Not every compensation will be a cost
Not every amount of compensation paid by an entrepreneur will be allowed as a tax deductible cost. The CIT Act defines exceptions in this respect.
When conducting business activity, payment of damages is a fairly common practice. Cases of payment of this type of compensation in connection with improper performance of a contract are becoming more and more frequent. Therefore, a doubt arises here as to whether such compensation, also paid as a result of concluding a court settlement, may be recognised as costs.
– When analysing this issue, one must look at Article 16 Section 1 Point 22 of the CIT Act. It explicitly excludes from tax costs all contractual penalties and compensations paid for defects of delivered goods, performed works and services as well as for delay in delivery of goods free of defects or delay in removal of defects of goods or performed works and services. According to the tax authorities this regardless of whether the liability of the debtor which is expressed by the payment of the contractual penalty/compensation, was based on the principle of fault or on the principle of risk – reminds Łukasz Kupryjańczyk, tax adviser, partner at Thedy & Partners.
This means that in order to exclude the possibility to treat as tax deductible costs the expenses for damages and contractual penalties for improper performance of an agreement, the reason for improper performance of the agreement is not important. A sufficient prerequisite is the existence of liability of the obligor for improper performance of the agreement, which may arise from the law or from the bond relationship between the parties. Payment of a contractual penalty or compensation to the contractor is the effect of the existence of such liability.
A similar standpoint is presented by the tax authorities, e.g. in the individual interpretation no. 0111-KDIB2-1.4010.4.2022.1.AT.