I. Assessment Collection Necessitates a Sound Accounting System

      At present, law firms in China are composed of three types: partnership law firms, individual law firms, and state-funded law firms. The taxation of law firms (excluding state-owned firms unless otherwise specified) is determined by the organizational form they adopt. At the legal level, law firms are non-legal professional institutions, not enterprises; however, in terms of tax identity, law firms follow the tax system of related enterprises and implement the tax policies for partnership enterprises and sole proprietorship enterprises according to different organizational forms.

      After law firms began collecting individual income tax in accordance with partnership enterprises and sole proprietorship enterprises in 2000, although the State Administration of Taxation once emphasized that assessment collection should be implemented for law firms that meet the conditions, they generally experienced a ten-year period of assessed taxation until 2010 when the State Administration of Taxation clarified that individual income tax should not be assessed and collected from intermediary institutions such as law firms, and the method of assessed collection in the legal profession was finally put on the brakes.

      In fact, for enterprises that collect individual income tax, assessment collection is also an abnormal tax collection and management method. On the one hand, Tax laws and regulations clearly stipulate that assessment collection is only applicable when it is impossible to conduct assessment collection under special conditions. The Notice of the Ministry of Finance and the State Administration of Taxation on the Collection of Individual Income Tax on Investors of Sole Proprietorship Enterprises and Partnership Enterprises (Cai Shui [2000] No. 91) lists the circumstances under which assessment collection is adopted, including: failing to set up account books as required by relevant national regulations; although account books are set up, the accounts are chaotic or the cost data, income vouchers, and expense vouchers are incomplete, making it difficult to conduct assessment; taxpayers who have tax obligations fail to file tax returns within the prescribed time limit, and fail to do so after being ordered by the tax authorities to file within a time limit. On the other hand, The conditions for assessment collection in tax law are also inconsistent with the management regulations of law firms. Article 23 of the Lawyers Law of the People's Republic of China stipulates that law firms shall establish and improve systems such as fee collection and financial management. Article 47, Paragraph 2 of the Measures for the Management of Law Firms (promulgated by Order No. 142 of the Ministry of Justice) also emphasizes that law firms shall establish and improve financial management systems in accordance with regulations, and establish and implement reasonable distribution systems and incentive mechanisms.

      At present, except for Hainan's authorization according to the regulations of the special zone, it is difficult to find room for assessing and collecting taxes for law firms at the policy level. To achieve assessment collection in the entire industry, there must be a supporting accounting system. The Ministry of Finance formulated the Accounting Calculation Methods for Accounting Firms, Asset Appraisal Agencies, and Tax Firms (Cai Kuai [2001] No. 61) in 2001, stipulating that law firms can refer to it for implementation. After referring to other intermediary institutions for 20 years, in September 2021, the Ministry of Finance issued the Accounting Treatment Regulations for Law Firm Related Businesses (Cai Kuai [2021] No. 22) (hereinafter referred to as the "New Regulations"), which finally has a special accounting method for law firms, a special organizational form.

        II. Main New Contents of Accounting Treatment for Legal Services

      In view of the industry characteristics of law firms, the "New Regulations" stipulate the accounting subjects that should be added or adjusted on the basis of the Accounting Standards for Small Enterprises, and explain the main accounting treatment of the relevant subjects. The main changes are as follows:

       First, In response to the characteristics of legal services, add the "Business Collaboration Funds" detailed subject under the "Other Payables" subject, add the "Business Collaboration Funds", "Special Supervision Funds", and "Temporary Receipts on Behalf of Clients" detailed subjects under the "Other Payables" subject, and clarify that advance payments, business collaboration funds, special supervision funds, and temporary receipts on behalf of clients are not included in the law firm's profit and loss tax reconciliation. Second, Add the "Public Interest Legal Service Income" and "Public Interest Legal Service Cost" detailed subjects under the "Main Business Income" and "Main Business Cost" subjects respectively, and add the "Public Interest Legal Service Case Handling Funds" detailed subject under the "Accounts Payable" subject to more clearly account for the tax-free income and related expenses of public interest legal services. Third, Add the "Payable Partner (or Individual) Lawyer Remuneration" detailed subject under the "Payable Employee Compensation" subject, which helps to determine the social security base and tax adjustment for partners. Fourth, According to the requirements of the joint liability risk borne by law firms and the establishment of a practice risk fund by departmental regulations, add the "Practice Risk Fund" subject and increase the "Practice Liability Insurance Premium" detailed subject under the "Management Fees" subject to enhance the ability to cope with practice risks. Fifth, Add the "Business Development Fund" detailed subject under the "Surplus Reserve" subject to account for the business development fund extracted by the firm according to the agreement of the partners, which is used for the development and expansion of the law firm.

