Legal and professional fees
Provides checks to make and what risks and mitigations to consider, including explanations and examples for legal and professional fees.
Risk
When a business incurs expenditure on an unsuccessful attempt to obtain an asset or other advantage that will be of enduring benefit to the business the expenditure is classified as capital for tax purposes, just as it would have been if the attempt were successful. The same principle applies where the expenditure in is connection with the disposal of an asset.
Mitigation
Establish whether the business was involved in any unsuccessful attempt to obtain an asset or other advantage for enduring benefit of the business during the period, and if so whether any related legal and professional fees or other costs incurred are capital for tax purposes. These costs are not allowable as revenue expenditure for tax purposes, except where the corporate intangibles regime applies.
Explanation
Incidental expenditure incurred in trying to obtain something that will be of enduring benefit to the business is normally not deductible for tax purposes, even if the attempt was unsuccessful. The costs incurred in these circumstances are sometimes known as ‘abortive expenditure’.
A typical example of ‘obtaining something of enduring benefit’ is the acquisition of an asset, but it may also mean trying to dispose of, or alter a burdensome asset, if the advantage delivered by doing so is sufficiently enduring.
An example of abortive expenditure, depending on the nature of the trade, is the cost of an unsuccessful planning application. If the application is successful the expenditure will be capitalised. Where the application fails, and no asset is acquired or modified, the expenditure will normally be charged to the profit and loss account but should be treated as capital expenditure for tax purposes.
The Business Income Manual — BIM35325 provides further guidance on abortive expenditure.
However where the abortive expenditure relates to an attempt to obtain an intangible asset by a company, rather than a sole trader or partnership, the expenditure may be covered by the corporate intangible assets regime, in which case the accounting treatment may be followed for tax purposes.
Further guidance on the corporate intangible assets regime can be found at:
Risk
Legal and professional fees incurred in connection with changes in how the ownership of a business is structured are generally regarded as capital for tax purposes and not allowable as a revenue deduction. For example, changing from a sole trader or partnership to a limited company is a change in the capital structure of a business, as is a change in the membership of a partnership.
Mitigation
Establish if any legal and professional fees have been incurred on issues relating to the ownership or capital structure of the business and ensure they have been treated correctly.
Explanation
Fees incurred in connection with the acquisition, alteration or enhancement of how the ownership of a business is structured should generally be disallowed. This will include costs incurred on items such as the following:
- forming, varying or dissolving a partnership
- the incorporation of a sole trader’s or a partnership’s business
- a partnership becoming a limited liability partnership
- defending a petition by shareholders to wind up a company
The Business Income Manual — BIM46435 provides further guidance on professional fees connected with the capital structure of the business.
Risk
Costs incurred by a partnership on recruiting new partners will normally be allowable as revenue expenditure. However, there are some circumstances in which these costs may be viewed as capital expenditure for tax purposes and so would not be allowable as a revenue deduction.
Mitigation
Where a partnership has incurred expenditure on the recruitment of a new partner or partners, check the circumstances surrounding the recruitment. Examples of where it may be necessary to consider whether the recruitment costs are capital expenditure include:
- where the admission of the partner has a fundamental impact on the structure of the firm’s business, this must involve more than a mere expansion of the business
- where the partner is recruited as part of the acquisition of a business
- where the new partner’s capital contribution is a material factor in the recruitment
In any of these circumstances however, whether or not the costs of recruitment are capital expenditure will be a question of fact and degree.
Explanation
In general, the cost of recruiting both equity and salaried partners to a partnership, whether they are replacement or additional partners, is revenue expenditure. In most cases the firm is paying to recruit a fee earner, who will generate profits for the firm, not to change the firm’s structure or to obtain a capital contribution. It is only where there is a significant additional factor relevant to the recruitment of a partner, such as those outlined above, where consideration may need to be given as to whether the expenditure is capital and therefore not allowable as a revenue deduction.
Risk
In some circumstances where costs are incurred on training and development for a proprietor or partner for example, acquiring new skills, these may be regarded as capital expenditure for tax purposes and therefore not allowable as a revenue deduction.
Mitigation
Establish whether training and development undertaken by business proprietors or partners is to update expertise which they already possess, or to give them new expertise, knowledge or skills. In the latter case, if the training brings into existence an advantage of sufficiently enduring benefit the expenditure incurred may be capital for tax purposes and if so, not allowable as a revenue deduction.
Explanation
In addition to the Capital v Revenue expenditure test, to be allowable the costs of training and development for the proprietors or partners must also be incurred wholly and exclusively for the purpose of the trade or profession at the time the training is undertaken. For example, where a completely new specialisation or qualification is acquired as a result of the expenditure, it is possible that the expenditure will not be wholly and exclusively for the purposes of the existing trade. Consideration should therefore be given to the allowability of the expenditure on the basis of the ‘wholly and exclusively’ test as well as Capital v Revenue grounds.
Further information
- Business Income Manual — BIM42526 provides further guidance on specific deductions for training courses
- Business Income Manual — BIM35660 details expenditure incurred by the proprietor of a business on training courses for themselves