Contractual penalty for delay in project implementation and tax costs

Service-Tax

Running a business involves certain risks. The entrepreneur must take into account the possibility of incurring various contractual penalties related to improper performance of concluded contracts. These penalties result, inter alia, from errors of subcontractors, delays in deliveries, disputes with contractors. How should the fines paid be accounted for in such a situation? Pursuant to the Act on Personal Income Tax, contractual penalties are in some cases classified as tax deductible costs. Here is an explanation.

Pursuant to Art. 23 sec. 1 point 19 of the PIT Act, contractual penalties and compensation for defects in goods delivered, works and services performed, as well as delays in the delivery of goods free of defects or delay in the removal of defects in goods or performed works and services are not considered as tax deductible costs.

Thus, contractual penalties related to other events, such as a project delay, were not excluded from the tax deductible costs category. To include the expenditure on the contractual penalty as costs:

  • it must have a direct causal link with the income obtained,
  • the entrepreneur should prove that he could not avoid incurring the costs of the contractual penalty due to reasons beyond his control.

The reasons beyond the entrepreneur's control include errors of the subcontractor, natural disasters, delays in the delivery of goods, disputes with contractors. Contractual penalties resulting from the above-mentioned reasons are included in tax deductible costs and are included in column 13 of the KPiR - Other expenses.

There are also situations when as a result of economic changes, e.g. inflation, the started investment becomes unprofitable. Then the entrepreneur, after conducting an appropriate profitability analysis and determining all possible pros and cons, may conclude that it is more advantageous for him to withdraw from the contract. Then the taxpayer voluntarily submits to a specific penalty, the amount of which results directly from the contract concluded with the contractor. In order to do so, the taxpayer must, however, have appropriate documentation presenting a summary of possible benefits and losses. From the comparison of both solutions (completion of the investment and termination of the contract), it should be clear that it is more profitable for the taxpayer to terminate the contract and pay the penalty. In such a situation, the expenses incurred in this respect can also be counted towards tax deductible costs.

It should be noted, however, that not all contractual penalties constitute tax deductible costs. First of all, the taxpayer will not include penalties resulting from the delay for which he himself is responsible as tax deductible costs. It is about delays resulting from his own carelessness or carelessness, due to which the project / contract could not be implemented within the specified period. Then the penalty cannot be considered as a tax deductible cost.

Including contractual penalties as tax deductible costs is a controversial issue due to the nature of failure to meet the contract and the liability incurred on this account. Therefore, the taxpayer must have appropriate documentation in order to be able to count the received penalties as tax deductible costs. The purpose of this documentation is to confirm the correctness of the adopted method of operation and the proper recognition of the received contractual penalties.