Advance payment in the preliminary contract - tax consequences

Service-Tax

It very often happens that before concluding a proper sales contract, the parties decide to sign a preliminary contract. One of the provisions of such an agreement may be the provision of an advance payment towards the future purchase price. Therefore, the question arises as to how the advance payment in the preliminary agreement affects the tax settlement method from the perspective of the entity receiving the advance payment.

Preliminary agreement

First, we need to explain what the essence of concluding this type of agreement is. For this purpose, refer to the provisions of the Civil Code. Pursuant to Art. 389 of the Civil Code, the contract by which one of the parties or both undertake to conclude a marked contract (preliminary contract) should specify the essential provisions of the final contract. In addition, in the content of such an agreement, the parties may reserve an advance payment, with the proviso that the rest of the agreed final amount will be transferred to the seller upon conclusion of the promised agreement.

For comparative purposes, let us then analyze the provisions that constitute a proper sales contract.

Pursuant to Art. 155 § 1 of the Civil Code, the contract of sale, exchange, donation, transfer of real estate or other agreement obliging to transfer the ownership of the thing, as to the marked identity, transfers the ownership to the buyer, unless a special provision provides otherwise or the parties have agreed otherwise.

In the light of the above, let's consider what are the differences between a preliminary contract and a sales contract. Well, the mere conclusion of the preliminary contract does not transfer the ownership of the real estate, as it is only a binding contract. Only the actual contract of sale has the dispositional effect in the form of the transfer of ownership of the real estate to the buyer.

As a consequence, the preliminary contract itself is the obligation of the parties to conclude a proper sales contract in the future. Such an agreement does not necessarily come into effect, which means that it is not final. In order to achieve the ultimate goal of transferring ownership of the property, it is necessary to conclude a contract of sale. The legal effect in the form of the transfer of real estate ownership results in the conclusion of a proper sale contract. The preliminary contract is only an obligation of the parties to sign a sales contract in the future, which may additionally be accompanied by an advance payment towards the selling price.

Preliminary agreement on the basis of PIT tax

The fact that the preliminary agreement is not definitive causes certain effects in terms of income tax. Well, as we can read in Art. 14 sec. 3 point 1 of the PIT Act, revenues from non-agricultural business activities do not include collected payments or booked receivables for the supply of goods and services that will be performed in the following reporting periods. The term "collected payments" includes, inter alia, an advance payment in the preliminary contract.

As a result, the advance payment in the preliminary contract for the future sale of real estate does not have the effect of generating taxable income. Such income arises on the general principles set out in Art. 14 sec. 1c above. of the Act, i.e. the date of delivery of the item, sale of property rights, performance of a service or partial performance of a service, no later than the day:

  • issuing an invoice or
  • payment of receivables.


Example 1.

In March, a taxpayer running a business signed a preliminary real estate sale agreement and received an advance payment of PLN 50,000 towards the price. The actual sale agreement was signed in June for the final price of PLN 200,000. In such circumstances, the taxpayer should recognize tax income in June in the amount of PLN 200,000. In terms of income tax, the advance payment received under the preliminary agreement does not generate tax revenue. Such income does not arise until the final sale is made.

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Advance payment in the preliminary contract on the basis of VAT

It is still appropriate to carry out an analysis of the effects of the preliminary contract in the field of value added tax. Importantly, unlike PIT, the receipt of an advance payment will have specific tax consequences.

According to Art. 19a paragraph. 8 of the VAT Act, if before the delivery of the goods or the performance of the service, all or part of the payment was received, in particular: prepayment, advance payment, advance payment, installment, construction or housing contribution before the establishment of a cooperative right to a dwelling or premises for another purpose, the tax obligation arises from upon its receipt in relation to the amount received.

The above provision results in the fact that due to the receipt by the seller of the advance payment under the preliminary contract, a tax obligation arises on his part under VAT. This results in the necessity to issue a VAT invoice documenting the receipt of the advance payment, as well as the necessity to pay the output tax. At this point, it is worth emphasizing that the VAT rate in this case will depend on the rate that will be applied to the main sale.If the sale of real estate will benefit from VAT exemption, the advance invoice will also be issued with the ZW rate.

So how do you document the final delivery of goods under a sales contract? The answer to this question is given in Art. 106f paragraph. 3 of the VAT Act, in which we can read that if the advance invoice does not cover the entire payment, in the invoice issued after the goods or services are delivered, the sum of the value of the goods or services is reduced by the value of the received parts of the payment, and the tax amount is reduced by the sum of the tax amounts shown in invoices documenting the receipt of part of the payment. The invoice referred to in the first sentence should also contain the numbers of invoices issued before the goods are delivered or the service is provided.

Example 2.

In March, a taxpayer running a business signed a preliminary real estate sale agreement and received an advance payment of PLN 50,000 towards the price. The actual sale agreement was signed in June for the final price of PLN 200,000. The sale of real estate will be subject to 8% VAT.

In such circumstances, the taxpayer should, in March, issue an invoice for the receipt of the advance payment at the rate of 8% VAT. Then, in June, he should issue a final invoice reduced by the value of the advance payment. Taxpayers must remember that in terms of VAT, the fact of receiving an advance payment under the preliminary contract causes the need to issue an invoice on this account and pay the tax due. Summarizing the above article, it should be clearly emphasized that the advance payment in the preliminary contract causes various tax consequences when it comes to income tax and value added tax. On the basis of the former, this activity is tax-neutral and does not generate income from economic activity. The issue of VAT is completely different, where the receipt of an advance payment results in a tax obligation. In this case, the tax rate applied to the down payment is the same as the one that will apply to the final ownership transfer agreement.