Accounting of Legal Services
- Accounting of legal services and judicial practice
- Legal services, accounting and taxation
- Recovery of legal costs from the losing party
During tax audits, inspectors pay close attention to all paid services, including consultations, advertising promotion and legal assistance. Therefore, it is important to properly conduct accounting of legal services. Moreover, in relation to this type of support, there may be a problem of proving compliance with the requirements imposed by the legislation. This mainly concerns the inclusion of income tax expenses and VAT deduction.
Judicial practice on this issue is contradictory, because the Presidium of the Supreme Court has formulated a unified approach to assessing the legality of including the work of third-party lawyers in expenses. According to the Tax Code, taxpayers have the right to take into account the costs of legal services as part of other expenses. However, an organization has the right to recognize expenses when calculating income tax only if they meet the following requirements:
- validity and economic justification;
- documentary confirmation – accounting of legal services;
- focus on earning income.
The reasonableness of expenses implies that the company’s costs are justified from an economic point of view, and this can be confirmed by financial calculations. Documentary proof of costs requires that all transactions and agreements between the parties be executed in accordance with legal requirements and business practices. This statement is also true for cases when the company’s activities take place in whole or in part on the territory of another state. You can also confirm expenses with the help of papers that indicate spending indirectly. For example, it can be customs declarations, business trip orders, travel documents, reports on work performed.
Expenses are recognized as any expenses, provided that they were directed to commercial activities and profit, in the presence of the requirements set out above.
To ensure that the accounting of legal services does not raise questions from the regulatory authorities when determining the tax base, the costs should correspond to the following arguments:
- Detailed documentation of services. When drawing up acts, the parties do not have the right to limit themselves to the wording “legal services under the contract have been rendered in full and with proper quality”. When making out the papers, describe in detail exactly what services and to what extent they were provided, how their cost was calculated.
- Positive economic result. The costs should lead to an increase in the company’s income, they should be justified from a financial point of view.
- Tax transparency. The assistance of lawyers cannot be aimed at unjustified tax benefits, for example, for the purpose of tax evasion. Your interests should not contradict the law.
- Lack of full-time lawyers. If the company has its own specialists, their duties and functions should not fully correspond to the subject of the contract with third-party lawyers. In this case, you can use the support of another firm or a separate lawyer, if their specialization or type of services do not overlap with the functions of full-time employees of the firm. However, this does not mean that the presence of a legal adviser in the staff does not allow you to involve a third party to solve work issues. It’s just that this attraction should be justified. According to the Letter of the Ministry of Finance dated May 31, 2004, if there is a lawyer position in the staffing table, the issue of spending on attracting third-party lawyers should be considered in each individual situation. At the same time, the provisions of Article 252 of the Tax Code are taken into account in terms of re-inclusion of expenses in the taxable base for income tax.
Accounting of legal services and judicial practice
Having analyzed the current judicial practice of tax disputes, VALEN specialists formulated the following conclusions. Firstly, the tax authorities cannot assess the expenses of an enterprise from the point of view of their economic feasibility. Based on the provisions of the legislation, expenses related to the company’s work require recognition as economically justified. Judicial control should also not check the appropriateness of decisions made by entrepreneurs who have independence and broad discretion in the field of business.
Secondly, during taxation, the price indicated by the parties to the transaction is taken into account. It is assumed that it corresponds to the level of market prices. The Tax Inspectorate does not have the right to verify the correctness of the formation of the cost of contracts and to question these prices, unless there are grounds for control provided for in Article 40 of the Tax Code. For example, these are transactions between interdependent persons, barter, foreign trade transactions, sharp price changes.
Thirdly, from a taxpayer who has confirmed the fact and the amount of expenses incurred, the regulatory authorities cannot require additional evidence of the justification of these expenses. But in accordance with Article 65 of the APC, the participants in the trial must prove the circumstances to which they refer as the basis of their own claims. At the same time, in the case of acts of state bodies, the obligation to prove the circumstances on the basis of which the act was adopted is assigned to representatives of the relevant official instance.
Legal services, accounting and taxation
In order to fill out the tax documentation correctly, all expenses related to arbitration lawsuits should be taken into account with other production and sales expenses. But also these expenses, coupled with the payment of representation in court, can be carried out as non-operating payments. Only the company itself or the managers decide which category these expenses belong to. This right is described in more detail in Article 252 of the Tax Code.
