A brief analysis of the impact of the provisions on the accounting treatment of the relevant business of law firms (draft for comments) on the fiscal and taxation matters of law firms.
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2021.03.10
Foreword:In order to standardize the accounting of relevant business of law firms and improve the quality of accounting information of law firms, the General Office of the Ministry of Finance issued the "Letter on Soliciting Opinions on the Provisions on Accounting Treatment of Relevant Business of Law Firms (Draft for Solicitation of Comments)" on February 9, 2021 (Caiban [2021] No. 3) (hereinafter referred to as "Caiban No. 3 Document 2021"), from the scope of application and basic principles, accounting account setting and main accounting treatment, financial statement presentation and disclosure, by-laws and regulations, the law firm engaged in public welfare legal services, business cooperation and other related business accounting clearly defined. Accounting treatment and its financial information is the basis for tax returns in accordance with the law, and the main content of the Finance Office's No. 3 document 2021 will be formally implemented as the "Accounting Treatment Regulations for Relevant Business of Law Firms", which will have a greater impact on the handling of tax matters of law firms. To this end, the author combined with the existing relevant tax laws and regulations and normative documents, a brief analysis of the impact of the Office of Finance 2021 No. 3 on the law firm's fiscal and tax matters.
1. Clarify the basis of accounting and consolidate the basis of tax-related financial accounting information.
At present, there is no special accounting document basis for law firms, and their accounting has been implemented with reference to the relevant provisions of the Accounting Measures for Accounting Firms, Asset Appraisal Institutions and Tax Agents (Caihui [2001] No. 61) (hereinafter referred to as "Caihui 2001 No. 61"). Caiban 2021 No. 3 outlines, clearly stipulates that partnership law firms and individual law firms established in China shall conduct accounting in accordance with the requirements for the recognition, measurement and recording of accounting elements regulated by the Accounting Standards for Small Enterprises, and prepare financial accounting reports in accordance with the provisions of the Accounting Standards for Small Enterprises. The implication is that the accounting element recognition, measurement and reporting framework of the law firm is incorporated into the accounting element framework of the Accounting Standards for Small Business.
Accordingly, Caiban No. 3 document 2021 requires law firms to classify, measure and report their economic resources and business activities according to accounting elements such as assets, liabilities, owner's equity, profit and loss (income, expenses, profits) in accordance with the Accounting Standards for Small Enterprises, and prepare accounting reports in accordance with the provisions of the Accounting Standards for Small Enterprises. Within the framework of these accounting elements, the Office of Finance 2021 No. 3 provides for a number of accounts that match the business characteristics of the law firm for related accounting. The name of such accounts or the substance of their accounting can be traced back to the accounts specified in the accounting document No. 61 of 2001.
It can be seen that the purpose of Caiban No. 3 document 2021 is to standardize the accounting and financial reporting matters of law firms according to the business characteristics of law firms, taking the "Accounting Standards for Small Enterprises" as the outline and the main body, taking the accounting subjects listed in Caikuai 2001 No. 61 document as the purpose and supplement, and at the same time consolidating the tax-related financial and accounting information foundation of law firms.
2. Accounting treatment is more in line with business practice, and the degree of conformity with relevant tax laws and tax regulatory documents is improved.
On the basis of clearly stipulating that law firms should conduct accounting in accordance with the Accounting Standards for Small Enterprises, the Finance Office's Document No. 3 of 2021 has adjusted and supplemented asset accounting subjects, liability accounting subjects, owner's equity accounting subjects and profit and loss accounting subjects to meet the special accounting and accounting needs of law firms in the process of business development and expansion, and to help increase the tax compliance of law firms and lawyers, promote the development of legal compliance in the legal industry.
(I) Advance expenses may not be included in the profit and loss category (tax-related) accounting.
Finance Office No. 3 of 2021 stipulates that under the "other receivables" account, a detailed account of "advances on behalf of clients" will be added to account for various advances paid by law firms on behalf of clients, such as transfer fees, litigation fees, arbitration fees, appraisal fees, assessment fees, inquiry and reproduction fees, etc. Accordingly, the various expenses paid on behalf of the client in the course of business are accounted for as "other receivables-advances on behalf of the client" at the time of the advance, and are no longer taxed as business income at the time of receipt of the advance. Accordingly, the law firm's agreement and treatment of such fees in the service contract should be strictly distinguished from the service charges, in order to avoid the tax-related risks or increased tax burden caused by the legal contract form of such advance fees that does not reflect the economic substance of their fees. In other words, for example, the various client fees or fees that should be borne by the client are included in the law firm's fees, resulting in increased tax burden or tax-related risks.
