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Contractual penalties as an allowable expense |
Source: Tax newsletter - March 2007, Strategia Horwath Sp. z o.o.
By article 16 section 1 item 22 of the Legal Persons Income Tax Act,
contractual penalties are not considered a cost of earning revenue when
they relate to:
- a defect in goods delivered or works and services performed,
- a delay in the delivery of goods not affected by a defect,
- a delay in the rectification of defective goods or a delay in the rectification of improperly performed works and services.
The effect of this provision is to allow contractual penalties to be
included in the cost of earning revenue when they concern a delay
caused by late performance of services or when they concern late
delivery of goods.
The Finance Ministry takes this position in a statement dated 5 May
1997 (no. PO3-MD- 722-114/97) and in statements by tax offices.
The requirement a company pay a contractual penalty is directly related
to its earning revenue as part of its business. Therefore a
contractual penalty for late performance of a service, when paid, will
be a cost of earning revenue. Although the contractual penalty is a
result of improper (i.e. late) performance of an obligation, in this
case the service itself cannoot be considered defective (see the
Kolbuszowa tax office’s statement dated 16 September 2005 no.
USI-1.1.423/2/2005 and others).
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Therefore, if it can be proved that a contractual penalty was paid in
order to earn revenue, unless it is affected by the exclusion
in article 16 section 1 item 22 of the Corporate Income Tax Act, there
is no bar to including it in the cost of earning revenue. It is only
necessary for there to be a legal (i.e. contractual) basis for payment
of the penalty.
Below we present the Supreme Administrative Court’s position on the subject of including in the cost of earning revenue contractual penalties for departing from an agreement.
In a judgment dated 12 March 1999 (case no. I SA/Po 1362/98) the Court
stated that costs of earning revenue are costs incurred in order to
gain revenue, that departing from an agreement is not aimed at gaining
revenue, and that the tax authorities were thus correct to insist that
contractual penalties be excluded from the cost of earning revenue.
Similarly, in a judgment dated 13 December 1999 (case no. SA/Łd
2683/95) in a case concerning the classification of expenses intended
to avoid or reduce future losses, the Supreme Administrative Court
stated that a contractual penalty could not be a tax-allowable expense
if it was incurred by repudiating a contract with the intention of
avoiding financial losses that would likely be
incurred if the contract were performed. |
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