Contract penalties and fines: accounting and tax consequences

Penalties under the Civil Code

When claiming a penalty the creditor need not prove its losses, and if the debtor is not liable for the breach the creditor may not claim it (Art. 260). An agreement on a penalty must be in writing (Art. 262) — an oral agreement on a fine has no effect.

• A fine is a penalty, usually a fixed sum, for non-performance or improper performance (Art. 261).
• A daily penalty (penya) is charged for delay as a percentage of the unperformed part of the obligation for each day of delay.
• A statutory penalty is recoverable whether or not the contract provides for it; the parties may increase it unless the law prohibits this (Art. 263).
• Damages are recoverable to the extent not covered by the penalty, unless the law or contract provides otherwise (Art. 325).
• A court may reduce a penalty that is clearly disproportionate to the consequences of the breach (Art. 326).

When to recognise a penalty

A breach alone does not create income for the creditor: the debtor may dispute fault and a court may cut the amount. The Tax Code sets a clear point: aggregate income includes fines, penalties and other sanctions for breach of contract, and compensation for losses, that are acknowledged by the debtor or payable under a final court decision (item 17, part 3, Art. 297 of the Tax Code). It is convenient to use the same point for bookkeeping in the accounting policy.

Acknowledgement may be a signed reconciliation statement showing the penalty, a letter of consent, actual payment, or withholding the penalty from a payment by agreement of the parties.

Recipient: corporate income tax income

A penalty received (acknowledged) is the creditor's income subject to corporate income tax in the usual way. Aggregate income is determined excluding VAT and excise tax (Art. 297), so if a claim shows an amount including VAT, check whether there is any basis for it (see the VAT section).

Compensation for losses is income under the same item, so the split between penalty and damages does not affect the recipient's income tax.

Payer: the expense is not deductible

For the payer a penalty is an accounting expense, but not for corporate income tax: fines, penalties and other sanctions for breach of commercial contracts, paid or acknowledged, are expressly on the list of non-deductible expenses (item 36, Art. 317 of the Tax Code). The full list is covered in our article on non-deductible expenses.

Example: a supplier missed a shipment date and acknowledged a penalty of 0.1% per day for 20 days on a 50,000,000-soum contract — 1,000,000 soums. For the buyer this is income of 1,000,000 soums in the period of acknowledgement; for the supplier it is an accounting expense added back in the tax computation.

Separately: Article 310 includes penalties in controlled debt to foreign participants and their related parties — such transactions require a separate calculation of limits.

VAT: is a penalty taxable

The object of VAT is turnover from the sale of goods (services) and import of goods (Art. 238), and revenue for the tax base is taken from income received as payment for goods (services) (Art. 247). A penalty is a liability measure, not payment for goods delivered or services rendered, so by itself it is not part of the VAT base and no e-invoice is issued for it.

Risk arises when a fine is really part of the price: for example, a fee for the right to terminate early, a fixed surcharge for urgency, or a sanction calculated on delivery volume without any breach. The tax authority may treat such amounts as payment for a service — draft the contract so that the penalty is tied to an actual breach.

Penalties paid to a non-resident

If an Uzbek company pays a penalty to a foreign counterparty without a permanent establishment, the non-resident earns Uzbek-source income: fines, penalties and other payments for breach of contractual obligations are expressly listed in Article 351. The tax agent calculates and withholds the tax on each payment.

Such income falls under other income taxed at 20% (Art. 353), unless a double tax treaty provides otherwise. Applying a treaty requires a certificate of the recipient's residence. This is often forgotten when a penalty is withheld from payment under an import contract.