The debate about whether legal and professional fees should be considered revenue or capital expenditure often rages on. Should you treat it as revenue or capital expenditure? If you’re confused, here’s how to decide.
In accounting terms, legal and professional fees fall into one of three categories: operating expenses, fixed assets and intangible assets. Fixed assets include items such as buildings, vehicles and equipment. Intangible assets include things like trademarks, patents and copyrights.
Operating expenses are costs associated with running a business. They include salaries, wages, insurance premiums, utilities bills, depreciation and interest payments. These costs are subtracted from the revenue generated by the business to calculate the net profit margin. Fixed assets are depreciated over a set period of time. Once the asset has been fully depreciated, the value is removed from the balance sheet. In contrast, intangible assets do not have a physical form and cannot be physically used up. Instead, they generate cash flows over a long period of time.
To determine whether legal and professional fees are part of operating expenses or fixed assets, look at what happens to the money. For example, if lawyers bill clients based on hours worked, then those fees are considered operating expenses. However, if lawyers charge flat rates per hour, then those fees are classified as fixed assets.
If you use the cash method of accounting, legal and professional fees must be treated as operating expenses. This means that the cost of legal services and professional fees are added to the rentables income before calculating taxable profits. On the other hand, if you use the accrual basis of accounting, legal and professionals fees are generally included as a deduction from the gross profit before calculating the net profit margin. Accrual basis means that the cost of the legal services and professional fees is recorded immediately.
Income tax law states that legal fees are deemed to be revenues in nature. Legal fees that are revenues in natures are considered income in nature. Legal fees which are capital in natures become assets in nature.
Cash or accruals basis
The choice of accounting method used to prepare a profit and loss account determines how much tax you pay on it. If you use the cash basis, you must deduct expenses from income immediately, while if you use the accruals basis, you must record them over a longer period. This article explains what the differences are between the two methods.
Example of allowable revenue items
The tax office has published examples of what constitutes allowable revenue items, including legal and professional fees. In addition to the usual costs associated with running a business such as rent, salaries, utilities, insurance etc., accountants can deduct some expenses related to getting a valuation or similar work done for the company. These include:
• Fees paid to lawyers or accountants;
• Costs incurred in preparing documents required by law;
• Expenses relating to obtaining a valuation or similar works;
• Any amounts you pay to obtain information about the value of your assets.
If you do not claim the deduction within 3 years of making it, you lose it forever.
Example of capital expenses
Capital expenditure refers to the purchase or acquisition of assets required to carry out a project. Capital expenditures include items like building construction, machinery, vehicles, office equipment, etc. These types of purchases are usually financed either by borrowing funds or issuing shares.
A legal cost is one type of expense associated with buying or selling real estate. This includes things like stamp duty, transfer taxes, conveyancing fees, registration charges, survey fees, and many others.
Fees paid to pursue debts of capital nature, like mortgages, are also considered capital in nature. They are often called interest payments because they represent the return earned by lenders on their loans.
Frequently Asked Questions
How do I seek tax deductions for my expenses?
Once you have all purchase records and invoices for the year, it’s time to prepare your annual self assessment tax return. This includes claiming your business expenses. These are things like rent, utilities, insurance, marketing, travel and training.
You do this through your annual tax return, which is submitted once a year around April 5th. To claim your expenses, you’ll need to provide proof of what you’ve spent. You don’t need to send this in with your tax return; however, you should keep copies handy just in case HM Revenue & Customs asks to see them.
If you have more than a couple of expense records to keep track of, having an accountant to look after your bookkeeping might be more efficient.
What are the allowable costs against rental income?
If you’re wondering what the difference is between a capital expenditure and a revenue expenditure, here’s our guide to understanding the difference between repairs and improvements, and how to claim expenses against rental income.