Legal costs in business litigation: their treatment as a deductible expense

The Directorate General of Taxes (DGT) has issued a relevant ruling regarding the deductibility of expenses derived from judicial processes. The issue focuses on determining whether the amount corresponding to legal costs, following a court order, can be counted as an expense linked to the exercise of an economic activity for Personal Income Tax (IRPF) purposes.

What the DGT has resolved

The advisory body has determined that a court order to pay legal costs arising from a lawsuit filed in the course of an economic activity must be considered an expense of said activity. The ruling establishes that, when taxing via the direct estimation method, the net income is determined following the rules of Corporate Tax (Impuesto sobre Sociedades).

Consequently, these expenses must be attributed to the tax period in which they accrue. This treatment must respect accounting regulations and the principle of correlation with income, ensuring that the expense is recognized at the moment the obligation to pay arises following the judicial resolution.

What it means for you

This pronouncement has a direct impact on self-employed individuals and professionals who tax under the direct estimation method. If, in the exercise of their professional activity, they are involved in a judicial dispute and the sentence orders them to pay the opposing party's legal costs, said amount does not constitute a personal expense, but rather an expense related to the economic activity.

This allows the amount of the court order to reduce the net income of the activity in the corresponding tax year, provided that the requirements for accrual and professional relevance established in the IRPF Law and the Corporate Tax Law are met.

What you should do

It is necessary to verify that the lawsuit or litigation that originated the court order is strictly related to the development of the professional economic activity. Proper documentation of the sentence and the accrual of the expense must be ensured to comply with accounting and tax regulations. Since the application of this criterion depends on the nature of the litigation, it is fundamental to assess each particular situation to confirm its deductibility.