No single best approach to self-employed income loss
This article originally appeared in the Feb 3, 2017 issue of The Lawyers Weekly published by LexisNexis Canada Inc.
In simplistic terms, self-employment is the act of generating one’s income directly from customers or clients as opposed to being an employee of a business or person. A self-employed person is effectively a business owner who bears the risks of profit or loss.
An important question to ask is, who has the claim? In its decision in D’Amato v. Badger  2 S.C.R. 1071, the Supreme Court confirmed that in the case of personal injury claims, the claim remains that of the injured self-employed person irrespective of how he or she carried on their business or vocation, whether by way of a sole proprietorship, partnership or corporation.
How then to determine income? When a business represents a self-employed person’s “alter ego,” for example in the case of a lawyer operating through a professional corporation, then subject to the exclusion of possible investment income and personal expenses, the lawyer’s income and the profits of the professional corporation would be similar.
However, the claims of self-employed persons are often a lot more complicated. Assume that Mr. A is the sole owner and chief executive officer of a corporation, Cars Inc., a business employing 300 people. After being injured in a motor vehicle accident, is it reasonable to assume that his pre-accident income is synonymous with and therefore should be based on the historical profits of the corporation?
Assume that, in this instance, the business continues to operate after the accident with Mr. A’s duties being assumed by other members of the corporate management team. Furthermore if there is no measurable diminution in corporate income, possibly as a result of pre-accident sales momentum or upturn in the economic environment, is it then appropriate to assume that Mr. A has no income loss claim?
The Supreme Court dealt with a similar issue in D’Amato v. Badger, where Badger was a 50 per cent owner of a business. After the accident and while off work, Badger continued to receive his full former salary. Thereafter, Badger returned to work at a significantly reduced capacity, at his full salary.
In our opinion in the case of a corporation of the size of Cars Inc., it is sheer guesswork to try to determine the impact of Mr. A’s injuries on short and long-term corporate performance.
For the above-noted reasons, in this type of situation, the fairest approach is likely to follow the methodology upheld in the Supreme Court decision in D’Amato v. Badger and base Mr. A’s losses on:
- the fair market value of his pre-accident contribution to the business (ignoring distributions either motivated by tax planning or attributable to his investment in the business);
- present value over the remainder of his projected pre-accident working life; and
- reduced to reflect the fair market value of his post-accident projected future contributions to the business.
In this instance, depending on the circumstances and subject to contingency issue, it may be possible to base the fair market value of Mr. A’s pre-accident salary on the remuneration of a replacement manager with comparable duties and responsibilities. His future income losses would then be based on the difference between his pre-accident salary and an estimate as to the value of the residual services that he is able to perform.
Another example: Mr. Driver is a self-employed limo driver who owns his vehicle and reports a net annual income of $10,000 on his income tax return. Notwithstanding his relatively low reported income, he may be doing considerably better than what a simple review of his income tax return may indicate.
His reported income could be equivalent to a salary of $50,000 per annum after adjustments for the following hypothetical personal and consumption type expenses. Adjustments totaling $40,000 per annum, include: excess depreciation (capital cost allowance) of $8,000; office in home expenses of $10,000; income splitting (spouse and family members) of $12,000; personal use of cell phone and computer of $4,000; and personal use of vehicle of $6,000. His comparable employment income therefore totals $50,000.
There is no single most appropriate method to determine income losses sustained by self-employed persons. Depending on the circumstances, it may be most appropriate to base income losses on actual reported income, comparable income statistics, replacement labour costs or a combination hereof.