You've just received a bill from your attorney, and fallen off your chair. To top it all, your tax adviser says that this cost might not be taxdeductible. So, unlike a lot of your other business costs, you aren't even able to take comfort from the fact that at least your tax bill will be reduced as a result of the expense.
Legal expenses can be so broad in what they relate to that there is no catchall statement to describe them as either tax-deductible or otherwise.
There are two sets of criteria to look to in order to establish if the particular legal expenses that you have incurred are taxdeductible.
Firstly, have they been incurred in South Africa and in the production of your trading business's income, and are they of a noncapital nature?
Examples of such legal expenses would be the costs of debt collection. Or the costs of enforcing a contract that is part of the everyday operation of your business.
If you were a car dealer, say, and had sold a car, but the purchaser was not fulfilling his or her obligations, you might incur legal costs in order to force the purchaser to do so. Such costs would tend to be deductible for tax purposes.
There are other examples.
The legal costs you might incur to reach consensus in a labour dispute would generally be deductible for tax purposes.
You see, by employing people you carry the inevitable risk of labour problems arising one sunny day. This, sadly, is considered to be so closely connected to your income earning operations as to constitute part of those operations.
The costs of drawing up a lease agreement would be deductible in your hands if you were a landlord, but not if you were a lessee from the hoi polloi (the cost is closely connected to the landlord's regular income earning operations, whereas for the lessee it is more related to the setting up of the income earning structure).
The costs you would incur if you formed a company, or if you asked your attorney to draw up a contract for the acquisition of capital assets (say plant and machinery), would not be taxdeductible.
But the legal costs of drawing up an agreement for the acquisition of trading stock (say boxes and boxes of butter, if you were a grocer) would be deductible.
The costs incurred in resisting a claim for damages and compensation would not be deductible under these requirements.
But if the legal fees do not satisfy the requirements as set out above, you may be able to deduct them under a second set of requirements, which relate specifically to legal fees.
These are incurred in respect of any dispute, claim or action at law which has arisen as a consequence of the ordinary income earning operations of your trade.
The requirements which these expenses must satisfy are:
* they must not be of a capital nature;
* if they relate to damages and compensation, the nature of the claim must be such that the receipt or payment arising from it would be included in, or deductible from, taxable income as appropriate; and
* they must not relate to a dispute or action at law relating to a claim, the legal expenses of which would not, in any event, be deductible.
Thus, if you receive compensation, and have incurred legal expenses to prepare a contract, or to win the compensation in court, the legal expenses are deductible, but only if the compensation is included in your taxable income.
If the compensation is not included in your taxable income because it is capital in nature (see last week's article on damages and compensation) the related legal expenses will not be deductible.
So don't despair, legal costs are high, but it's worth exploring those leafy, taxdeductible avenues.