       III. Suggestions on Strengthening the Standardized Construction of Law Firms from the Perspective of Finance and Taxation

       1. The premise of doing a good job in accounting is to clarify the essence of economic business.

      In the process of providing legal services, lawyers often pay various advance payments such as litigation fees and appraisal fees on behalf of clients, keep various special funds such as execution refunds and performance bonds on behalf of clients, and temporarily collect various temporary receipts such as compensation from the other party on behalf of clients. These funds do not belong to the business income of the law firm. If the law firm fails to account for them separately, they will be regarded as extra-price expenses for tax purposes and will be included in the scope of income to pay value-added tax and surcharges, and individual income tax. Therefore, law firms should have a "one-game-of-chess" concept. On the one hand, they should guide financial personnel to make full use of the accounting detailed subjects added by the "New Regulations" to do a good job in classification accounting. More importantly, they should strengthen business management and avoid the contract content involving such expenses from reflecting the economic attributes of the expenses through measures such as reminding lawyers to pay attention or strictly approving contracts, resulting in tax-related risks or paying more unjust taxes due to inaccurate accounting.

       2. Distinguish between the different financial and tax treatments of business collaboration and business outsourcing.

In certain situations, law firms may collaborate with other law firms or professional entities/individuals to undertake specific business. In this case, there are two forms of cooperation. One is the business collaboration model, where the client purchases services separately from each entity/individual, and the law firm only collects the payments on behalf of everyone. At this time, when the law firm receives the full payment from the client, it recognizes the portion belonging to it as lawyer fees, recognizes revenue and issues an invoice, and includes the other amounts in the "Business Collaboration Funds" account and issues a receipt. The amount included in the "Business Collaboration Funds" account does not need to be declared for tax purposes and is declared and taxed by the entity or individual that ultimately obtains the funds and actually provides the service. After the business collaboration funds are transferred to other entities or individuals, the entry is made based on the transfer bank transfer record and receipt. The other model is business outsourcing, where the client only purchases the services of the law firm, and the law firm purchases services from other professional entities or individuals in its own name. At this time, all fees obtained by the law firm should be recognized as revenue and an invoice should be issued. When the law firm pays other entities or individuals, the amount of the expenditure should be included in the "Main Business Costs" and an invoice should be obtained for the entry. The above two models have different tax burdens due to the differences in the VAT taxpayer status of the law firm and the collaborating unit and the applicable small and micro enterprise income tax policies, but the "Business Collaboration Funds" account cannot be abused in order to reduce the tax burden. The key to determining the business model lies in the agreement in the contract, that is, determining who the counterparty to the client's service purchase transaction is and the legal relationship between the client and each party.

      3. Correctly apply the special deduction policy for lawyer business handling fees.

This "Regulation" separates the "Public Interest Legal Service Handling Fees" detailed account from the normal lawyer business handling fees for accounting purposes. On the one hand, it is convenient to collect the cost expenses corresponding to the tax-free income, and on the other hand, it also involves the non-partner lawyer handling fee deduction policy. This policy once increased the standard for deducting handling fees to 35%, and after the policy expired on December 31, 2015, it returned to the 30% ratio. In addition to clearly requiring that non-partner lawyers' handling fees that are subject to the income sharing method shall not be listed repeatedly in the law firm, attention should be paid to several issues from the perspective of standardized operation. First, The employment contract between the non-partner lawyer and the law firm shall stipulate that "the law firm shall not bear the expenses incurred by the lawyer in handling the case". If it is agreed that the law firm shall bear the expenses, the policy cannot be applied. For example, lawyers who choose to reimburse the handling fees based on actual expenses and lawyers who adopt a salary system and do not bear the handling fees cannot deduct the handling fees. Second, The legal service contract signed with the client shall not simply stipulate that all handling fees shall be borne by the client, otherwise there is a tax risk in applying this policy, but it shall be agreed that: in addition to the lawyer service fee, the fees paid by the client on behalf of the client and the travel expenses for handling cases in other places shall be borne by the client, and other handling fees shall be borne by the handling lawyer; Third, The law firm shall perform the necessary formal review procedures for the handling fee expenses of lawyers who apply this policy, so as to avoid the responsibility of the withholding agent for untrue declaration. For example, the lawyer shall fill in the specific amount of handling fees in writing and make a written commitment that the declaration is true and that he/she is willing to bear the relevant legal responsibilities. Fourth, It is possible to decide whether to stipulate all the remuneration of qualified lawyers as case-handling income as much as possible to increase the deduction base after necessary measurement based on the actual situation of the law firm, but it should be noted that the non-case-handling income obtained by the lawyer shall not be included in the base, and the lawyer's total income shall not be used as the base for calculating the deduction in general.