Taxation of contractual penalties and damages with value added tax

In the course of their business, entrepreneurs may receive contractual penalties and damages as a result of contracts signed with contractors. This happens when the other party to the contract does not comply with the arrangements provided for therein and is therefore obliged to pay a specific compensation or the so-called contractual penalty.

Are contractual penalties subject to VAT?

Pursuant to Art. 5 sec. 1 of the VAT Act, subject to tax on goods and services, hereinafter referred to as "tax":

• delivery of goods for consideration and provision of services for consideration within the territory of the country;
• export of goods;
• import of goods into the territory of the country;
• intra-Community acquisition of goods for consideration within the territory of the country;
• intra-Community supply of goods.

Within the meaning of the above Act, payment of compensation or contractual penalty is not a paid service or a paid delivery of goods. This is because this activity is not a benefit in return for which the provider would obtain some benefits. Thus, it should be stated that the payment of compensation or contractual penalty is not subject to VAT, which is confirmed, inter alia, by the interpretation of the Tax Chamber in Bydgoszcz of February 9, 2012, file ref. ITPP1 / 443-1593 / 11 / TS, which stated that:

“(...) a contractual penalty serving as a compensation (compensation) for the losses suffered is not included in the catalog of taxable activities listed in Art. 5 sec. 1 of the act on tax on goods and services and thus is not subject to taxation. "

Accordingly, since the payment of compensation and contractual penalty is not subject to VAT, such an event is not documented by an invoice. In such a situation, it is possible to issue e.g. an accounting note.