both the new corporation as well as Archibald. However, investors did not appear and the new business failed.

Justice Judith Woods found for the partnership for a number of reasons. She concluded that Ian Archibald had incurred the legal fees in his role as a business partner (and not personally), partly because he expected to receive income from the partnership as a result of the new venture.

Woods also concluded that the legal fees were incurred by the partnership, with a “contingent right” to be reimbursed for the legal costs by the corporation if the new venture succeeded. Woods noted that this followed from common sense. “The new venture was likely a highly risky one from the partnership’s perspective. It appears to have been a new type of venture for Mr. Archibald, and the legal fees were incurred prior to his knowing whether sufficient investors would be interested,” the judgment says.

In the result, it appears that small businesses looking to expand by starting up a new venture that includes a corporate entity will nonetheless be able to deduct the costs of startup from the income of their pre-existing businesses.

IE