A decision by Murcia Regional Economic Administrative Tribunal (TEAR) concluded that the capital gain obtained from collecting the legal costs received by the successful party in a lawsuit must be calculated by reducing the received indemnification by the fee expenses paid.

The settled administrative interpretation is that awarded legal costs are a capital gain for the beneficiary of those costs, which must be included in the general component of taxable income, because it does not hail from a transfer (and is taxed therefore at the marginal rate). The authorities themselves, however, consider that the court costs paid by the party receiving the legal costs are to be treated as consumption expenditure and therefore cannot be computed as a capital loss.

The Ombudsman’s Recommendation dated July 18, 2017 (complaint 16007256) had already flagged up the asymmetry arising in the personal taxation of the beneficiary on the legal costs according to this official interpretation. The Ombudsman remarked that the Supreme Court, in a judgment rendered on November 30, 2005, had held that the legal costs are really a repayment of the costs of the proceeding to the successful litigant, and therefore making the legal costs taxable without reducing them by the costs of the proceeding was tantamount to taxing an invented gain, which violates the constitutional principle of economic capacity.

As the Ombudsman mentioned, if the interpretation of the Directorate-General for Taxes (DGT) is upheld, the “principle of effective judicial protection could be affected”, because this scenario may have a bearing on a citizen’s decision to use the courts. He therefore recommended studying a change to the taxation of legal costs as a capital gain subject to personal income tax, to make taxable only the amount over and above the costs of the proceeding.

In the meanwhile there have already been administrative decisions finding in favor of more reasonable treatment, such as that mentioned by the Ombudsman. Among these, the decision by Murcia TEAR rendered on January 11, 2019, in which the tribunal concluded that:

  1. The legal costs received by the successful party in a lawsuit are aimed at indemnifying the party for the lawyer’s and court procedural representative's fees, which implies a capital gain has been obtained.
  2. That capital gain, however, must be calculated by reducing the received indemnification by the fee expenses paid.
  3. The resulting sum must be included in the general component of taxable income.