Given the cost of legal fees, their deductibility is an important issue for most clients. For tax purposes, an individual’s business income is his net profit from the business, that is, revenues less expenses to earn income. practices. Hence, legal fees to earn business income should be deductible even if they arise from illegal commercial operations that generate taxable income. Legal fees are simply “working expenses” – one incurs them in the process of earning business income. Absent statutory provisions, tax law is neutral and does not morally judge behaviour.
We use the primary purpose test to evaluate the deductibility of legal fees. A taxpayer can deduct legal fees in the normal course of business.
However, legal fees on account of criminal charges are a challenging problem in tax law. Although courts look at accounting and commercial principles to determine business practice, determining net profit is essentially a question of law. One starts by asking whether the taxpayer would have incurred the expense “but for” the pursuit of business income. Would the need to incur the expense exist apart from the business?
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