tax advisor, Junior Tax Manager at RSM Poland
Our clients have been recently asking more and more questions about VAT treatment of notices to pay penalty fees and contractual interests for failure to perform provisions of an agreement. Such notices may occur, for instance, when it is necessary to inform counterparties on payment delays. A party who issues a notice, not only charge fees on its issuance, but also settle the tax due for this issuance, including the amount of tax on the invoice. Is this the right thing to do? Since I look at such situations more and more often, I would like to explain in brief how notices to pay shall be settled in respect of VAT.
We can imagine the issuing party saying: but what’s the matter? I conduct business activities, which is subject to VAT, so why shouldn’t I tax my counterparty on such occasion? Isn’t the issuance of a demand for payment to my counterparty, who, for example, has leased a car from me, related to my business activity (for which I need to pay taxes!)?
The thing is that, even though such activities are related to business conduct, they are not subject to tax with respect to VAT unless they meet the definition of a taxable activity – which most often means supply of goods or provision of services. And that is where the shoe pinches… The reminder itself (requesting payment or monitoring it) cannot be treated as provision of services and neither, even more obviously, can be recognized as supply of goods.
To talk about service, there has to be some kind of equivalence of benefits, in other words, a measurable financial advantage for both parties. A company provides car lease whereas its client pays the company for this service. I keep my clients’ tax books and the clients pay me remuneration in return. As a general rule, the mentioned activities are, for tax purposes, considered services provided to the other party because they bring a direct and measurable benefit to this party.
As for the notice or request for payment, talking about service provision is out of question. Although paying for the issuance of notices to pay usually stems from an agreement, such payments are not in any way related to the service of providing access to the leased car (coming back to the example of a car lessor) but to the failure to comply with contractual obligations. The payment for issuing the notice is more a compensation for the delayed payment or for possible losses resulting from the delay. In this situation, there is no service provision, and therefore, no VAT obligation arises. Any kind of compensation claims, penal interests or contractual penalties shall be approached in the similar manner.
This approach is so important due to the fact that, under Article 88 item 3a point 2 of the VAT Act, one cannot deduct input tax from invoices covering non-taxable activities.
If it is so, the arising question is how to settle such non-taxable activities? The best thing to do would be to issue an accounting note for the issuance of a notice to pay. What is more, neither should this activity be recorded in VAT registers nor in VAT returns.