(II) Public welfare legal services case-handling expenses can be deducted before income tax.
Finance Office Document No. 3 of 2021 provides for the addition of a "public interest legal services case" line item under the "accounts payable" account to account for all outstanding payments incurred by the firm in the course of engaging in public interest legal services activities such as legal aid. When confirming the above-mentioned amount, the firm debits the account "main business cost-public interest legal service cost" and credits the account "accounts payable-public interest legal service case payment"; when the firm pays the above-mentioned amount, it debits the account "accounts payable-public interest legal service case payment" and credits the account "bank deposit. Accordingly, expenses incurred in the handling of public interest legal services are deductible before income tax.
With regard to "public interest legal service costs" and "public interest legal service case payments", they are measured and paid directly through "accounts payable", without involving the collection and carry-over of expenses. The author believes that its normative connotation can be loosely understood as the expenditure of such costs, based on legality and legitimacy, rather than entirely demanding costs or expense bills. In practice, too, such fees are usually paid directly to the individual of the firm specifically providing public interest legal services and cannot and should not be required to provide the instrument.
(III) Amounts payable to business collaborators are treated as collection and payment, with no recognition of accounting gains or losses (taxable income)
Finance Office No. 3 of 2021 provides for the addition of a "business collaboration" line item under the "other payables" account to account for the amounts that should be paid to business collaborators when business collaboration occurs between firms or between firms and other professional units. In recognizing revenue, the firm does not include payments to business collaborators for business collaboration. When confirming business cooperation funds, the firm debits "bank deposits" and "accounts receivable" according to the total amount to be collected from customers, credits "other payables-business cooperation funds" according to the business cooperation funds to be paid to business cooperation parties, and credits "main business income" according to the amount to be recognized as income; When the firm actually pays business cooperation funds, debit the account "Other payables-business collaboration" and credit the account "Bank deposits.
As mentioned earlier, the agreement and treatment of business collaboration fees in service contracts by law firms should be strictly distinguished from service fees in order to avoid tax-related risks or increased tax burdens arising from the fact that the form of legal contracts for such business collaboration fees does not reflect the economic substance of their fees. In other words, possible collaboration fees should not be included in the law firm's lump sum fees, or the fees involved in the service fees should be stripped out of the fees that will be distributed to the business collaborators.
(IV) Practice risk funds may be expensed as a pre-income tax deduction.
Finance Office No. 3 of 2021 provides for the addition of a "2801 practice risk fund" account to account for the practice risk fund drawn by the firm in accordance with relevant laws and regulations. When the firm withdraws the practice risk fund, it debits the subject of "management fee-practice risk fund" and credits the subject of "practice risk fund"; When the firm makes compensation according to law, it debits the subject of "practice risk fund" and credits "bank deposit" and other subjects. When the drawn practice risk fund is insufficient to compensate, it shall be debited to the subject of "management fee" according to its difference.
The withdrawal of the practice risk fund, on the one hand, consolidates the risk pad for the steady operation of the law firm, on the other hand, it also provides planning space for the law firm to save taxes and even optimize the tax-related operation structure.
(V) Practice liability insurance premiums are deductible before income tax.
Finance Office No. 3 of 2021 stipulates that a detailed account of "practice liability insurance premiums" will be added under the "management expenses" account to account for the practice liability insurance premiums incurred by the firm in accordance with relevant laws and regulations. When confirming the insurance premium for practicing liability, the firm debits the account "Administrative Expenses-Insurance Premium for Practicing Liability" and credits the account "Bank Deposit.
Under the implication of this tax normative document or document, facing the frequent occurrence of compensation for the practice of law firms, the purchase of practice liability insurance has the dual functions of tax planning and practice risk management for law firms.
(VI) The inclusion of partner lawyer's compensation in the account of employee compensation payable, which involves tax adjustment issues.
Document No. 3 of 2021 of the Finance Office stipulates that a detailed subject of "remuneration payable to partnership (or individual) lawyers" shall be added under the subject of "remuneration payable to employees" to account for various forms of remuneration other than profit distribution obtained by partnership lawyers of partnership law firms or individual lawyers of individual law firms (hereinafter referred to as partnership (or individual) lawyers) for providing legal services and participating in operation and management of the firm, including wages, bonuses, allowances, subsidies, welfare expenses, social insurance premiums, housing provident funds, trade union funds, education funds, non-monetary benefits, etc. When confirming the above-mentioned remuneration of partnership (or individual) lawyers, the firm debits the subjects of "main business costs", "other business costs" and "management expenses" and credits the subject of "remuneration payable to employees-remuneration payable to partnership (or individual) lawyers". When the firm actually pays the above-mentioned remuneration to partnership (or individual) lawyers, debit to the account "Compensation payable to employees-remuneration payable to partnership (or individual) lawyers" and credit to the account "Bank deposits. It follows that the various forms of remuneration paid by the law firm to the partnership lawyer, other than the distribution of profits, are expensed for accounting purposes and can be deducted when calculating the total profit.
