Not all attorney fees are tax deductible

Disputes are a part of humanity, they are inevitable, and most of us will someday need a lawyer to defend us. When you are thinking of getting a divorce, writing or entering into a lease agreement, fighting a tax dispute or you were involved in an accident and want to sue the other driver you will definitely need the services of an attorney where upon legal fees may be payable. Legal fees broadly cover fees for services of legal practitioners, expenses incurred in procuring evidence or expert advice, court fees, witness fees and expenses, taxing fees, the fees and expenses of sheriffs or messengers of court and other litigation expenses etc.  Whether all these expenses are tax deductible or not, it depends on the underlying claim.

An expenditure or loss is deductible for tax purposes if it is incurred for purposes of trade or in the production of income other than expenditure or losses of a capital nature. Accordingly legal expenses must meet this test to be deductible. The claim, dispute or action at law should arise in the ordinary course of or by any reason of the taxpayer’s trade or during the course of producing income. Exceptions are with regard to legal costs of a capital, domestic or private nature, those incurred in earning exempt and non-taxable income or legal costs that are contrary to the public policy doctrine.

Capital in nature legal costs are those incurred for the purposes of acquiring or improving a capital asset for the enduring benefit of business, costs incurred in defending an act which is meant to protect a capital asset, amending the corporate charter, incorporation, amalgamation, corporate reorganization, share issue, initially listing or increase in capital stock etc. Fees paid for advice or in litigation to establish an exclusive right to a trade name are also capital in nature since the benefit is of indefinite duration. The cost of preserving asset or copyright is also capital in nature. It was however held in ITC 1528, 54 SATC 243,that capital in nature legal costs do not include the cost of removing a business obstacle since this is not designed to bring an asset into existence. All is not lost with regards to legal costs incurred in relation to assets ranking for capital allowances such as factory buildings, commercial buildings, intangible assets in the nature of acquired or developed computer software, movable assets to be used in business etc. These may have to be added to the cost of an asset and written off over the useful life of the asset through a method of capital allowance. If the asset does not rank for capital allowances, the fee becomes deductible only for purposes of capital gains tax when the asset is sold or disposed.

Any legal fees associated with production of income save for those which are of a capital nature are tax deductible. This covers legal expenses incurred by a landlord in an appeal to the rent board regarding rental increase. The same applies to cost of evicting a tenant to seeking more rentals as opposed to those incurred when contemplating change of use of property. Legal expenses for employee related dispute are also deemed incurred in the production of income.  On the other hand, legal costs incurred in order to protect impairment of right or preventing total or partial extinction of the business (see African Greyhound Racing association Ltd v CIR) are disallowed on the pretext that they are deemed connected to the protection of an asset or right. So are legal costs incurred in resisting an order of ejectment from business premises because this is linked to the business more than the impairment of current year income.

A long established rule is that expenditure contrary to the public policy doctrine should never be allowed for tax purposes. This doctrine is against promoting activities which are against the national or state policies or interests. Simply put expenditure or expenses resulting from unlawful or undesirable conduct cannot be considered incurred in the production of income or for purposes of trade. The same applies to legal expenses incurred by the taxpayer seeking advice on tax matters or in fighting a tax bill. However, the Income Tax Act provides for deduction of income tax appeal costs in the High or Supreme Court on a tax case successfully won by the taxpayer and if the case is partially won, partial deduction is granted. In practice legal costs incurred in the collection of outstanding debts are deemed incurred in the production of income and are tax deductible.

No deduction is allowed for payments for legal services in primarily personal matters, for example legal costs for the preparation of wills; the prosecution or defense of actions to recover damages for personal injuries, or the prosecution or defense of actions for separation or divorce etc. Personal or domestic expenses broadly covers cost of maintaining taxpayer and his family, household expenses e.g. food, clothing and shelter etc., medical expenses and clothing, other than protective clothing or compulsory work clothing and those worn by television presenters and related cleaning cost. Therefore related legal costs are accordingly disallowed. A lawyer fees that is incurred in respect of exempt or income not from a source within Zimbabwe is non-deductible.

In conclusion legal expenses take their tax nature from that of the underlying claim. If the claim is about damage to a capital asset like goodwill, the legal costs will not be deductible. If it involves loss of earnings, for example, the legal costs will be deductible. Meanwhile, you should scrutinize legal expenses to ensure that they are deductible in terms of the law in order to avoid penalty implications and any business reputation.

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