Disputes between entrepreneurs are common in business activities. Some of them end at the pre-trial stage, e.g. by concluding a settlement. What are the consequences of concluding such a settlement in terms of income taxes? Let us consider it on the example of a settlement in which the entrepreneur infringing someone else’s copyright undertakes to pay the agreed amount to the beneficiary, and the latter waives his claims in return.
In the case of CIT taxpayers, the amount obtained will constitute taxable income.
The same situation occurs in case of PIT taxpayers, however, it will additionally have to be assessed whether the income received in connection with the settlement will be related to the economic activity of the entitled or not.
In a situation in which he is related to one’s activity, then there will be no obligation to collect the tax by the payer, or to prepare PIT-11 information. The entitled person will be obliged to independently settle the income (from this source – Article 14 of the PIT Act).
In a situation where it is not related to this activity, I believe that there will be income from the so-called other sources (Article 10 sec. 1 point 9 in conjunction with Article 20 sec. 1 of the PIT Act). It is worth pointing out that the tax authorities accept this approach (e.g. the Director of the National Tax Information in the individual tax ruling of December 13, 2017, ref. 0114-KDIP3-3.4011.475.2017.2.JK3), in particular the claims arose under the Copyright Law (such as the Director of the Tax Chamber in Bydgoszcz in the individual ruling of April 14, 2015, reference number ITPB1/4511-40/15/KW).
Hence, the paying entity should prepare and submit PIT-11 to the competent tax authority (Article 42a sec. 1 in conjunction with Article 20 sec. 1 of the PIT Act).
As the settlement is concluded at the pre-trial stage, I believe that the PIT exemption regulated in Art. 21 sec. 1 point 3 lit. g) the PIT Act will not apply.
In case of CIT taxpayers, pursuant to art. 15 sec. 1 of the CIT Act, tax deductible costs are the costs incurred in order to achieve income or to maintain or secure the source of income, with the exception of the costs listed in art. 16 sec. 1 of the CIT Act.
In art. 16 sec. 1 point 22 of the CIT Act, the legislator indicated certain categories of damages and contractual penalties which, even if the general conditions for tax costs are met, cannot be charged to the tax result. The exclusion referred to above applies to contractual penalties and damages for:
- defects of delivered goods, works and services performed;
- delay in delivering defect-free goods, or
- delay in removing defects in goods or performed works and services.
The above provision does not exclude contractual penalties and damages paid for other reasons than those indicated above from tax deductible costs.
This means that the paid contractual penalties or damages resulting from other titles listed in Art. 16 sec. 1 point 22 of the CIT Act, may constitute a tax deductible cost, as long as they meet the conditions under Art. 15 of the CIT Act.
Similar conclusions result from the PIT Act.
The classification of such expenses as tax costs is one of the “sensitive” tax issues. The tax authorities often argue that the taxpayer acts negligently here, so he should not burden the state budget with the consequences of his actions.
However, I believe that there are arguments in favor of including the expense as tax costs – especially if the violation was not due to culpability, especially gross fault. In particular, the purpose of the settlement is to remove the uncertainty as to the legal status of the other party’s claims, and the waiver of claims – from a business point of view – may also validate the past use of the rights of the rightsholder. At the same time, failure to reach a settlement could result in a lawsuit that could generate costs higher than those resulting from the settlement. A similar argumentation was accepted as correct in the individual interpretation of August 31, 2021, ref. No. 0111-KDIB2-1.4010.138.2021.MK. Therefore, it is important to highlight these circumstances in potential settlement documents.