The Notice of the State Administration of Taxation on Business Issues Related to the Collection of Individual Income Tax on Income Obtained by Practitioners of Law Firms (Guo Shui Fa [2000] No. 149) stipulates that the annual operating income of sole proprietorship and partnership law firms funded by lawyers shall be levied on the taxable items of "income from production and operation of individual industrial and commercial households" from January 1, 2000. In calculating the income from its operations, the wages and salaries of the contributing lawyer shall not be deducted. There are differences with the above accounting treatment and should be adjusted for tax purposes.
In my opinion, the Ministry of Finance, through Caiban 2021 No. 3, has recognized and stipulated that the partners (contributors) of law firms can obtain both profit distribution based on partnership operations and remuneration income through the provision of services (services) to law firms, and has strictly distinguished the fiscal and tax nature of the two types of income. Against this background and trend, the tax authorities continue to implement tax adjustment management on the remuneration paid to partners by law firms in accordance with the provisions of Guo Shui Fa [2000] No. 149, which is not appropriate in terms of economic substance, regulatory purposes, and policy timeliness. Details of the reasons, do not repeat here.
For the direct deduction of expenses without tickets when calculating the taxable income of partners of law firms, the Announcement of the State Administration of Taxation on Individual Income Tax Issues for Practitioners of Law Firms (Announcement of the State Administration of Taxation No. 53 of 2012) stipulates that partner lawyers shall deduct expenses in accordance with the Individual Income Tax Law and relevant provisions on the basis of legal and valid credentials when calculating taxable income. For expenses related to business that cannot be provided with legal and valid credentials, after being signed and confirmed by the parties concerned, the expenses can be deducted according to the following standards: 8% for the part of personal annual business income not exceeding 500000 yuan; The part of personal annual business income exceeding 500000 yuan to 1 million yuan shall be deducted by 6%. The part of personal annual business income exceeding 1 million yuan shall be deducted by 5%.
(VII) Full-time lawyers share income tax-related issues can be specifically considered.
The notice of the State Administration of Taxation on business issues related to the collection of individual income tax on the income obtained by employees of law firms (Guo Shui Fa [2000] No. 149) stipulates that the income paid by law firms to employees (including lawyers and administrative support personnel, but excluding investors of law firms, the same below) shall be subject to individual income tax according to the taxable items of "income from wages and salaries. Lawyers who are employees of law firms and law firms share their income according to the prescribed proportion. Law firms do not bear the expenses incurred by lawyers in handling cases (such as transportation, information, communication and personnel). After deducting the expenses incurred in handling cases according to the provisions of the second paragraph of this article, the balance is combined with the wages paid by law firms, and individual income tax is levied according to the taxable items of "income from wages and salaries. The standard for lawyers to deduct the expenses incurred in handling cases from their share of income shall be determined by the provincial tax bureaus within the proportion of 30% of the lawyer's share of income in the current month, based on the general situation of the expenses incurred by local lawyers in handling cases, the proportion of income sharing between lawyers and law firms and other relevant reference factors.
According to Article 49 of the Accounting Standards for Small Businesses, remuneration payable to employees refers to various forms of remuneration and other related expenses paid by small businesses to employees for services provided by employees. The calculation and withholding of personal income tax on employee compensation by a general enterprise usually does not involve a direct deduction of a certain percentage of expenses before tax. Therefore, law firms should combine their full-time lawyer's share of income in accordance with the provisions of Guo Shui Fa [2000] No. 149, and should pay attention to the upper limit of the deduction of this cost when accounting.
(VIII) The establishment of a career development fund is of great significance
Document No. 3 of 2021 of the Finance Office stipulates that the subject of "profits payable" shall be adjusted to the subject of "profits payable to partnership (or individual) lawyers" to account for the profits distributed by the firm to partnership (or individual) lawyers. A detailed account of "career development fund" is added under the account of "surplus reserve" to account for the career development fund drawn by the firm in accordance with relevant laws and regulations, cancel the "statutory surplus reserves" and "arbitrary surplus reserves" detailed accounts under the "surplus reserves" account.
