Penalty for withdrawing from the contract at the tax cost

Service-Tax

Running your own business involves entering into many transactions, sometimes additionally documented by agreements or contracts. In a situation where one of the parties decides to withdraw, they must take into account any consequences resulting from the content of the concluded contract, such as a penalty for failure to comply with the terms of the contract.

When can punishment be a cost?

As is clear from the content of Art. 22 sec. 1 of the Personal Income Tax Act, any expenses that are not listed in the catalog of non-tax costs (so-called NKUP) may be a tax deductible cost and serve:

  • achieving revenues,

  • maintaining the source of income,

  • securing the source of income.

As it results from the above regulations, the expenditure must be 100% related to the conducted business activity and demonstrate the economic justification for incurring it.

When can punishment not be a cost?

The Income Tax Act explicitly specifies situations in which the taxpayer cannot qualify for the costs of imposed penalties. First of all, it is necessary to refer to Article 23 par. 1 point 19 of the act. According to its content, contractual penalties and damages for:

  • defects of the delivered goods, works and services performed and

  • delay in delivering goods free from defects or

  • delay in removing defects in goods or performed works and services.

If the penalty applies to one of the above situations, it cannot be classified by the taxpayer as tax deductible costs.

Sometimes an important economic reasonableness of the cost

In strictly defined situations, the entrepreneur may include in the costs the penalties imposed for withdrawal from the previously concluded contract, provided that it is related to the business conducted by the taxpayer. In addition, the withdrawal from the contract itself must contribute to the achievement, security or preservation of income - then the cost will be considered rational and economically justified.

Such a position was presented, among others, by Director of the Tax Chamber in Warsaw in the individual interpretation with reference number IPPB1 / 415-873 / 12-2 / AM of October 11, 2012, in which it explains that:

"When referring to the possibility of including compensation for withdrawal from the contract as tax deductible costs, it should be noted that penalties for failure to perform the contract (withdrawal from the contract) in most cases are not classified as tax deductible costs due to the lack of a prerequisite for acting in order to achieve income ( Article 22 (1) of the Personal Income Tax Act). The exception is when the taxpayer proves that it was beneficial to withdraw from the contract and pay compensation, and then conclude a more profitable contract in order to achieve higher revenues or to preserve or secure the source of income. "