Contractual penalties and tax deductible costs

Service-Tax

Contractual penalties often apply to contracts concluded by entrepreneurs as part of their business activities. Therefore, can the payment of such a fee be classified as tax deductible costs, and thus - reduce the tax base?

As a rule, if contractual penalties apply to contracts concluded within the enterprise, it is considered that it affects the acquisition of income or secures or maintains the source of this income. However, according to Art. 23 sec. 1 point 19 of the PIT Act, there is a certain range of contractual penalties that cannot become at the company's expense. These include penalties imposed for:

  • defects of the delivered goods,
  • defects of works and services performed,
  • delay in delivering goods free from defects,
  • delay in action to remove a defect in the goods,
  • delays in removing the works or services performed.

As you can see, penalties incurred due to defects in goods or services cannot be tax-deductible. In addition, the cost will not be a penalty due to another title, but resulting from negligence, breaking the law, etc.

However, if the contractor's misconduct relates to something other than a defect in the goods or service, the penalty may be included in the costs. An example is failure to deliver defect-free goods on time, if the taxpayer proves that he made every effort to ensure that the delivery was completed on time. Another situation concerns, for example, breaking the contract with the contractor, if it turns out that the payment of the penalty will be more profitable than the continuation of the contract. In such a situation, the payment of the penalty is treated as economically justified, however, there are divided opinions among the tax authorities on this issue.

If the taxpayer decides that the penalty paid by him may constitute a tax deductible cost, he should account for it as an expense on the date it was incurred, i.e. the date the payment was made.