Legal fees

Conditions

1. GOV.UK says a sole trader can claim for hiring of accountants, solicitors, surveyors and architects only for business reasons. It says you cannot claim for legal costs of buying property and machinery — if you use traditional accounting, claim for these costs as capital allowances — or for fines for breaking the law.
2. For a sole trader using traditional accounting, and for a company, HMRC's manual adds that professional fees connected with the acquisition, disposal or modification of a capital asset will also be capital expenditure and so disallowable (BIM46400). That test applies whether or not the fees were incurred for business reasons.
3. Most sole traders now use the cash basis: all eligible businesses must start using it from 6 April 2024 unless they elect to calculate their profits in accordance with generally accepted accounting principles (BIM70000). On the cash basis the general capital rule in section 33 ITTOIA 2005 does not apply (section 32A ITTOIA 2005). Instead, section 33A ITTOIA 2005 allows no deduction for an item of a capital nature incurred on, or in connection with, the provision, alteration or disposal of land, a car, an asset that is not a depreciating asset, or certain other assets, or with the acquisition or disposal of a business. GOV.UK says that on the cash basis you claim the cost of equipment you buy to keep and use in your business as a normal allowable business expense. So fees connected with buying property are still not deductible on the cash basis, while fees connected with buying equipment may be. Whether a particular fee qualifies is a question for your accountant.
4. The cost of defending title to trade or professional assets is generally allowable, while the costs of defending personal reputation are not, because of duality of purpose (BIM38545). Whether there is a dual purpose is essentially a question of fact (BIM38545).
5. Legal costs of resisting disciplinary proceedings can be allowable even where the resulting fine is not. In McKnight v Sheppard the House of Lords decided that a stockbroker's legal expenses were expended wholly and exclusively for the purposes of his trade, while his fines were not deductible (BIM37965). HMRC tests whether protecting personal reputation was also a purpose, and says there will normally be a private purpose in trying to avoid a criminal conviction (BIM37965).
6. Professional fees on renewing a short lease with the owner's consent are capital, but HMRC says they are likely to be small and may be allowed on de minimis grounds (BIM46420). HMRC tells its officers to contend, in appropriate cases, that they are capital where the new lease is for a long term — say a period which exceeds, or may at the lessee's option exceed, 50 years — or where the lease provides for a premium, in which case the disallowance may be limited to a proportion of the renewal costs appropriate to the premium (BIM46420). Costs of resisting ejection from the premises, obtaining a new lease in face of opposition by the landlord, or securing statutory compensation are not an admissible deduction (BIM46420).
7. A fine incurred as a result of a trader's infraction of the law is not allowable, and nor is a penalty a regulatory body imposes for breach of regulations (BIM42515). A liability to a regulatory body that is broadly intended to cover the regulator's costs of performing its duties will normally be allowable even where the trader has committed a breach (BIM42515). Where an employer pays a fine that is an employee's own liability, so that the employee is taxable on the payment as employment income, the employer's cost is allowable (BIM42515).
8. GOV.UK says you cannot claim for the cost of preparing and submitting your Self Assessment tax return. Fees for the business accounts are covered on the accountancy fees page.
9. For a limited company, the same two tests apply under the Corporation Tax rules: no deduction for items of a capital nature (section 53 CTA 2009), and none for expenses not incurred wholly and exclusively for the purposes of the trade (section 54 CTA 2009). HMRC's guidance on fines and on defending trade assets is written under section 34 ITTOIA 2005 and section 54 CTA 2009 together (BIM38515, BIM38545).
10. An employee's general rule is narrower. A deduction is allowed only where the employee is obliged to incur and pay the amount as holder of the employment, and it is incurred wholly, exclusively and necessarily in the performance of the duties (section 336 ITEPA 2003). Legal costs an employee incurs to establish a legal right they enjoy as an employee are not deductible — HMRC's example is a director's costs of recovering remuneration due to him (EIM32865).
11. Separately, section 346 ITEPA 2003 allows an employee a deduction from earnings for costs or expenses incurred in connection with a claim that the employee is subject to a liability related to the employment, or proceedings relating to or arising out of such a claim. It also covers costs of giving evidence about matters related to the employment, and costs connected with a proceeding, other process or investigation in which acts of the employee related to the employment, or any other matters related to the employment, are being or are likely to be considered (section 346 ITEPA 2003). A liability is related to the employment if it is imposed because the employee did, or failed to do, an act in their capacity as holder of the employment or in the performance of its duties, or is imposed in connection with proceedings arising from a claim of that kind (section 348 ITEPA 2003). No deduction is allowed where it would be unlawful for the employer to insure against the liability or costs, which HMRC says includes fines and penalties (EIM30523), or where the payment is made under arrangements whose main purpose, or one of whose main purposes, is the avoidance of tax (section 346 ITEPA 2003). The deduction is available only against earnings of the employment concerned (EIM30505); a payment made after the employee has left is dealt with under section 555 instead (section 347 ITEPA 2003). Whether a particular claim qualifies is a question for an accountant.

Common mistakes

• Deducting legal fees paid on buying business premises as a running cost. If you use traditional accounting, GOV.UK lists legal costs of buying property and machinery among the costs you cannot claim, and professional fees connected with the acquisition of a capital asset are capital expenditure (BIM46400). On the cash basis, no deduction is allowed for a capital item incurred in connection with the provision of land (section 33A ITTOIA 2005).
• Claiming fines for breaking the law, or a regulator's penalty for breach of regulations, as legal costs (GOV.UK, BIM42515).
• Treating the cost of preparing your Self Assessment tax return as a business expense — GOV.UK says it cannot be claimed.
• Assuming every legal cost that relates to the business is allowable. Business purpose is necessary but not sufficient: under traditional accounting, fees connected with the acquisition, disposal or modification of a capital asset are capital (BIM46400), and the cash basis has its own capital rules (section 33A ITTOIA 2005).
• Assuming an employee can never deduct legal costs. Costs connected with a claim that the employee is subject to a liability related to the employment fall within section 346 ITEPA 2003.

What to keep

• Solicitor's invoices or bills of costs describing the matter and the fees charged.
• A note of the business purpose for each piece of legal work commissioned.
• Where legal work covers both capital and revenue matters — for example, renewing a lease that provides for a premium — an allocation between the two elements.

Real-world example

A limited company instructs solicitors for two matters in the same year: £1,200 for reviewing and negotiating a new supplier contract, and £3,800 in conveyancing fees on buying a commercial unit. The conveyancing fees are connected with the acquisition of a capital asset, so they are capital expenditure and cannot be deducted as a running cost (BIM46400); how, if at all, they are relieved through the cost of the property is a question for the company's accountant. Only the £1,200 can be deducted as a running cost, if it was incurred wholly and exclusively for the company's trade (section 54 CTA 2009).

Frequently asked