Compensation for Contract Violations: Is It Subject to CIT?

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Our party produces and exports goods for another Export Processing Enterprise (EPE) in Vietnam based on a monthly contract whereby the other enterprise sends a purchase order for us to supply goods in a specific quantity. In June 2019, the customer suddenly stopped placing orders, ceasing orders entirely. All raw materials had been ordered, with a portion of goods in production and another portion of finished products already produced. Currently, in August 2020, the customer has compensated us due to the breach of the ordering obligation under the contract, and both parties have made a compensation agreement. I would like to inquire: is the compensation amount received by us subject to Corporate Income Tax (CIT)?

According to the provisions in Clause 13, Article 7 of Circular 78/2014/TT-BTC:

"In case an enterprise receives fines, compensation payments due to the partner's breach of contract, or bonuses for good performance of the commitment under the contract that exceed the expenses for fines, compensation payments due to breach of contract (these fines do not include administrative penalties according to the regulations of the law on handling administrative violations), after offsetting, the remaining difference is included in other income.

In case an enterprise receives fines, compensation payments due to the partner's breach of contract, or bonuses for good performance of the commitment under the contract that are lower than the expenses for fines, compensation payments due to breach of contract (these fines do not include administrative penalties according to the regulations of the law on handling administrative violations), after offsetting, the remaining difference is deducted from other income. If the unit does not generate other income within the year, it is deducted from the production and business income.

The aforementioned fines and compensation payments do not include fines and compensation payments recorded as reductions in the value of construction projects during the investment phase."

Accordingly, if the compensation income exceeds the expenses (damage costs), the difference will be subject to Corporate Income Tax and vice versa.

Respectfully!

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