Accounting for legal services is also based on Articles 264 and 265 of the Tax Code. One of them fixes the expenses for the work of lawyers and legal advisers as production expenses. Moreover, the article does not define which services can be classified as legal aid, so a broad interpretation of this right is possible. Another article indicates that court costs and arbitration fees can be attributed to non-operating expenses of the company. In other words, the accounting department can issue them as expenses for the company’s work that are not directly related to production or sale.
The list of court costs can be found in Article 106 of the APC. If we talk about the arbitration court, then usually belong to this category:
- payment for the assistance of experts, translators and other specialists necessary to prove the company’s position in court;
- expenses for notification of a corporate dispute, if the situation requires it;
- fees of lawyers and other lawyers involved in the process;
- cost of on-site inspection of evidence;
- other expenses incurred by the participants of the case.
According to the above norms, all the above expenses can be attributed to the court costs only by the parties to the process: the plaintiff and the defendant. In all other situations, such expenses cannot be characterized as legal costs, even if the company incurs such expenses.
Recovery of legal costs from the losing party
In order to take into account the costs of conducting the process as costs, it is necessary that the services of a lawyer be provided to a legal entity, and not to its management, specialists or partners. It is impossible to take into account the costs of legal assistance if the subject of the agreement concluded on behalf of the company was the provision of legal assistance to an official. Thus, the costs include only the work done for the company, and not its individual representatives, including the director.
Another important point: the costs collected from the authorities as compensation for losses are necessarily reduced by the amount of VAT deducted. According to Article 106 of the APC, the reimbursable court costs include the costs of the work of a lawyer who provides assistance to the company. Article 110 indicates that expenses incurred by the participants in the process are also reimbursed if the court takes the side of this party.
If the court sides with the company, it can count the awarded amount as income. According to accounting, they must be included in other income for the reporting period, which accounts for the issuance of a court decision. From the point of view of tax accounting, these are unrealized incomes that are recorded on the date of entry into force of the judicial act.
The package of documents for confirming expenses depends on the organizational form of the company that provides legal assistance. When concluding an agreement with a representative, payments are most often made in accordance with the requirements of the law “On Accounting” and the procedure for conducting cash transactions.
If the documents do not formally comply with the requirements of regulatory acts, this in itself cannot be a reason for refusing to satisfy the recovery requirements. Nevertheless, such decisions should be avoided, since these violations, coupled with the discrepancy between the payment order details specified in the contract data, may affect the court’s decision.
You can confirm the fact of payment of legal support with the help of such papers:
- a payment order,
- an expense cash order,
- a receipt.
Despite this, a receipt confirming the transfer of funds can formally be recognized as proof of payment made under an agreement concluded with an individual, regardless of the presence or absence of a cash order. However, it is important to take into account that the performance fee does not reduce the taxable base for income tax. The amount of this fee is 7% of the amount that is collected in court.
Legal services are provided on the basis of a contract. As a rule, 3 types of agreements are used:
- paid provision of services – suitable for advisory support or in cases when the company hires a lawyer to draw up important documents;
- assignments – this type of agreement is chosen when it is required to represent the interests of the company in the courtroom;
- a mixed contract combines elements of the two previous forms of documents, suitable for situations where a whole list of legal assistance is required. These can be consultations, preparation of papers, settlement of disputes in a pre-trial order and representation of the client’s interests in court.
After the contract is executed, an act on the provision of services is drawn up. This document prescribes the details of the parties to the agreement, it is attached to the main contract and accounting papers. There is no uniform form for this act, but the law requires that the parties to the agreement, the details and the cost of services are clearly indicated in it.
All operations must be accompanied by standard transactions. If the costs of the lawyer will be compensated by the second party of the lawsuit, the amount should be reasonable. It is necessarily compared with similar offers on the market. In this case, the court will determine the term and procedure for payment by the losing party for the work of lawyers. An important feature of the refund: it occurs only if there is evidence of the cost of the work done.
VALEN company has extensive experience in the field of accounting of legal services. We cooperate with large and small businesses, advise international corporations and foreign companies operating in Russia. Our specialists advise on accounting issues, prepare documentation, act as representatives in the courtroom.
To order a service or consult with specialists, dial: +7 (495) 7-888-096! We are also waiting for you in our office in Moscow.