Compensation from a court settlement may be an expense

The case was analysed by Aleksandra Kodłubaj of Thedy & Partners and indicated that it concerned a company which, under a cooperation agreement, granted its counterparty, to whom it supplied goods, exclusive rights to sell the company’s products on selected markets. The counterparty was subsequently acquired by another entity, which was a direct competitor of the company. In view of the above, the company concluded that continuing the contract would mean supporting a competitor, so it ceased to perform the contract and sought to terminate it. Eventually, the parties entered into a settlement agreement, under which the company undertook to pay compensation to the counterparty and, at the same time, was given the opportunity to sell its products in markets that had previously been contractually reserved for the counterparty.
In the opinion of the Director of KIS, the payment of damages to the counterparty was a consequence of the company’s recognition of the claim of the dissatisfied counterparty, i.e. in essence, it constituted a confirmation that the company had improperly performed its contractual obligations. At the same time, the faulty performance of the contract determines the impossibility of recognising the expense incurred on this account as a tax deductible cost.
The WSA in Poznań disagreed with the NSA, holding that in this case there could be no question of defective goods or works or services. This position was upheld by the NSA, pointing out that if it had not been for the settlement, which the company concluded and on the basis of which it paid the disputed amount, the company would not have been able to introduce its products on markets hitherto reserved for the contractor, as well as support the activities of its competitors. In the court’s view, the authority misinterpreted the concept of ‘defectiveness’ by applying an expansive interpretation of Article 16(1)(22) of the CIT Act. The NSA also drew attention to the changing circumstances in connection with the acquisition of the company’s counterparty by a competitor. According to the court, in these circumstances, the conclusion of the settlement was aimed at securing (preserving) the source of revenue.
The NSA’s judgment is very important, as it confirms that tax authorities may not apply an excessively broad understanding of damages excludable from tax costs. Nevertheless, it should be noted that in order to recognise as a tax deductible cost the amount established as a result of a settlement, the basis is not the mere fact of concluding a settlement between the parties, but the purpose of this settlement and the conditions accompanying it, concludes Aleksandra Kodłubaj of Thedy & Partners.