According to this provision, the law firm may withdraw the career development fund in accordance with the law before distributing profits to the partnership (or individual) lawyers, and allow the law firm to retain undistributed profits. Therefore, the two subjects "Profits payable to partnership (individual) lawyers" and "Surplus-Business Development Fund", similar to the balance weights, play the role of law firms in regulating the accumulation or distribution of amounts, the applicable tax rate and the amount of tax payable. In fact, it also has the policy guidance and practical effect of encouraging law firms to focus on accumulation and become bigger and stronger.
3. Reflection and Suggestions
(I) Income and expenditure on public interest legal services shall be treated as collection and payment, not included in profit or loss, and shall not be tax-related.
Finance Office 2021 No. 3 stipulates that the collection of public welfare legal services is included in the main business income, and its expenses are included in the main business cost. Law firms usually settle all government-subsidized public interest legal service receipts to specific managers, with no profit and zero taxable income from income tax. However, if the fees for public welfare legal services are included in the main business income of the law firm, it will cause the law firm to generate value-added tax and cannot be deducted, which will only increase the tax burden. Incorporating the income and expenditure of public interest legal services into the income and cost profit and loss calculation of the law firm is inconsistent with the economic substance of the law firm's subject and business, on the grounds that:
1. The Lawyers Law stipulates that a law firm is an institutional organization for lawyers to practice, with the practice of lawyers as the core and foundation, rather than the operation of a law firm as the core and foundation, similar to a consortium of lawyers, the law does not include law firms As an enterprise, there is no need to register as an enterprise.
2. The enterprise is engaged in business on the basis of the resources owned by the enterprise, and the business funds received by the enterprise have business attributes and should be accounted for and taxed as income, so the public welfare subsidies received by the enterprise can be regarded as the business income of the enterprise. The law firm operates on the basis of the professional services of lawyers, and partners and lawyers pay taxes on their professional service income according to their tax-related status differences. When the handling lawyer obtains such income, he will also be liable for personal income tax.
3. The ultimate purpose of business and its economic essence is the pursuit of profit and return. In the case that the law firm transfers all the public interest legal service fees to the handling lawyer, the law firm has no legal form and economic substance to operate the fees. It is not appropriate to treat it as a law firm's income in accounting treatment and tax policy.
4. The public welfare legal service subsidies issued by the government are public welfare, non-operating, and non-profit. The use of such subsidies as operating income is contrary to the essence and purpose of public welfare legal service subsidies.
Therefore, it is more in line with the economic substance of such matters to treat the income and expenditure of public interest legal services as collection and payment. It is suggested that the accounting treatment of the business be adjusted to "when receiving subsidies for public welfare legal services, borrow: bank deposits, loans: other payables-payable public welfare legal services handling fees; when transferring to the handling lawyer, borrow: other payables-payable public welfare legal services handling fees, loans: bank deposits".
(II) Under the "Other Payables" account, a "Case Costs Payable" line item is set up to account for the transfer fees, litigation fees, arbitration fees, appraisal fees, assessment fees, inquiry and reproduction fees, etc. that should be borne by the customer.
The provisions of Caiban No. 3 of 2021 have provided for the addition of a detailed account of "advances on behalf of clients" under the account of "other receivables" to account for the fees paid by law firms for clients, such as transfer fees, litigation fees, arbitration fees, appraisal fees, assessment fees, inquiry and reproduction fees, etc. There is often a risk that such advances will not be recovered for a long period of time or will eventually not be recovered. In order to guard against operational risks, law firms usually receive such payments in advance and then make payments to clients during the service process, eventually refunding more or less. Therefore, the establishment of a detailed account of "case costs payable" under the "other payables" account to account for the aforementioned costs received in advance from clients is more conducive to risk prevention and clear accounting by law firms.
The author believes that according to the non-tax-related nature of such expenses, the tax-related essence or financial essence of such expenses collected in advance by law firms will not be changed even if they are not accounted for in the "case expenses payable" detailed account under the "other payables" account stipulated in the "other payables" account No. 3, 2021, and are added to the "temporary collection on behalf of customers" or similar accounts.
4. Epilogue
With the continuous improvement of China's economic strength and the deepening of the process of the rule of law, the market economy and the rule of law have formed a virtuous circle. Today, with the rapid development of the market economy, the demand for legal services is also increasing. As the main body of legal services, law firms should be bigger and stronger, and the perfection of their financial accounting system, the standardization of financial accounting treatment and the compliance of tax-related matters are becoming more and more important. The publication of document No. 3 of 2021 by the Finance Office aims to formulate accounting rules that are more in line with the actual situation of the lawyer industry, so as to standardize the fiscal and taxation management of law firms and improve the quality of their accounting information. it fully reflects the recognition of the social value and importance of the lawyer industry by the central finance and taxation administrative department, and shows the good will to promote the standardized, steady and better development of law firms.
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