Introduction
Legal fees are a recurring cost for incorporated businesses, professionals, and individuals. The tax deductibility of those fees depends on why they were incurred — and the answer is not always intuitive.
For law firms themselves, the question is different: the legal work they perform for clients generates income, and the expenses of the firm are deductible in the usual way. This article is primarily for incorporated businesses and professionals that pay legal fees to external counsel — and want to understand when those fees are deductible.
The General Rule: Legal Fees Are Deductible When Incurred to Earn Income
Legal fees paid by a corporation are deductible as a business expense when they are incurred for the purpose of earning income from the corporation's business. The same test applies as for any other business expense under section 18(1)(a) of the Income Tax Act: the expense must be incurred to earn income from a business or property.
Common examples of deductible legal fees for a corporation include:
• Fees to review or draft commercial contracts
• Employment law advice for hiring, terminations, or workplace disputes
• Legal costs related to collections (pursuing amounts owed to the business)
• Costs of defending a business lawsuit where the claim relates to the corporation's business activities
• Legal fees related to a business acquisition or sale (though these may need to be capitalised rather than expensed — see below)
When Legal Fees Must Be Capitalised
Not all legal fees are immediately deductible as current expenses. Fees that relate to the acquisition of capital property — a business purchase, commercial real estate acquisition, or a financing arrangement — are generally treated as part of the cost of the capital asset, not as a current deduction.
For example, legal fees paid on the acquisition of equipment or real estate are added to the adjusted cost base (ACB) of that asset. They are deducted over time through capital cost allowance (CCA), not in the year of the expenditure.
For a share acquisition, legal fees are typically added to the ACB of the shares. They reduce the gain (or increase the loss) when the shares are eventually sold — but do not reduce current-year income.
The distinction between capital and current legal fees is important and not always obvious in practice. Large transactions often involve multiple types of legal work, some deductible currently and some capitalised.
Legal Fees to Establish or Defend a Business Structure
Legal fees incurred to incorporate a business are generally treated as eligible capital expenditures (or under current rules, as class 14.1 assets subject to CCA) rather than as immediately deductible current expenses. The rules around incorporation costs have been updated in recent years, and the treatment of these amounts should be reviewed with a CPA at the time of incorporation.
Legal Fees That Are Not Deductible
Not all legally-incurred costs have a business purpose. Legal fees paid in connection with:
• A shareholder dispute that is personal in nature
• A personal lawsuit unrelated to the corporation's business
• Matrimonial or estate matters, even if the corporation is involved peripherally
...may not be deductible to the corporation and could constitute a shareholder benefit if paid by the corporation.
Additionally, legal fees paid to defend against criminal charges, even where those charges relate to business activity, may be denied as deductible expenses on public policy grounds.
Legal Fees Paid by Employees or Individuals
For individuals (rather than corporations), the deductibility of legal fees is more restricted. Individuals can generally deduct legal fees paid to collect or establish a right to salary or wages, to recover wrongfully withheld wages, or to challenge a CRA assessment. Personal legal costs — divorce, property disputes, personal injury — are generally not deductible.
HST on Legal Fees
A law firm charging for services to an incorporated business will charge HST on those fees. The corporation receiving the invoice can claim an input tax credit for the HST paid, provided the legal services relate to the corporation's commercial (taxable or zero-rated) activities. If the legal fees relate to an exempt activity, the ITC may not be claimable.
When to Speak With a CPA
Large or unusual legal expenditures — acquisitions, major litigation, financing transactions — should be reviewed with a CPA to determine whether the fees are deductible currently or must be capitalised, and whether the HST treatment is correct.