This article addresses an issue that was brought to our attention last year by Ronald Cummings, QC (Cummings Andrews & Mackay). It eventually led to an article that was published in the June 2001 issue of The Barrister. For the purposes of this article (published in the Winter 2001/02 issue of the Expert Witness), we focus on one particular issue contained in the earlier article.
Suppose that a defendant insurance company has incurred costs totalling $50,000 in the course of defending itself in a civil lawsuit. For simplicity, let us assume that the plaintiff’s costs were also $50,000. For simplicity, we will also ignore the size of the claim. If the plaintiff is successful in his action and is awarded costs, the defendant will not receive any relief from its $50,000 in expenses and it will also need to give $50,000 to the plaintiff to cover his costs. Thus, its total profit for the year will be $100,000 less than it would have been if it had been successful in the lawsuit and the plaintiff had been ordered to pay the insurance company’s costs. Clearly the defendant insurance company will need to generate $100,000 in revenue in order to pay for these costs.
Alternatively, let us suppose that the plaintiff was not successful in his lawsuit, and the Court requires that he pay the defendant’s $50,000 in costs. Thus, the plaintiff needs to have an additional $100,000 on hand to cover his own bill and that of the defendant. However, assuming that 25 percent of the plaintiff’s employment income goes toward income-tax, he will need to earn $133,333 in order to have $100,000 in after-tax dollars with which he can pay his bills. Because the plaintiff is an employee and not a business, he effectively faces a greater burden of costs if he loses the case than the defendant insurance company faces if it loses.
It is clear that there is an injustice due to the tax treatment of the employee-plaintiff versus the corporate-defendant. In this example, despite incurring the same costs ($50,000 each), a losing plaintiff will need to earn $133,333 to pay his bill, compared to a losing defendant which will only have to earn $100,000 to pay its bill.
Also, note that the tax treatment may affect a potential plaintiff’s ability and/or willingness to advance a “just-case”. Because these tax-effects clearly raise a plaintiff’s costs (both direct costs and potential costs if he loses his case), some just-cases “at the margin” will not be advanced because of unmanageable costs. Some of these cases would be advanced if the tax disincentives we have described were eliminated.
The fairest solution would be to allow the plaintiff to treat his payment of these costs as a deduction from his income (for tax purposes), so he would face the same burden as the defendant insurance company or a plaintiff-corporation. Of course this would require changing the tax laws – an option that is not available to the Court.
Note that the tax system has already been adjusted to allow income from structured settlements to escape tax. So if the plaintiff wins his case, favourable tax policies are already in place to ensure that his monetary compensation is not diminished by tax. A reasonable next-step would be to ensure that tax policies do not influence potential plaintiffs when they are deciding whether or not to advance a just-case.