In accordance with tax laws, an advance payment received for services or supplies of goods carried out in the future does not constitute revenue for CIT purposes, but determines the moment when the VAT liability arises.
Payment towards future benefits (transactions) – when the tax obligation arises in CIT and VAT
The rules seem simple, but only in theory. In practice, not every payment made before the performance of the service constitutes an advance payment within the meaning of tax acts, and thus not every payment affects the moment when the tax consequences arise in CIT or VAT. The nomenclature does not determine the tax consequences of a particular payment. Therefore, each case should be analyzed individually to avoid business and tax problems. This may include among others:
- prepayments / advance payments / payments made on the basis of framework agreements for the provision of services or supplies of goods;
- deposits, fees paid to secure possible damages or arrears (e.g. in a lease agreement);
- tender deposit paid in the tender process;
- reservation fees (charged e.g. by real estate developers).
Advance payment and CIT – when tax revenue arises
In principle, the date of income from business activity is the date of delivery of the item (goods), sale of the property right, performance of the service or partial performance of the service, but no later than the date of:
- issuing an invoice,
- payment of receivables.
At the same time, the Corporate Income Tax Act (and, by analogy, the Personal Income Tax Act) explicitly indicates that revenues do not include “payments collected or receivables accounted for supplies of goods and services that will be performed in subsequent reporting periods”1. This means that the payment received before the performance of the service or the delivery of goods can be:
- tax revenue – but only if it is a non-refundable payment of receivables (resulting in a definitive payment for the recipient) for the performance of a specific service/supply to be performed (e.g. when buying tickets online for a concert, without the right to refund them)
or
- a tax-neutral event in CIT – if it is a prepayment (advance) for future services/supplies, i.e. a payment of a refundable (returnable) nature (such as, for example: a deposit/reservation fee/tender deposit) or made for services not yet defined (not specified in the order).
Advance payment and VAT – when to show the output tax (and deduct input tax)
As a rule, the VAT liability arises at the moment of delivery of goods or performance of services. However, if all or part of the payment (including prepayment, advance payment, deposit, instalment, etc.) was received prior to this event, the tax liability arises at the moment of receipt in respect of the amount received (with certain specific exceptions indicated in the Value Added Tax Act)2.
In principle, a prepayment or advance payment towards a future transaction (although neutral on the basis of CIT) determines the moment when the output VAT should be shown (in the part corresponding to the payment received). However, the practice of tax authorities and the case law of administrative courts show that the matter is not so obvious here either. They indicate that in order for a payment to be considered an advance payment recognised for VAT purposes:
- the payment must be made for a specific transaction, i.e. the future performance should be specified in terms of type in an unambiguous manner (the characteristics identifying the type of goods or services should be specified),
- the specification of the future performance (transaction) should be sufficiently precise to determine the rules of taxation of the supply, i.e. in particular, it should be possible to determine the place of supply and the tax rate,
- at the time of making the advance payment, the parties should not have any intention of changing the performance (transaction) in the future.
Therefore, if a taxpayer receives a payment from a contractor for future services or supplies of goods that can only be ordered in the future (e.g. from a wide range of available products), such a payment may not meet the above conditions at the time of its receipt. The decisive factor will be to what extent, and at what point, the purpose of the received payment is/becomes so precise that it can be linked to the performance of a specific type of service or good (depending on the case, it may be the date of receipt of the payment or, for example, the date of placing the order or making arrangements to credit the earlier payment towards a specific service).
Deposits of different nature – when no tax liability arises
Sometimes the payment is in the nature of collateral, e.g. for potential losses or the performance of a specific obligation. Such a payment can be tax-neutral.
However, it is possible and often used in practice that the status of this payment changes at a certain moment, after a specific condition is met, e.g. the payment of the deposit/reservation fee is credited towards the price for the delivery of the property (and only at that moment is considered an advance payment).
Rules for taxation of advances / early payments – summary
The nature of the payment received may have a real impact on when the entrepreneur should report the income in CIT and settle the output VAT. What is more, it is also possible that only after receiving the payment an event occurs that results in a change in its nature (affecting tax settlements).
Improper qualification of prepayment, on the other hand, may lead to:
- tax arrears with the supplier and be associated with the need for the supplier to incur additional costs, for example related to the payment of interest for late tax payment,
- negative effects also for the purchaser/person making the payment – his right to deduct input tax materializes only in the period in which the VAT liability actually arose on account of a given transaction with the seller (in his VAT settlements), so if it was determined incorrectly or prematurely, the buyer is not entitled to deduct such input VAT.
Therefore, it is necessary to analyze the conditions under which payments are made each time and take care of:
- their precise description in the contract/order (its nature, nature of payment),
- use of terms/nomenclature adequate to situations such as advance payment, reservation fee, deposit, tender deposit),
- regulating the issue of whether the status of this payment may change (when, under what circumstances),
- appropriate documentation.
If you need support in the above area – please contact us.
The law firm’s offer – support in preparation of VAT and CIT settlements
As part of our services, we offer:
- analysis of transactions already made, with recommendations as to the necessity and method of rectification of tax settlements,
- drafting contractual provisions setting out the rules for settling future transactions in a tax-safe manner (using adequate nomenclature, terms such as: advance payment, reservation fee, deposit, etc.).
Authors: Katarzyna Jaromińska / Agnieszka Czarnecka
1 Article 12(4)(1) of the Corporate Income Tax Act and Article 14(3)(1) of the Personal Income Tax Act.
2 Article 19a(8) of the Value Added Tax Act
